The coronavirus pandemic is spreading in Europe, the UK,
Canada, and the US — and economic activity is grinding to a halt in some
sectors as discretionary spending and activity have been sharply reduced in
favor of basic needs. Real-time indicators of demand such as restaurant
patronage, traffic, and cellphone mobility data are all down dramatically on a year-over-year
basis across several major regional and local economies.
The market response has been equally sharp. Stocks rose and
fell dramatically last week, especially on Thursday when the Dow experienced
its largest drop since 1987 and the STOXX® Europe 600 Index experienced
its largest drop ever. The bond market experienced dramatic volatility as well,
with the 10-year US Treasury yield falling to as low as 0.4% last week. 1
Markets appear to be experiencing a lack of confidence in the policy responses
in Europe and the US, and that seems to be continuing into this week.
One of the questions we have been receiving lately is: What
is the appropriate policy response? There’s a lot embedded in that question. In
the past, we have written about the importance of a three-pronged policy
response to coronavirus: 1) public health policy to contain the virus, 2) monetary
measures to ensure financial liquidity and functionality, and 3) fiscal support
to contain the real economic damage. Combating the crisis from these three
angles remains critical today — here’s how we assess progress in these areas
across the globe.
1. Public health policy: Contain the virus
by restricting economic activity
China’s measures — locking down parts of the country — have
been described as draconian, but they were effective: China’s new infections
have dwindled. The ongoing issue here is that Western democracies — which prize
freedom of association, movement, and choice — are reluctant to take or enforce
such measures. This in turn implies that the virus may be able to spread
further before it is contained in these areas.
South Korea has also taken impressive measures to stem the
spread of the virus in its country, including extensive, early, and exhaustive
testing — its most innovative being drive-thru coronavirus testing. This
approach appears to have been very successful, both in containing the virus and
in containing fatalities, thanks to early action and mobilization of treatment
What appears to be happening across the EU and the US is a
gradual but uneven movement toward adopting China-type policies that would lock
down non-essential economic activity to stop the virus. Embracing these
policies would imply that recession will be required to contain the virus (which
has been named COVID-19). The data released in the last day on Chinese economic
activity is a reminder of the economic damage that can come from attempting to
control the contagion: China reported the worst monthly economic data on record
due to the COVID-19 national lockdown and business shutdown. Investments,
retail sales, and industrial production all came in much lower than consensus. The
hope would be that a V-shaped recovery would follow, with a sharp, quick upturn
following the bottom. Although, based on what we are seeing in China, the
recovery appears to be less quick and sharp than we would like to see.
We worry that the paroxysms in global financial markets
reflect a sudden perception that neither China’s draconian but effective
containment strategy nor South Korea’s effective testing and treatment approach
is feasible in the West, despite movements toward both strategies across a
variety of Western economies, and that therefore a more drawn-out recession and
gradual recovery lies ahead.
For example, Italy was proactive in testing citizens, but
appears to have had more difficulty in encouraging people to stay home and self-isolate
in the early weeks of the virus. Several weeks ago, it made the dramatic
decision to lock down the northern part of the country, and then more recently expanded
the lockdown to the entire country, with essentially just grocery stores and
pharmacies remaining open. However, it appears that both the regional and
national lockdowns were not fully adhered to, initially, though compliance did
improve over time as the gravity of the public health threat became apparent.
The coronavirus mortality rate in Italy2 is nearly 7%, a staggering
figure, as the health care system is overwhelmed — though we note that as
testing widens, and more people with perhaps milder symptoms are being
identified, the mortality rate seems to be falling.
Elsewhere in the West, France appears to be following
Italy’s pattern — widening lockdowns but with only gradual public adherence.
Spain is already on lockdown, and national borders are being closed across the
EU. And the UK and the US have had slower starts in combating the virus.
The US thus far has had very limited testing. It is only
now mobilizing its efforts to contain the virus by heeding warnings from the
Centers for Disease Control (CDC) and practicing what is called “social
distancing.” Many sporting events, colleges, and school districts — and even
theater on Broadway — have closed in the last week, but many fear that the US
response may be later than ideal.
