By Chan Kung and Wei Hongxu*
On March 16, the Federal Reserve announced that it would lower the target range for the federal funds rate to 0% – 0.25%, marking the first time it has been reduced to extremely low levels since the financial crisis. The Federal Reserve has also simultaneously announced the purchase of government bonds and mortgage-backed securities worth US$ 700 billion, as well as a series of measures to stimulate borrowing. Apart from that, the Fed has slashed the rate of emergency lending at the discount window for banks by 125 basis points to 0.25% and lengthened the term of loans to 90 days. This means that the Federal Reserve will start quantitative easing once again.
The motivating factor behind the Fed’s act of early interest rate cuts and large-scale quantitative easing program shows it is highly concerned about the liquidity tightening in the stock and bond markets last week and thus, is trying to prevent credit market shocks and curbing the spread to the other sectors of the economy. Meanwhile, its policies will be crucial in mitigating cash flow risks faced by households and businesses and prevent the rapid rise in credit risk. Meanwhile, regarding the coordination of monetary and fiscal policies, the zero-interest rate policy helps reducing the cost of debt for the United States government and promotes the implementation of corresponding fiscal expenditure plans. Fiscal policy is more targeted at providing cost-effective control of infectious disease outbreaks and supporting the impact of lower-income groups and business sectors. As it stands, all these plans have a short-term but practical effect in preventing the U.S. economy from “hard landing” and a systemic risk from happening.
While the Fed has assured the rate cut will help support the U.S. economy, stabilize the job market, and maintain inflation targeting, the act is being perceived differently by financial markets. To them, rate cuts speaks of the effect the COVID-19 pandemic has on global financial markets and the global economy, including the U.S. and it has far exceeded their expectations. The Fed originally intended to hold a March interest rate decision meeting on Thursday. However, to please the market and protect the economy from further shock, they decided to take earlier actions instead. Historically, the Fed has made a few unconventional but rare decisions to protect the economy. During the 2008 financial crisis, it took them several months to gradually roll out a stimulus package. This time however, they have implemented multiple interest rate cuts and quantitative easing within a day.
Such unconventional policies are similar to the previous interest rate cuts and has once again caused panic in the market. The three major U.S. stock indices futures on the evening of March 15 local time have hit trading restrictions across the board. The “panic index” of VIX futures rose to 53.65%, 22.21% higher. On March 16, the major European stock indices fell sharply at the opening, with the Euro Stoxx 50 index falling by 10%. As of 4:00P.M Beijing time, the Euro Stoxx 50 index fell by 8.80%, the DAX (Deutscher Aktienindex) German stock index fell by 7.96%, the British FTSE 100 index fell by 7.60%, and the France CAC 40 index fell by 9.09%. The major Asia Pacific stock indices also fell across the board. The Shanghai A Share index fell by 3.4%, the Shenzhen Component index fell by 5.34%, the ChiNext index fell by 5.9%, and the Hong Kong Hang Seng index fell by 4.03%. The Nikkei index fell by 3.46%, and the South Korean KOSPI index fell by 3.19%.
Researchers at ANBOUND have warned that global stock market volatility caused by the COVID-19 pandemic could trigger a new round of financial crisis. The successive major stimulus implemented by the Federal Reserve indicates that the crisis has become a reality. The MSCI (Morgan Stanley Capital International) research report commented that the COVID-19 had triggered global market turmoil, similar to the market situation after the September 11 attacks in 2001 and the global financial crisis in 2008. Currently, the spread of the COVID-19 and the plunge in oil prices have caused global stock markets to fall by nearly 20%, and the volatility is expected to soar to more than 40%. Researchers of ANBOUND have also pointed out that the crisis is different from the risks of the financial system in 2008. It is predominantly caused by external shocks to the economy and finance, not only the financial market, but also the simultaneous shocks to physical enterprises.
