investment insights
COVID-19: Assessing the first policy responses
On COVID-19, global and coordinated stimulus is needed to reduce immediate cash-flow pressures from affected businesses to prevent potential defaults, and ensure households’ revenues by avoiding an unemployment spiral.
Indeed, in order to put this external shock behind us, we need to see three responses:
- A public health response: to contain the spread of the virus, and gain time so that cases do not overwhelm hospital capacity;
- A monetary response: to avoid a funding shortage and ensure liquidity at a cheap borrowing cost;
- A fiscal response: perhaps in the form of tax rebates or income transfers, to partially shield economic actors from the temporary demand side shock.
We are moving in the right direction, with two of the three measures – public health and monetary – already materialising, although more might still be needed in the weeks to come.
While we would argue that monetary policy is less equipped to deal with this kind of external shock than fiscal policy, the European Central Bank (ECB) has also used two of the three levers at its disposal to deliver a substantial set of measures on 12 March.
Despite no change on rates (which disappointed markets), the ECB supported liquidity and credit with new, targeted, longer-term refinancing operations, at rates as low as -0.75% and easing capital buffer rules for banks. This was perhaps close to market expectations, in the light of the Bank of England’s (BoE’s) actions on 11 March. The rationale is to have a positive impact on lending without hurting depositors and banks’ net interest margins with rate cuts.
The ECB also announced an additional EUR 120 bn of bond buying through the year-end. There was no comment on issuer limits for now, and nothing on peripheral Europe/Italy. However, President Christine Lagarde mentioned that these measures should help as fiscal authorities start taking hopefully coordinated measures to combat the shock.
This move is good for credit stress, but probably not enough to surprise markets. The additional EUR 120 bn adds around EUR 10-15 bn per month to the EUR 20 bn already in place. So an increase in monthly purchases to approximately EUR 30-35 bn, versus EUR 80 bn when the ECB was pursuing maximum quantitative easing from 2015 to 2018.
Following in the ECB’s footsteps the Federal Reserve (Fed) announced that it would increase the size of its repo auctions very significantly. This adds market liquidity in order to backstop early signs of stress in Treasury and funding markets. In addition, the monthly USD 60 bn of Treasury purchases that the Fed was already conducting will now be spread across all maturities, rather than focusing only on short-term Treasury bills. The Fed has abandoned a proposal to wind-down those purchases. This retooling of the balance sheet’s expansion corresponds to a return to sizeable, and open-ended, quantitative easing.
Overall, central banks are not particularly behind the curve when it comes to monetary conditions. The ECB, Federal Reserve and BoE have all now moved decisively. Commercial banks are also better positioned than in 2008-2009. They have higher levels of capital and liquidity and less risky balance sheets, while central banks have tools and backstops in place.
However, the reaction from fiscal authorities has been slow and the announcements, so far, are far from comprehensive. Support needs to be substantial for most economies (upwards of 0.5% of GDP) and affected economies clearly need more sizeable packages (upwards of 1.0% of GDP). In this respect, China’s 2% fiscal easing is a good example.
That said, despite strong market volatility, we already see public health and monetary policymakers taking decisive steps in the right direction to combat the temporary economic shock – and thus two of the three necessary measures are advancing well.
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