The UK response has been relatively laissez-faire, thus far
reasoning that health care resources and containment measures should be targeted,
rather than adopting widespread testing and containment. However, UK and US
policies are becoming more proactive and widespread under public and
international health policy pressure.
policy: Support financial stability and market functioning via liquidity
Central banks are moving to keep the financial system
stable by ensuring that there is enough liquidity to keep banks and financial
markets functioning, thereby supporting businesses and households during this
downturn. We have seen signs of market dysfunction, including reduced market
liquidity and counterintuitive movements as many market participants moved in
the same direction (for example, there have been occasional, atypical declines
in both US Treasuries and risk assets like equities). This reflects a
“dash-for-cash,” and we believe the US Federal Reserve (Fed) and other central
banks are absolutely right to satisfy this extreme demand for cash. We expect
such monetary policy measures can help maintain financial system stability, a
key requirement for the rest of the policy response, and for eventual recovery.
Fed has been quite proactive, providing an emergency rate cut of 50 basis
points in early March, and then providing another emergency rate cut of 100
basis points on March 15. In addition to the latest rate cut the Fed announced
several other measures:
- The Fed
will undertake a new quantitative easing (QE) program of at least $700 billion
to begin March 16, with asset purchases divided between Treasuries ($500
billion) and mortgage-backed securities ($200 billion).
- It encouraged banks to lend to households and businesses by relaxing capital
and liquidity buffer requirements as well as eliminating the reserve
Fed lowered the discount window rate (formally known as the
primary credit rate) by 150 basis points and increased the length of time money
could be borrowed (from overnight to up to 90 days). The Fed is trying to
encourage use of the discount window and remove the stigma associated with
- The Fed is attempting to help banks with their dollar funding
requirements by lowering the cost of liquidity swaps with
foreign central banks.
believe that the Fed’s reduction in the capital buffer should be a positive — the
Bank of England (BOE) and European Central Bank (ECB) signaled cuts in the capital
buffer last week as well — and that reducing the rate on the discount window
China’s monetary response
has been multi-faceted. To counter the economic shock from the coronavirus, it
provided a series of smaller, targeted liquidity injections to support
relending measures, boost confidence through regulatory forbearance, and lower
funding costs to keep smaller companies afloat. It has lowered the reserve
ratio requirement and also provided policy rate cuts.
Interestingly, the People’s
Bank of China decided on March 16 to not provide more easing, although it was
widely expected, perhaps signaling that monetary policy support has already
been adequate now that the crisis is subsiding in China. However, this also
suggests that China may not offer enough stimulus to provide a major lift to
the rest of the world (unlike its big credit and investment pushes in 2009-10
and 2015-16, which contributed strongly to global recovery). We believe the
decision to refrain from further easing is appropriate, because China’s and the
world’s long-term growth will be better served, in our view, by maintaining debt
stabilization policies rather than rapid debt growth. This means the onus will
be greater on other major central banks, and on fiscal policy.
Some other aspects of the central bank response could be
improved. Words from central banks matter, as they did during the Greek debt
crisis when then-ECB president Mario Draghi pledged to do “whatever it takes”
to support the economy and markets. Unfortunately, current ECB president
Christine Lagarde spooked markets last week with her comments in a press conference on Thursday. Lagarde said that
the ECB was not there to “close spreads” between countries, suggesting the ECB
would not be supportive of Italy. In addition, she suggested she would not advocate
for “whatever it takes” to support markets. This was far from reassuring, and
she had to walk back those comments because of the negative impact they had.
In addition, it’s important
to remember that central banks can cause more fear than calm if their decisions
are dramatic and occur during emergency meetings — as we have seen with the Fed’s
decisions this month.
3. Fiscal policy: Soften the economic blow through
targeted spending and relief
In the last decade, central bankers have
bemoaned the absence of adequate fiscal stimulus. However, that situation must
change for economies to lessen the impact of recessionary policies intended to
control the virus.
