We wanted to pass along an update on the quickly changing news over the weekend and the implications to financial markets/economy. It is important to recognize that the current market and economic conditions are event driven vs. technical driven as we saw in 2008. The plumbing in the financial markets continues to be fully functioning at this time.
Given the extreme volatility and tight liquidity last week, as well as additional restrictions on public gatherings (restaurants, bars, etc.), the Federal Reserve launched emergency measures Sunday night. These measures were part of a globally-coordinated effort by central banks to ensure continued proper functioning of the “plumbing” of our financial markets; this was not an effort to boost the stock market. The Federal Reserve’s aggressive actions were:
- Cutting short-term interest rates to 0% to 0.25% range, which was a drop of 100bps to the Federal Funds rate, following an emergency 50bps cut last week. They also provided changes to forward guidance
- Relaunching a version of Quantitative Easing (QE) – buying $700bn of government securities (Treasurys and Mortgage Backed Securities)
- Various measures to improve short-term lending in the form of global currency swaps which encourages banks to borrow for shorter-periods of time.
These measures will go a long way to reducing stress on short-term funding markets and improving liquidity in the Treasury market. The actions taken over the weekend are meant to ensure the financial markets continue to operate uninterrupted without structural problems. It is important to note that the Federal Reserve has “saved some bullets” with regards to additional policy action.
The coordinated global monetary policy intervention is a very important step, but financial markets will continue to be volatile until a) there are additional significant fiscal measures taken (similar magnitude to the global monetary policy actions taken Sunday) and b) there is clarity around the path of COVID-19 in Europe and the United States (improvement in Asia will not be enough to offset uncertainty in Europe and the US in the short-term).
While the recovery should still be “v-shaped” in nature (meaning we will see a quick rebound from the bottom rather than a slow gradual climb up), the question is how much further will be go before bottoming out. Given the path of economic data, it is likely that we will meet the technical definition of entering a recession (defined in the United States by NBER “as a significant decline in economic activity spread across the economy, lasting more than a few months”). It is also important to remember in times of uncertainty that financial markets are forward looking and constantly price in changes in future expectations. Global equity markets have fallen into a bear market, to a magnitude that is in-line with historical examples of “event-driven” occurrences and should bottom out ahead of the complete economic recovery.
We understand that the volatility in the short-term may not always feel great, but as long term investors we continue to look to take advantage of opportunities that have been created over the past several weeks. Please don’t hesitate to contact us with any questions you have.