Wall Street wants more than Fed rate cuts to deal with the coronavirus scare

FAN Editor

President Donald Trump, left, and Jerome Powell, the new chairman of the Federal Reserve on Thursday, Nov. 2, 2017.

Carlos Barria | Reuters

Between Congress’ fiscal stimulus and the Federal Reserve’s easing, Wall Street sentiment is clear: Government spending is way more important in trying to combat the virus and, in turn, calm investors.

The emergency 50 basis point Fed cut, while perhaps a reassuring signal the central bank is willing to act with speed to support the economy, isn’t able to correct big supply shocks caused by the virus, said Nathan Sheets, chief economist at PGIM Fixed Income.

“The Fed’s stimulus doesn’t fix broken supply chains or persuade people who are worried about being exposed to the virus to leave their homes and spend,” Sheets wrote in an email to CNBC. “But it should provide a safety net of sorts by helping ensure that financial conditions remain supportive, lifting sentiment more generally, and helping to ensure that there is ample liquidity in the system.”

“Bottom line is that the Fed’s action is helpful, but it’s not a panacea,” he added.

Instead, Sheets said Congress’ $8.3 billion fiscal package could better show that lawmakers are taking the virus’s spread seriously and are willing to underwrite tangible efforts to curb its impact with vaccine research or purchasing medical masks and other equipment.

That may be what motivated the CEO of one of the globe’s largest investment firms to tell CNBC’s Scott Wapner on Tuesday that the Fed moved too early in its cuts and that investors had been hoping for more in the way of fiscal policy.

U.S. lawmakers on Wednesday tentatively agreed to the emergency funding package to address the spread of the deadly coronavirus as the Centers for Disease Control and Prevention reported that 129 cases had been identified in the United States. The congressional spending proposal is more than three times the $2.5 billion President Donald Trump proposed last week.

More palpable and immediate than lower interest rates, fiscal stimulus could have an impact on real economic outcomes: a quicker return to work for employees, better preventative measures for the public and ultimately, a shorter wait for a vaccine.

Supply-side issue

“If this spending meets its objectives of protecting the public and limiting the spread of the virus, it could yield economic (and humanitarian) returns literally hundreds of times over,” Sheets said. “The Fed’s move is helpful and supportive. But spending the resources necessary to fight the virus and protect the public is absolutely critical.”

Sheets’ comments also speak to a broader concern with the current state of U.S. monetary policy. Though the Fed, in theory, will make it easier for corporations to borrow money and perhaps buoy risk appetite at the margin, cash was already readily available when it cut rates Tuesday.

The issue here is that adjustments to interest rates affect the demand side of the economy: that is, how easy it is for businesses and, ultimately, consumers to borrow money. The coronavirus scare, in contrast, has had a far larger impact on the supply side of the economy, as firms around the globe fret over whether China will be able to export its goods out from beyond its shores.

Alternatively, the Fed may be more worried about keeping near-term Treasury yields well below their long-term peers and maintaining the usual, upward shape of the yield curve. A yield curve is a plot of interest rates of bonds having equal credit quality but differing maturity dates.

“There’s this growing narrative that the Fed expected the 50 bps cut to shock equities higher. This couldn’t be further from the truth,” wrote Thomas Tzitzouris, head of fixed-income research at Strategas Research Partners.

“The Fed, under Powell, has been very clear that the only market that matters to them is the bond market, and they will do anything to keep inflation near target, including unexpected moves,” Tzitzouris added. “The Powell Fed has been open that it wants to keep the 2s/10s spread from inverting, because they view this as a hindrance to monetary policy transmission.”

Watching the curve

Normally, when investors think the economy is on track for healthy economic growth, long-term rates exceed short-term rates and the curve slopes upward. But the Treasury curve can invert when investors believe economic growth will slow, or turn negative. 

One critical part of the curve, between the 3-month and 10-year notes, steepened sharply after the Fed move, while the 2-year/10-year spread also remained out of inversion.

There’s also the issue that rates were already low by any historical measure. Even if the U.S. economy was slowing because businesses were reluctant to borrow for big-ticket capital expenditures prior to the Fed’s emergency cut, incremental tweaks to lower rates further may not have as great an impact as hoped. And investors, in turn, may soon come to realize that adjustments to an already-liquid market may not be as bullish for equities as once thought.

“We know the limits” of monetary policy, said Liz Ann Sonders, chief investment strategist at Charles Schwab. “Now that hasn’t prevented the narrative … [that] any kind of stimulus by the Fed automatically means risk assets go higher. I think the broader question is, is that narrative shifting?”

“Even last fall, when the Fed had to step in and start buying Treasury bills in order to stabilize the repo market, the narrative was still in place: The Fed’s providing liquidity, the Fed’s buying securities: It’s good for the stock market.”

“I’m not saying that narrative is dead, I just think it’s going to be an interesting thing to watch,” Sonders said.

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