In China, fiscal policy has focused on
lowering corporations’ operating costs and ensuring local governments are well-endowed
with funds via bond insurance. We expect China’s fiscal stimulus to be
significant, led by special quota bonds (totaling 3.5 trillion renminbi) to
support provincial infrastructure projects, and also including diminished tax
and fee cuts compared to last year. China has implemented targeted
programs such as subsidized loans in order to keep companies running and paying
workers while factories were shut down.
The Italian government is taking all manner of drastic
economic measures to soften the economic blow of coronavirus, such as
suspending mortgage payments across the country. Lenders are offering debt
holidays to small firms and families. On March 15, a very comprehensive fiscal
stimulus package was signed that included fiscal support for households (social
welfare payments) as well as to SMEs (small to medium-sized enterprises).
The UK announced cuts
in business taxes and other support measures for SMEs, as well a significant
infrastructure spending stimulus plan last week, which was well-received by
The US declared the
coronavirus a national emergency last week, freeing up to $50 billion to be
spent on fighting the crisis. Also in the works is a fiscal stimulus bill that
has passed the US House of Representatives and is awaiting approval by the US
Senate and the president. We view this as an initial response that will likely
need to be followed by more fiscal stimulus.
And, finally, European
Commission President Ursula von der Leyen announced that it is ready
to support widespread fiscal stimulus for euro nations. This was an important
development, especially given that a number of policymakers used the term
“doing whatever it takes,” harkening back to Mario Draghi’s famous words during
the Greek debt crisis.
At some point, the US
federal government may need to do another Troubled Asset Relief Program if
defaults start to rise and banks come under pressure. We believe the government
should probably signal that it stands ready to do that if needed (though some may
say that sending such a message may trigger a solvency problem that doesn’t yet
exist). Illiquidity becomes insolvency very quickly for banks and even for less-leveraged
firms if they can’t rollover their debt or lines — as well as for households
that don’t get paychecks.
The policy prescription: What would we like to see
size does not fit all when it comes to the health care response. China was able
to be extremely effective in its containment measures, but it would be very
difficult for Western democracies to achieve similar results. However, the more
that citizens can self-isolate for an extended period of time, the more likely
that governments will be able to “flatten the curve” (in other words, slow the
infection rate to a level that doesn’t overwhelm hospital resources). That,
however, requires effective support from monetary and fiscal policies, because such
health care policies would have a recessionary effect.
policy. Monetary policy must continue to keep banks liquid
and markets functioning, possibly for an extended period. The bottom line is
that helping banks to extend loans and give mortgage/loan holidays is critical.
Both the Fed and BOE are helping with this through their recent decisions. We
hope that the crisis can be contained rapidly, but are concerned that the
slower start and weaker mass testing compared with Asia, and lower
enforceability of containment measures compared with China, points to more like
a two-quarter than one-quarter shock, with some risk of an even longer
containment period. If the economic fallout is extended, as we fear, because
recessionary public health policies are required to save lives, the Fed may
need to engage in facilities reminiscent of the global financial crisis, such
as ensuring firms can roll over commercial paper for working capital needs.
All that said, we must
stress that we don’t believe the Fed or the BOE should move to negative rates —
a policy that has proven ineffective in the eurozone and Japan, and has many
bad side effects, including undermining banks long term. Above all, we would
prefer a more aggressive fiscal policy if the Fed gets to zero and bond yields
go and stay below zero, rather than negative Fed rates (which could validate
and hold long-term yields below zero on a running basis).
We believe negative Fed
policy rates and bond yields, if they persisted for a long time as in Europe
and Japan, would be a very disturbing signal about the long-run outlook.
Negative rates and yields would mean that money today is worth less
than money in the future.3 Therefore, persistently negative
interest rates could imply that the markets expect a smaller economy (through
negative real growth) in the future and/or lower prices (and hence a smaller
nominal economy). Such market pricing and expectations could become
self-fulfilling, as people and firms might delay consumption and investment in
the expectation of lower prices in future, or avoid such decisions entirely
because they expect the economy to shrink.
This may be a time for
some central banks to explore more experimental monetary tools such as
helicopter money, which could simulate fiscal stimulus.
