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Federal Reserve cuts rates further

16 March 2020

Following another badly received emergency Federal Reserve (Fed) cut, the markets are yet again further spooked that the coronavirus outbreak is almost certainly tipping the global economy into a deep recession. I believe this outcome is essentially guaranteed for the first half of the year.

The Fed’s actions, however, are much needed – injecting liquidity and restarting quantitative easing in an effort to avert any funding crisis is of paramount importance right now, and the Fed knew a developing dollar funding crisis over the weekend was building. Other central banks joined in with additional cuts and stimulus, indicating this is a co-ordinated plan of action, which should be seen as a positive. The negative aspect is that the market was reacting with obliviousness in the first two months of the year, as they viewed Covid-19 as a local Chinese problem that was under some sort of control. We now see this opinion, sadly, is far from the case, and reality is rapidly pricing in recession valuations.

The fiscal measures will likely have to be as big as, if not bigger than, the Fed’s actions, comparable to a minimum of hypothetically 0.5% of GDP just to help bolster demand. That said, the jury is out on whether that will have any short-term palliative effect. Supply shocks accompanied with demand shocks are obviously the worst case scenario. What we will need to see is a lessening of new cases (and from a psychological perspective, a slowdown in the rate of new deaths), but pessimistically that feels some way off yet.

If you had not sold up all risk assets and parked in treasuries and gold or cash before last week, then I would proffer that it is probably now too late to do so. Market action will continue to be choppy, and we cannot invest or trade on those lines. Underlying managers are of course freer to do that, but the evidence so far is that they have not.

I do not think we are yet at the bottom of this sell-off, which will continue to build as more countries attempt to lockdown. How far it goes is quite difficult to model, as this is such a monumental black swan – bigger than the financial crisis certainly. The expectation is still that a sharp recovery builds in the second half of the year, and if governments can support businesses in the interim then the bounce back in prices will be almost as sharp.

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