Jean Boivin, Head of BlackRock Investment Institute together with Elga Bartsch, Head of Macro Research and Mike Pyle, Global Chief Investment Strategist within the BlackRock Investment Institute share their insights on global economy, markets and geopolitics. Their views are theirs alone and are not intended to be construed as investment advice.
The coronavirus outbreak has continued to roil markets, even as significant monetary policy steps have been taken. Uncertainties related to the outbreak give public health officials a strong incentive to act aggressively to mitigate its human toll. These measures, though temporary in nature, slow economic activity, sometimes precipitously. We believe this will eventually set the scene for a strong rebound, but a decisive policy response is needed to safeguard fundamentals.
Central bank policy rates and market pricing of future rates, 2018-2020
Sources: BlackRock Investment Institute, with data from Refinitiv Datastream, March 2020. Notes: Data are as of March 5, 2020. The solid lines show the market pricing of policy rates in overnight index swaps on a one-year horizon starting in one year’s time. Dotted lines show policy rates for each region; we use the midpoint of the fed funds target range for the U.S.
Policy can target three things in the face of this shock:
- Prevent a sustained tightening of financial conditions;
- Help stave off cash flow shocks that would threaten to shutter otherwise sound businesses;
- Support individuals whose incomes are eroded by the disruptions.
We see a need for a decisive and pre-emptive policy response across these dimensions. The remaining space for traditional monetary policy tools such as rate cuts is limited, with interest rates near all-time lows. Simply using up that space – especially without coordination with fiscal policy – could quickly draw attention to the empty toolbox and backfire. The Federal Reserve cut interest rates last week, outside a policy meeting for the first time since the 2008 financial crisis. That rate cut failed to stabilize markets, which are now pricing in an even steeper drop in the Fed’s policy rates – as the chart shows.
The only way to address the diminished monetary policy toolkit is to add more lines of defense, such as bringing in fiscal policy explicitly as part of the emergency response. This echoes our view that monetary-fiscal coordination is critical in dealing with the next downturn. We are seeing early signs of a response to the current shock. Fiscal policy is the space to watch. Europe’s finance ministers appear prepared to launch fiscal measures. U.S. officials are likely to take up greater fiscal action if events warrant it – beyond the $8.3 billion in emergency spending approved last week – even in an election year with a divided government.
We expect policy responses across economies to be loosely coordinated – yet differentiated – due to the varied characteristics of economies as well as political and policy constraints. One example is the key funding sources of economies – and their implications on policy actions. The U.S. economy is relatively dependent on funding from capital markets. In economies that rely more on bank lending, policymakers have additional policy options to keep credit flowing, such as targeted liquidity operations in combination with regulatory relief. The Bank of Japan and European Central Bank (ECB) may have less room to cut rates, but can support the private sector by buying equities and corporate debt – a tool that the Fed doesn’t have. The Fed may cut its policy rate again later in the month, but at this stage we do not expect a renewed expansion of its balance sheet. We see the ECB announcing policy actions this week, likely putting more emphasis on targeted credit easing measures than the Fed.
Bottom line, we see monetary policy responses as helpful, but they will be wasted without complementary fiscal and targeted liquidity measures. The coronavirus shock is similar to shocks caused by natural disasters in the sense that their impact on economic activity tends to be temporary. We see a sharp economic rebound once potential disruptions dissipate, and expect the global economic expansion to remain intact – albeit on a lower trajectory. Yet the unknown depth and duration of the shock add material risks, and markets will need greater clarity on the outbreak itself as well as the overall policy response before stabilizing. We believe investors should stay invested, but keep risk near benchmark weights. We have recently updated our views on equity factors – highlighting resilient exposure like quality and minimum volatility – and are still reviewing our regional equity and fixed income views.
- Tuesday to Sunday: China total social financing, new loans
- Wednesday: U.S. Consumer price index (CPI)
- Thursday: ECB monetary policy meeting
- Friday: University of Michigan surveys of consumers
China’s total social financing data will be a focus, with markets expecting weaker new loan growth as the outbreak has stalled lending to consumers. The lending figures come on the heels of data pointing to plunges in activities in both manufacturing and services sectors. The University of Michigan survey could shed some light on the resilience of U.S. consumers that has underpinned the economy in recent years, as the outbreak spreads in the world’s largest economy.
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