Those brave souls that have been buying into the recent rout in markets have a rallying cry – that policymakers will come to their aid. In their view, stimulus is inevitable in response to the crisis. However, there remains considerable debate on how this stimulus should happen and whether it will work.
There is little doubt that looser monetary policy is on the table. JP Morgan Asset Management chief market strategist for EMEA Karen Ward says: “We have heard from the central banks that they are willing to work pre-emptively. We had an emergency rate cut from the Federal Reserve. We will see more rate cuts from the other central banks and other unconventional policy.”
On Wednesday the Bank of England followed in the footsteps of the Fed by announcing an emergency 50 basis point cut to the base rate, taking it to 0.25%. It also announced a lending scheme aimed at small and medium-sized enterprises to help support the economy.
However, Ward points out that the clear message from markets is this is not enough: “Markets are rightly saying this is not a problem that can be solved by rate cuts and therefore the focus is on fiscal policy. What can the governments deploy that will support business and limit the long-term ramifications? The market is looking for that fiscal intervention.”
This crisis is different
Why aren’t conventional monetary policy measures likely to work? Quantitative easing has worked by central banks buying government and corporate bonds. The banks and insurance companies selling those bonds have money in their coffers and are therefore more likely to lend to businesses and individuals. This worked well in the financial crisis, but this crisis is different, businesses need more immediate and direct help. If a restauranteur has empty tables, he doesn’t need the bank to lend him money to grow, he needs short-term direct support to pay bills.
Ward says that the problem for markets today is they don’t know when governments will come forward with interventions that are sufficiently large and timely. In the UK, we can expect some of these fiscal measures in the budget on Wednesday. Chancellor Rishi Sunak, for example, has already said he will raise the employment allowance giving businesses a short-term reprieve from the pressures of a higher minimum wage and the coronavirus. In practice, this is unlikely to make the difference for many under-pressure business and more measures could be announced.
The IMF recently outlined the type of measures governments could be taking: “Households and businesses hit by supply disruptions and a drop in demand could be targeted to receive cash transfers, wage subsidies, and tax relief, helping people to meet their needs and businesses to stay afloat. For example, among other measures, Italy has extended tax deadlines for companies in affected areas and broadened the wage supplementation fund to provide income support to laid-off workers, Korea has introduced wage subsidies for small merchants and increased allowances for homecare and job seekers, and China has temporarily waived social security contributions for businesses.”
It also suggested governments could offer temporary and targeted credit guarantees to help companies pay their bills. Korea, for example, has expanded lending for business operations and loan guarantees for affected small- and medium-sized enterprises.
Response from the US is critical
As the world’s largest economy, the response of the US will be crucial. There are various options, including sending funds to state and local governments to tackle the virus or reducing payroll taxes to discourage layoffs. However, here, policymakers may face a political problem. The Democrats are unlikely to vote through fiscal stimulus measures designed to shore up the economy, thereby boosting Donald Trump’s chances of re-election in November (particularly because they know that the Republicans wouldn’t do the same for them).
What does this mean for financial assets? Government bond yields are likely to stay low, but investors shouldn’t expect continuously looser monetary policy. Central banks are well aware that they are reaching the limits of what is effective. Nevertheless, it seems likely to support certain types of company.
As Quilter Cheviot investment director David Miller says: “Well managed, financially sound companies will find a way through this period of uncertainty, but, as in previous troubled times, more vulnerable business models will be exposed and won’t make it. In particular, those that need to borrow to pay the daily bills or are simply past their sell by date. Flybe won’t be the last to go bankrupt and it wouldn’t be a complete surprise if a few frauds surfaced.” The outperformance of growth and underperformance of value seems unlikely to shift in the short-term.
Fiscal policy may not come soon enough to save imperilled businesses. It is a tougher, slower response. It requires consensus among politicians – less easy to achieve than a monetary response. Those countries worst-hit by Covid-19 have already put fiscal measures in place. However, in the world’s largest and most important economy, these fiscal measures may be harder to achieve.
Equity markets may only bounce back once meaningful fiscal stimulus measures have been announced or if there is a sign that the virus is loosening its grip. This is possible. JPMAM points out that coal usage is picking up again in China, a sign of a rebound in economic activity. People are returning to work as the infection rate starts to diminish. This, at least, would set some kind of time limit on the economic disruption.
