Stimulus-fueled relief rally runs out of steam  

Brian Nick

The last week’s market highlights:

Quote of the week:

“The saddest aspect of life right now is that science gathers knowledge faster than society gathers wisdom.” – Issac Asimov

A Fed/U.S. Congress tag team      

As it turns out, the Federal Reserve’s earlier decisions to slash interest rates to zero, announce $700 billion of quantitative easing (QE) purchases and revive a series of financial crisis-era programs were not enough to quell market panic over the coronavirus. Despite these initial bold moves, the S&P 500 fell 15% from March 16-20, and during that week, the VIX, or Wall Street’s “fear gauge,” hit a post financial crisis high.4 Investors sold whatever assets they could find buyers for, gold included, and hoarded cash. Tight liquidity conditions resulted, fueling extreme volatility in stock and fixed-income markets. To help quell the turmoil, more aggressive monetary policy medicine would be needed—and the Fed delivered a heavy dose.
On Monday, March 23, Chair Jerome Powell and his colleagues unleashed even more firepower. Committing to open-ended QE, they promised to buy U.S. Treasury securities and agency mortgage-backed securities (MBS) “in the amounts needed to support smooth market functioning and effective transmission of monetary policy to broader financial conditions and the economy.” In other words, the Fed put no limits on the amount of its future Treasury and MBS purchases. It also pledged to include agency commercial mortgage-backed securities (CMBS) in its MBS purchases.
That same day, the Fed expanded its 2008 financial crisis playbook by adding investment-grade corporate bonds to its QE-eligible assets. The central bank will buy newly issued corporate debt through a Primary Market Corporate Credit Facility (PMCCF), as well as already issued bonds through a Secondary Market Corporate Credit Facility (SMCCF). In another first, the Fed will purchase investment-grade corporate debt through exchange-traded funds (ETFs).
Meanwhile, as the Fed was unveiling its extraordinary monetary policy measures, Congress stepped up with a massive fiscal stimulus program: the Coronavirus Aid, Relief, and Economic Security Act (CARES). At $2 trillion (more than 9% of U.S. GDP), CARES dwarfs the 2009 financial crisis rescue package ($800 billion, or 5.5% of GDP).5 It's components include:
  • Direct payments to individuals and families (an estimated $300 billion) via checks of up to $1,200 for individuals, $2,400 per couple and $500 for each child under 17.
  • Small business loans ($350 billion), with a loan forgiveness clause for businesses that retain workers or rehire those laid off. This provision is crucial amid the spike in first-time unemployment claims, which hit a record 3.3 million for the week ended March 21 (vs. 282,000 the week before).6
  • Unemployment insurance benefits ($250 billion), which will pay jobless workers an extra $600 per week in addition to any state unemployment benefits.
  • Loans, loan guarantees or other aid to large businesses, states and municipalities ($500 billion) made through the Federal Reserve, with the possibility that the government will take an equity stake in select distressed companies.
  • Supplemental spending ($340 billion), including $117 billion for hospital and veterans’ care, and $25 billion for public transit to compensate for lost revenue due to dwindling ridership.
  • Direct aid to states ($150 billion), distributed according to population size.
The combination of monetary and fiscal stimulus acted as a balm for markets. Inflation expectations perked up from their multi-year lows, signaling the potential for a pickup in economic growth. Spreads on corporate bonds—the extra yield offered by these securities because of their higher risk versus U.S. Treasuries—narrowed considerably. (Narrower spreads are generally a positive for corporate bond performance.) And the U.S. dollar, which benefits from being a haven for rattled investors, weakened after surging 8% during the prior two weeks, according to the Wall Street Journal Dollar Index.7
Against this more optimistic backdrop, the S&P 500 Index jumped 10.3% for the full week. Volatility remained front and center, though, with the index sandwiching Tuesday’s 9.4% surge between losses of 2.9% and 3.4%, on Monday and Friday, respectively. Stocks in Europe followed Wall Street higher, with the STOXX 600 Index returning 6.1% for the week (in euro terms). The weaker greenback amplified that gain to 9.8% for dollar-based investors.8

It’s too early to celebrate, though 

While last week provided a much-needed boost to investor sentiment, the coast is far from clear. The U.S. has now overtaken China as the country with the most confirmed coronavirus cases, and the disease has been diagnosed in more than 100 other countries. About one-third (1.8 billion) of the world’s 5.5 billion people have been ordered to stay home or limit their movements.9
Such restrictions have already begun to have severe economic consequences. Last week we got a sense just how severe, based on IHS Markit’s “flash” (preliminary) Purchasing Managers’ Indexes (PMIs) for March:
  • Business activity in the eurozone collapsed from 51.6 to 31.4, the biggest one-month slump ever. (PMI readings below 50 indicate a contraction.) The services sector was especially hard hit, notably within consumer-facing industries such as hotels, travel, and restaurants. The U.K. experienced a similar downturn.
  • The U.S. PMI plunged to a record low 40.5. Here, too, the services sector bore the brunt of the drop. Although companies were generally optimistic that activity would rebound in the next 12 months, the decline in business confidence deepened dramatically.
These PMIs, as discouraging as they are, were based on survey responses collected in mid-March, before the implementation of the most drastic elements of national and state-level lockdowns. That means April’s results may be worse. 
Moreover, we’re not expecting a “bounce” in global economic data until the crisis has passed. Although monetary and fiscal policy actions should help limit further damage to the economy and markets, they alone cannot spark a recovery. For that to happen, we need improvement at the core of the health crisis itself. Absent a breakthrough vaccine or treatment, this would mean effective containment of the virus.
  1. Haver
  2. Equity data from Haver, Marketwatch and Bloomberg
  3. Treasury data from Haver
  4. Haver
  5. Wall Street Journal
  6. Haver
  7. Haver
  8. Haver, Bloomberg
  9. Web MD
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