Act now or face a bloodbath, Wall Street urges governments as virus hits markets


London — Financial markets have thrown down the gauntlet at governments worldwide: act now to stave off disaster.

Having forced the Federal Reserve into its first emergency rate cut since the 2008 crisis, a free fall in stocks on recession panic is raising the ante for policymakers. US financial conditions are now the tightest since 2011, spurred by the oil-price collapse and growing cases of the coronavirus. The fear is that market stress will hit economic growth just when aggregate demand takes a hit, with businesses and consumers in lockdown.

“Unfortunately, when everyone except the US government is panicking, market tail risk increases,” Evercore ISI strategists, led by Dennis Debusschere, wrote in a note. Investors won’t focus on any positive signs from a potential recovery in Chinese production to attractive valuations “until they have confidence that the US government and Fed will ‘do what it takes’ to lower tail risk”, they said.

The Trump administration is drafting measures, including a temporary expansion of paid sick leave and possible help for companies facing disruption from the outbreak, according to three people familiar with the matter, while the Federal Reserve said on Monday morning it will boost this week’s repo operations to relieve money markets.

For investors, it’s not enough. The S&P 500 looks set to tumble nearly 5% at the open, while yields across the entire treasury curve have hit a record low.

At Deutsche Bank, global head of currency research George Saravelos has a wish list that includes fiscal stimulus “on the order of magnitude of the Lehman crisis, above 1% of global GDP”, he wrote in a note on Monday. Central banks should “offer to buy risky assets including equities and corporate bonds, at least temporarily, and as soon as this week”, he said, so as to alleviate liquidity risks in markets.

Fed cuts

While governments, especially in Europe, have been reluctant to turn on the fiscal taps, some market players are now expecting more drastic action to arrest declines. At Mediolanum Asset Management in Dublin, head of equity strategy David Holohan says “a significant step-up in fiscal stimulus” in the US could come in days. There could be similar measures in Europe, though these may come later.

As for the Fed, he says there may be another 50-basis-point cut before next week’s scheduled meeting, after last week’s emergency reduction failed to inspire confidence.

The firm hasn’t bought the dip yet, having turned underweight on stocks and added hedges earlier, head of investment strategy Brian O’Reilly said. US shares are still valued at about 17 times 2021’s earnings, compared with the sub-15 multiple seen during the sell-off in late 2018, he pointed out.

“Overall we expect declines in equities to continue until the co-ordinated response has a size where it offsets the impact from Covid-19,” said Peter Garnry, head of equity strategy at Saxo Bank. “What is happening now is that the oil price war and Covid-19 have increased the probability of a new credit crisis.”

‘Helicopter money’

As such, the stars may be aligning for extraordinary stimulus. “If fiscal expansion comes with explicit guarantee from the central bank to backstop any funding required, then you basically have the closest you get to ‘helicopter money’,” said Garnry. “It’s too early at this point, but it all depends on how the global pandemic plays out and whether we get another credit crisis.”

Ian Shepherdson, founder of Pantheon Macroeconomics, said on Twitter rising coronavirus cases in the US could see the Fed cut rates to zero and introduce a $1-trillion stimulus package. In the meantime, potentially brace for the treasury curve to fall near zero, with the S&P 500 tumbling further, he wrote.

Former Fed economist Claudia Sahm suggests the federal government should send money to people affected, push banks to ease pressure on borrowers and boost unemployment support. Bill McBride, who runs the Calculated Risk blog, has floated making all virus tests free and expanding insurance for the jobless.

So far, US President Donald Trump has directed his ire at the Fed, but more forceful measures may come as equity losses grow ahead of his re-election bid in 2020, given his long-standing obsession with stock performance, Mediolanum’s Holohan suggests.

“Having drummed up the fact that the economy is doing quite well and the stock market was at a high not long ago, he then needs to be seen to be taking action to try to arrest the rapid decline that we’ve seen,” he said.