Fiscal policy. Governments need to provide adequate support to
companies and households so that they can follow health guidelines (staying in
rather than going out shopping and dining) and economically survive the crisis through the protection of household and corporate cash
flows. We would like to see governments give corporate tax holidays or rebates
and improve safety nets for workers (such as guaranteed sick pay). Again, both the
UK and US are moving in this direction. We believe governments should indicate
a willingness to make people and firms temporarily whole with zero interest
rate loans to cover their liabilities. (If there is a V-shaped recovery, this
could be repaid over time; but if not, it could be simply monetized and cancelled.)
We would also like to see monetary and fiscal coordination that is aimed at
restoring price and financial stability expectations in the immediate future, and
giving time to affected households, firms, financials, and sovereigns (as was
illustrated in the global financial crisis, each liability is an asset to
In addition, we believe
major governments should lay out a plan for coordination with the World Health Organization,
International Monetary Fund, and the World Bank in case there are waves of the
virus, or it starts to propagate in countries with even weaker public health
systems, especially in emerging markets. We will continue to monitor the emerging
market space because of the oil price fall (emerging market energy firms have
issued a lot of debt recently as have US shale oil producers) and because the
virus seems to be taking root in some emerging market countries and could
challenge their health systems and economies too.
cooperation. We would like to
see greater international coordination and cooperation to signal that national
governments see this crisis as a shared shock with shared solutions, instead of
focusing on mainly national solutions with borders going up to protect national
populations. Such barriers may be an inevitable counterpart of domestic
lockdowns, but vaccine development efforts, information about the virus and its
spread, as well as the longer-term outlook for recovery would be boosted by
clear signaling that governments are prepared to work together as they did in
the global financial crisis. The major central banks moved in this direction over
the weekend with coordinated easing and shared dollar swap lines. The public
health and fiscal authorities, as well as political leaders, should show the
same resolve and cooperation, in our view, to instill both public and market
In short, markets want
to see that policymakers are willing to step in where markets are failing. They
want to see functional governments, independent central banks, and global coordination
among policymakers. We believe this is needed to help prevent a crisis in
confidence and help economies and capital markets get past the pandemic.
With contributions from Arnab Das, Global
Market Strategist for EMEA; David Chao, Global Market Strategist for Asia
Pacific; Paul Jackson, Head of Asset Allocation Research; and Luca Tobagi,
Product Director and Investment Strategist for EMEA.
1 Source: Bloomberg, L.P.
Istituto Superiore di Sanità
3 Investors normally
require a positive interest rate to tie up money in a bond compared to cash,
and a higher interest rate or return, the longer the money is not available for
consumption or other investment choices; with negative rates and yields, the
reverse would be true – and the more compelling this view could become, the
longer negative yields persisted.
image: esemelwe / Getty
A basis point is one hundredth of a percentage point.
A shared dollar swap line is a temporary reciprocal
agreement between central banks to trade currencies at the current exchange
The discount window is a
central bank lending facility meant to help commercial banks manage short-term
liquidity needs. The discount window rate is offered to the most financially sound institutions.
Liquidity swaps are used
by central banks to provide liquidity of their currency to another country’s
The reserve ratio is
the portion of reservable liabilities that commercial banks must hold, rather
than lend or invest. This requirement is determined by each country’s central
bank. The reserve ratio requirement is the percentage of depositors’ balances
banks must have on hand as cash.
was a term coined by economist Milton Friedman in 1969 to describe the concept
of central banks dropping money into an economy.The Dow Jones Industrial Average, or “the Dow,” is a
price-weighted index of the 30 largest, most widely held stocks traded on the
New York Stock Exchange.
With a fixed number of 600
components, the STOXX Europe 600 Index represents large, mid and small
capitalization companies across 17 countries of the European region.
referenced above are those of the authors as of March 16, 2020. These comments should not
be construed as recommendations, but as an illustration of broader themes.
Forward-looking statements are not guarantees of future results. They involve
risks, uncertainties and assumptions; there can be no assurance that actual
results will not differ materially from expectations.