March 3, 2020 – The Federal Reserve decision to cut the Fed Funds Rate by 50 bps brings a number of economic and financial market forces into sharper focus. Reason dictates that the Fed is proactively ensuring adequate liquidity to economic and financial markets that are going to be challenged by falling demand and weak earnings as a result of the COVID-19 epidemic. It is notable that the Fed chose to take this action prior to the public release of the Federal Reserve Beige Book on March 4. The Beige Book “gathers anecdotal information on current economic conditions in its District through reports from Bank and Branch directors and interview with key business contacts, economists, market experts and other sources” (https://www.federalreserve.gov/monetarypolicy/beige-book-default.htm) and is widely viewed as a key source of insight on fast moving economic developments. It is not unlikely that the Beige Book process was amended as recently as 10 days ago to solicit input from businesses on the effects of the virus spread.
Furthermore, it is also likely that the Federal Reserve’s actions have been prompted by the failure of the G-7 countries to announce concrete fiscal spending plans (specifically, increased government spending and/or directives aimed at reducing the risk of bankruptcy for companies negatively impacted by the virus) to support economic growth while an organized response to the COVID-19 virus is developed. With the leadership of the Federal Reserve, other central bankers are likely to take action as well.
However, as indicated above, liquidity is only half of the battle. In and of itself, it cannot immediately solve the problem of falling earnings as companies and populations adjust to disrupted supply chains and uprooted lives. Thus, it is best to think of the Fed’s actions as a line of defense, attempting to establish a floor for equity markets and keep markets functioning as economic forces play-out over the next few months. A better sense of the length and breadth of the economic impacts from the virus in the United States will be achieved as employment numbers start to come through, with the first insight being provided this coming Friday. The Beige Book release of March 4 will be thoroughly digested, but the Beige Book released on April 15 will be more revealing.
How to position one’s self as an investor throughout this battle is the immediate question. A defensive, well-diversified portfolio is a useful starting point, but it should not be assumed that it is an iron-clad protection in times of uncertain and competing forces. It is important to think through what the ultimate resolution of this battle will look like, the breadth and depth of the downturn, and the timing of the economic recovery. Increasingly, this is our focus as professional money managers and we will be updating you frequently as the smoke clears and the contours of the battleground become clearer.
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