However, one thing that makes it similar to the financial crisis is the collapse of the financial market bubble. The market panic may further intensify the collapse, causing liquidity risks, and these chain reactions are precisely what the market is worried about. In addition to worrying about economic financial risks, the market panic is also concerned about the effect of the Federal Reserve policy. Currently, the policy interest rate has dropped to zero, and at the same time, the Fed maintained that it will not implement the negative interest rate policy, which means that the Fed has exhausted most of its monetary policy tools and the market will only have itself to rely on in the future. If the Fed’s monetary policy tools have been exhausted, just imagine how many tools are left in other financial institutions, big banks and large traders?
The U.S.’ act implementing major stimulus to its economy has led the global central banks to follow in its footsteps. Japan, South Korea, New Zealand and other countries have also announced successive easing policies of different strengths, which will bring the world back to the era of “super bubble”. ANBOUND has warned about the zero percent interest rate environments in the case of excess capital numerous times. This epidemic has turned it into a reality and its path and evolution will also cause changes in the international monetary and financial system in the long run as previously expected.
In the short to medium term, under the current market panic and pandemic situation of COVID-19 which is still growing, investors will face financial assets revaluation and impairment of wealth. It should be noted that during the period of great impairment of wealth caused by the financial crisis, such impairment will manifest in the form of sharp declines in asset prices. The plan of holding onto assets was to maintain and perhaps, increase its value and the logic has always been that the more the investment, the more the risks are spread out, but the systemic risk brought by the crisis have caused assets to fall sharply and depreciate. Even with cash in hand, it is impaired at zero and negative interest rates. The flow of funds will only be the service sector of the real economy to increase short-term cash flow. On another hand, it is to invest in financial products linked to sovereignty, such as bonds, and let’s not forget about the currency investment or national investment too. The consequence of this is the credit differentiation of the coexistence of asset as well as capital shortage, which is also a consequence during the period of zero and negative interest rates.
It should be noted that one of the reasons the U.S. faces repeated debts is largely due to the fact the Fed had purchased US$ 700 billion worth of U.S. treasury bonds and mortgage bonds. However, the unstable yield of the U.S. treasury bonds will make pricing difficult for the capital market and will increase market volatility, thereby making it impossible to predict future trends. Going by that, if the change in asset prices becomes dependent on the intervention of the Fed, the Fed will be forced to continuously buy U.S. bonds. Driven by the market, the Fed can only continue to launch quantitative easing program again to inject U.S. dollars into the market, forming continuous currency easing.
In fact, since the 2008 financial crisis, central banks around the world have continued to implement major stimulus, using even bigger “bubbles” to cover up the 2008 bubble burst and the credit crisis. Now, under the dual factors of adjustment of the global financial market and response to the impact of the epidemic, the Fed has adopted an unprecedentedly major stimulus to save the financial crisis that has already occurred and avoid the collapse of American finance. Looking from the perspective of the mechanism, the logic of the financial crisis in 2008 was repeated. Therefore, Chan Kung, chief researcher of ANBOUND, believes that the world will once again return to the era of “super bubble”, and the priority is to save financial markets and the Wall Street. As for the recovery of the real economy which includes investments, consumptions and trade activities, it will be a rather long process that cannot be predicted. It is also difficult for it to recover in the short run. Judging from the perspective of the two financial crises in 2008 and 2020, the world economy has embarked on a financial-driven track and is unable to extricate itself.
Final analysis conclusion:
If the Fed’s sudden interest rate cut was an alarm that had cause panic throughout the market, then the Fed’s unprecedented implementation of the major stimulus will be even worse this time around. This has further exacerbated the financial crisis and brought the world back to the era of “super bubble”.
*Founder of Anbound Think Tank in 1993, Chan Kung is now ANBOUND Chief Researcher. Chan Kung is one of China’s renowned experts in information analysis. Most of Chan Kung‘s outstanding academic research activities are in economic information analysis, particularly in the area of public policy.
*Wei Hongxu, graduated from the School of Mathematics of Peking University with a Ph.D. in Economics from the University of Birmingham, UK in 2010 and is a researcher at Anbound Consulting, an independent think tank with headquarters in Beijing. Established in 1993, Anbound specializes in public policy research.
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