Last week, the Corona Virus took the driver’s seat in markets. While this risk is real and on-going, the economic problem may come years down the road.
COVID-19
Markets deteriorated last week as corporate earnings season wound down and the focus shifted from earnings to illness. The S&P 500 moved into correction status at its fastest pace ever. The Corona Virus, COVID-19, has become the world’s problem, rather than China’s problem. There are hopes that the COVID-19 contagion will slow as warmer weather comes. If that were to happen, it would buy time for a vaccine to be produced. Last week, the Federal Reserve Board (FRB) indicated a willingness to take measures to support the economy. Markets have interpreted that to mean a 0.5% rate cut.
Economic Background
The classic structure of FRB activity is to cut rates during economic weakness and raise rates during economic strength. Likewise, fiscal policy is intended to expand spending during economic weakness and tighten spending during economic strength. These activities would support job growth and inflation stability. Over the last 40 years, we have experienced substantial growth, which should theoretically lead us to higher rates. To the contrary, we have seen interest rates at the zero bound and recently coming back down even during a record long expansion.
2020
Last year the FRB lowered rates to support the economy through an earnings deficit and trade conflict. Before COVID-19 a broad recovery was expected for 2020. Much of that recovery is expected to be delayed until the second half of the year. The concern is that with a lack of time between FRB rate cuts last year and the rate cuts expected this year, FRB ammunition will be non-existent.
Conclusion
Economically, it was always intended for the monetary policy of the FRB to be supported by fiscal policy, however, that has not happened. With the FRB having a lack of ammunition now, fiscal policy will have to take the lead during the next recession, whenever it may come.
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