Sunday evening the Federal Reserve acted, dropping the range for its policy rate of interest by 100 basis points. It also advised on the amount of securities its was willing to add to its portfolio, along with other actions, some aimed at opening up channels to central banks in other nations.
The United States stock market declined on Monday by its largest one-day drop ever. The S&P 500 dropped 325 points, the Dow Jones Industrial Average dropped almost 3000 points, and the NASDAQ fell by 970 points.
This is a very similar result to the one following the Fed action on March 3 when the central bank reduced its policy rate by 50 basis points. The stock market dropped after that change, too.
Advice for Acting in the Face of a Pandemic
A good part of the advice being given by doctors and experts on pandemics is that because of all the uncertainty that surrounds spread of the virus, it is better for governments and others to overreact to the threat in order to make sure that the efforts to minimize the impacts of the virus are successful.
The advice is: you do not want to underestimate the effects of the threat and thereby expose yourself to the bigger risk.
Often, one of the consequences of this overreacting is that it puts a greater fear into the people facing the spread of the virus. It breaks expectations and causes an emotional shift where people readjust their expectations to the possibility that things might be a lot worse than they currently are.
Financial Markets Are No Different
Financial markets are made up of investors that are very human in their reactions to changes in expectations.
As I wrote in my earlier article about the 50-basis point drop in the Fed’s policy rate of interest “The Federal Reserve Acted Alone: Stock Market Dives”:
Investors interpreted this lone move as an indication that the United States economy was in a much worse shape than had been believed. That is why, it was believed, that the Federal Reserve moved all by itself.
As with other announcements relating to the growing spread of the coronavirus, investor expectations were broken. The apparent response was, “Things must be worse than we thought,” and the investors sold.
The stock market dived.
It looks as if this type of reaction just goes with the territory.
The Point of the Move: The Longer Run
The objective of operating in this way, however, is what can be achieved over the longer run.
The objective is for the monetary authorities to err on the side of too much ease because potential disaster resides on the side of responding with too much caution.
This erring on the side of too much ease is being compared with the statement of Mario Draghi, former president of the European Central Bank, when he stated during the financial crisis in Europe of 2012 that the ECB would do “whatever it takes” to preserve the euro.
Mr. Draghi is given a lot of credit for his stance and for following up on the statement.
The Euro was preserved.
Unfortunately, Christine Legarde, Mr. Draghi’s successor, has apparently fumbled her first go-around with the press, and this resulted in some distress in financial markets, especially in the market for Italian government bonds.
Although the 100-basis-point move by the Federal Reserve may appear to be a short-run effort to bolster up the financial markets, the move may be the signal to the financial markets that the Fed is ready, willing, and able to do “whatever it takes” to preserve the US economy,
The Future
For now, the Fed move has apparently broken investor expectations.
Investors have reacted to the Federal Reserve move by taking the position that things, economically and financially, are a lot worse off than they had believed.
The reality of the situation is that there is still so much that is not known about how this whole thing will work out.
Uncertainty rules the roost. And, it looks as if we are going to have to live with that fact for a relatively long time – several weeks or several months. Again, we just don’t know.
So, investors hold onto your seats. Uncertainty is in charge for the time being. Volatility in markets will continue.
Let’s just hope that our leaders have erred on the side of too much caution so that the impacts of the coronavirus will be minimized.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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