Coronavirus, Market Expectations, and the Fed

In the last half of 2018 (with a economic model driven Fed funds rate hike in December in which the Fed message was interpreted as rates will continue to rise) and the data driven Fed holding pattern through 2019 until August, September, and October Fed funds rate cuts of 25 basis points each month from 2.5% to 1.75% in order to tame and prevent inflation as the result of the Trade War economic disruption, the market expectations and self-serving political pressure were never completely satisfied, economic data realistic, or rationally predictive.  The market is irrational and reactive to human behavior much like an infant's terrible twos.

By Friday, February 28, 2020, we had seven consecutive down market days and the market had fallen into correction territory with an approximately cumulative 11.5% drop as the global economic impact of the coronavirus infection starting to sink in and the fears of a potential global pandemic.  As of Wednesday morning, the 26th, economists could see no data reason for the Fed to act.  By the morning of Thursday the 27th, economists were acknowledging the short run economic impact of the coronavirus infection but stating the obvious reality that the data was not present to indicate how long or how deep.  On Thursday the Dow fell 1190.95 points, after a Presidential televised message/presentation the night before raised many doubts as the competence of governmental leadership.  The need for the Fed to make a statement was necessary and Chairman Powell appropriately did so indicating the Fed stood ready to act in response to the evolving risks when appropriate.  By Friday morning, this had caused the economist Tim Duy to change his assessment from an appropriate wait for economic data to the need for a 25 to 50 basis point cut in the Fed funds rate and Goldman Sachs seeing stagnant earnings growth for U.S. companies through 2020 and three 25 basis points rate cuts from March to June of a total 75 basis points and Wall Street expecting at least 50 basis points in March. 

By the morning of Monday, March 2, Goldman Sachs aggressively stated there needed to be a 50 basis points cur in March and at least 100 basis points this year.  Marc Chandler, a forex and macro analyst, was accurately reporting the negative economic data and commenting that central banks words of assurance have a short life.  Tim Duy was concluding the Fed would need to cut 25 basis points in March with a tilt towards 50 basis points and sooner, although the Fed's initial response might be to expand repo operations.  In this same Monday morning, another economist was commenting that central banks are already doing enough for now and that the emphasis in combating a potential pandemic is appropriately directed fiscal spending by government to support the public health system and provide direct (not tax cuts which would come to late and often to the "special" people who do not need them) stimulus to economy as the global impact on the United States becomes more obvious.  As of this Monday the CDC has yet to deliver accurate testing kits to state, county, and local public health agencies and hospitals to provide timely testing.  By this Monday afternoon, general doubts were beginning to be raised that, while the market expects rate cuts, cuts will not work and that the Fed is more likely to cut rates due to a demand shock leading to inflation rather than a recession.  However, a demand shock can also be a supply shock and lead to recession.

By market end this Monday, March 2nd, the Dow finished up 1293.96 or 5.09%, despite European markets being up then turning down (except for UK) on coronavirus concerns.  Hope springs eternal in the market however fleeting the moment may be.

At this moment, I expect the Fed will hold the Fed funds rate in March, unless data between now and the meeting March 17-18 significantly changes.  The growth of the coronavirus infection will get much worse before it gets better.  Expect the Fed to look at the repo rates and repo operation (and the effect of hedge funds on the repo market) as well as bank liquidity throughout the system, particularly the largest banks which handle most repo facilities.  If the data does become more negative, there might be a 25 basis points cut.  This a wait a see how bad and how serious the public health problems impact the economy, prices, and employment --- and for what length of time.  The Federal government needs to listen to Congress and spend money to stimulate the public health response and directly stimulate the economy with spending which has more immediacy of impact than possible future impact.

If the economic impact grows more negative over the next two to three months, we may see the data showing that a recession could start in May-June.  Notice the use of the word "may" and not "will".


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