In the modern era, the global credit crunch of 2008 is the standard for financial crises. A product of toxic asset securitization and subprime mortgage lending, 2008 brought to light severe shortcomings in the world’s monetary system. Twelve years later, the coronavirus (COVID-19) pandemic has once again forced the hand of the U.S. Federal Reserve (FED).
How Does the FED Manage Financial Crises?
During times of financial tumult, the FED is the institution in charge of managing the chaos. The FED takes this daunting task head-on, as outlined by their Board of Governors’ mission statement:
The mission of the Board is to foster the stability, integrity, and efficiency of the nation’s monetary, financial, and payment systems so as to promote optimal macroeconomic performance.
The FED works toward achieving this goal by crafting U.S. monetary policy. These are the primary tools the FED deploys to ensure pricing stability:
- Adjustments to the Federal Funds Target Rate (interbank lending)
- Reserve requirements (cash on hand)
- Open market operations (purchase/sale of U.S. Treasuries)
- Interest on reserves (interbank interest payments)
Since the tech meltdown and recession of the late 1990s, the FED has chosen to fight economic downturns primarily by cutting the Federal Funds Target Rate. However, the global credit crunch of 2008 called for a more aggressive policy known as quantitative easing (QE). QE is a multifaceted approach that includes rate cuts, Treasury purchases, and fiscal stimulus.
QE is a controversial policy because it boosts inflation and leads to a devaluation of the USD. However, a succession of aggressive FED QE programs is credited with staving off a second Great Depression during the financial crisis of 2008. In the wake of the novel coronavirus, QE is once again the FED’s go-to policy.
Managing the Coronavirus Panic
Although the breakout of the novel coronavirus may be traced back to December 2019, global markets didn’t begin taking the threat seriously until late February and early March 2020. However, once the presence of COVID-19 was confirmed in Japan, Europe, and the United States, market volatility reached a critical mass.
COVID-19 began to flex its muscle during the trading sessions of Monday and Tuesday February 24-25. Following weekend reports of a severe outbreak in Italy, U.S. equities reacted violently. During the two-day period, the Dow Jones Industrial Average (DJIA) and S&P 500 each fell by more than 6 percent. Unfortunately for equities market bulls, the volatility of February 24-25 was only a preview of things to come.
In the week that followed, wild swings in the U.S. stock markets highlighted the financial tumult. U.S. 10-year Treasury yields plunged to all-time lows and gold rallied above $1,700 for the first time ever. To combat the volatility, the FED instituted an emergency rate cut of ½ point on March 3.
The emergency cut was the first since 2008 and wasn’t the last coronavirus-induced move from the U.S. FED. A March 12 plunge in the DJIA of more than 2,000 points, the second in less than a week, prompted the FED to inject a massive $1.5 trillion into the financial system. Once again, QE was the policy of choice to combat the COVID-19 financial panic.
So will rate cuts and stimulus mitigate the economic fallout from the coronavirus pandemic? As of this writing, the jury is still out. However, there are a few likely effects of aggressive FED QE:
- Increased inflation: Low interest rates and trillion-dollar injections are designed to stimulate borrowing and consumption. The byproducts are typically a devalued U.S. dollar and inflation.
- Investor confidence: From an investor’s standpoint, it is reassuring that the FED will step in when the going gets tough. Although asset prices may not immediately rebound, FED QE promotes liquid and orderly markets.
- Prolonged FED intervention: If history has told us anything, it’s that when the FED intervenes, there’s more to come. The crisis of 2008 brought three rounds of QE, spanning six years.
Theoretically, the U.S. equities indices will be positioned to appreciate in the wake of FED QE. Low-interest-rate loans and an abundance of capital are designed to spur economic growth. If additional measures are taken, such as emergency tax relief, American stock prices are likely to rise over the intermediate to long term.
What Can You Do?
Times of panic challenge the integrity of our financial systems and institutions. During such periods, staying on top of FED policy is the key to successfully navigating the market turbulence.
For expert analysis and guidance during trying times, check out Daniels Trading’s Trading Advice and Resources online portal. Featuring insights from our experienced brokers and third-party advocates, it is an essential tool for navigating the COVID-19 chaos.