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  • KPB & Co Research

Summary

Going into Q1-2020, many parts of the world faced more tepid economic growth as a result of the lingering effects of consecutive monetary tightening. The marked slowdown in economic activity led some central bankers, and the US Fed in particular, to backpedal as they cut rates and pulled back on commitments to end quantitative easing. Now that COVID-19 is wreaking havoc on consumer and business confidence globally, many central bankers had to pull way-back, by further cutting rates and opening-up the door for extraordinary easing measures in the near term. While data on the current health of the economy will be slow in coming, there are indications that a lot of irreversible damage has been done, damage that is being manifested in the sharp decline of the major stock market indices. Going forward, getting the global economy back on track will likely hinge upon how quick central government officials can put out the rising paranoia.

Bankers Cutting Rates and Improving Liquidity

Fed Chair Jerome Powell slashed rates about four (4) times (from 2.5% to 1.25%) since implementing a rate increase in early 2019, with the last rate decrease done near the end of March-2020 in response to the impact of COVID-19. On Sunday, the US Federal Reserves followed up by cutting its key policy rate by 100 basis points, and committed to purchase US$500Bn of US treasury securities and US$200Bn of mortgage-backed securities. The Bank of Canada (BoC), after keeping higher rates unchanged throughout all of 2019, slashed rates by 50 basis points on March 4, 2020 and again on March 15, 2020. Part of the reason for the quick cut to rates was the rapid fall off in oil prices to US$30 per Bbls, a commodity which the Canadian economy relies on.

The European Central Bank (ECB), with very little room to manoeuvre has kept interest rates on their deposit facility at -0.5% and fixed rate loans at 0% from as far back as 2015. Within the context of rising uncertainties (Brexit & COVID-19), the Bank of England on Wednesday voted unanimously to cut the base rate from 0.75% to 0.25%, while freeing up £100Bn in lending to support small and medium size businesses with a view to pump an overall £200Bn of extra credit into the economy. In a co-ordinated attempt to quell market fears, The Bank of Canada, the Bank of England, the Bank of Japan, the European Central Bank, the Federal Reserve, and the Swiss National Bank are today announced the following:

central banks have agreed to lower the pricing on the standing U.S. dollar liquidity swap arrangements by 25 basis points, so that the new rate will be the U.S. dollar overnight index swap (OIS) rate plus 25 basis points. To increase the swap lines' effectiveness in providing term liquidity, the foreign central banks with regular U.S. dollar liquidity operations have also agreed to begin offering U.S. dollars weekly in each jurisdiction with an 84-day maturity, in addition to the 1-week maturity operations currently offered. These changes will take effect with the next scheduled operations during the week of March 16.1 The new pricing and maturity offerings will remain in place as long as appropriate to support the smooth functioning of U.S. dollar funding markets. The swap lines are available standing facilities and serve as an important liquidity backstop to ease strains in global funding markets, thereby helping to mitigate the effects of such strains on the supply of credit to households and businesses, both domestically and abroad.

This is a solid show of commitment that suggest that Central Bankers are prepared to throw the kitchen sink behind supporting a positive economic momentum. Nevertheless, weaker confidence can be very difficult to manage especially within a context of global paranoia around COVID-19.

Regaining Confidence Will Be Tough

Looking back to what happened in 2008, it is pretty clear to us that confidence is a key factor in keeping economic stability. At the same time maintaining confidence is extraordinarily difficult. As COVID-19 continues to impact global supply chains, consumer demand, and jobs, elevated concerns about the future will likely drive banks to hoard cash, consumers to spend less, and non-financial companies to cut back on investment spending. Already, major consumer and electronic companies are closing stores, global travel demand has plummeted, and job losses to the tune of 50% are expected in the travel Industry. Keep in mind that many corporations and customers in some countries already have a stretched balance sheets with little or no wiggle room to accommodate wild swings in  incomes, though it may be short term. In this context, we could see a lot of corporate and individual bankruptcies globally, which could further dry up liquidity and willingness to take risks.

In Closing

Central bankers in the major industrialized countries have shown their willingness to back up financial markets with capital to stave off a potential recession, but will it be enough. Consumer and business confidence are fickle in times of elevated market pressure, and with a global pandemic on the loose there is no telling how conservative businesses and consumers will become. The more conservative businesses become the more they cut back on investments, freeze hiring, and possibly layoff excess employees. Consumers when faced with uncertainty about their future incomes will undoubtedly cut back on spending. When these dynamics are placed within the context of already stretched balance sheets, the likelihood a further economic slowdown is very high.

​Listen to what James Sweeny Chief economist of Credit Suisse has to say about the implications of COVID-19 on the global economy going forward:

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