Join our community of smart investors

Market Outlook: Stimulus bets boost equities as central banks respond to crisis

Central bank support gives equities a boost
March 2, 2020

From today we welcome a new Trader writer in the form of Neil Wilson, a regular contributor to Investors Chronicle and chief markets analysts at Markets.com. 

You got to stimulate to accumulate: after the worst week since the great financial crisis, stock markets have rebounded on Monday on hopes of some kind of permanent never-ending stimulus. The Federal Reserve and the Bank of Japan have signalled a strong policy response with emergency statements, whilst Italy will inject €3.6bn into the economy to deal with the virus outbreak. Out the door this morning the Bank of England has joined them to say they will take all steps to protect stability.

Markets are now pricing in a 100 per cent chance the Fed will slash rates by 50bps later this month, and increasingly market indications suggest the ECB will also trim rates by 0.1 per cent in April. Market pricing indicates a two-thirds chance that Andrew Bailey will use his first meeting as Bank of England boss to cut rates to 0.5 per cent on March 26th. 

Asian shares reversed early losses to trade broadly higher after the Bank of Japan said it would step on the easing pedal even more. The BoJ’s Haruhiko Kuroda hinted at raising asset purchases and promised liquidity, following up with a $4.6bn short-term liquidity operation for banks. This follows the Fed’s emergency statement on Friday that helped send US stocks to a firmer finish. ‘The fundamentals of the U.S. economy remain strong. However, the coronavirus poses evolving risks to economic activity. The Federal Reserve is closely monitoring developments and their implications for the economic outlook. We will use our tools and act as appropriate to support the economy,’ the Fed said in a brief statement on Friday at 14:30 eastern time. With the BoJ issuing its statement, this is starting to look like some kind of coordinated response by global central banks.  

Hong Kong and Tokyo made small gains but shares in China rallied 3 per cent. European shares are bouncing off the lows and US futures are higher but you have to remember where we have come from – after last week’s plunges the market has had a chance to come back a bit. The test is whether this tentative stabilisation in evidence now holds. The key question is do you think monetary stimulus will solve this supply shock? I don’t really see how it does, but equally central banks have a learned reaction function to ‘step in’ and the market has been egging them on to do something.

Expectations for monetary and fiscal stimulus are shooting higher and this will offer some respite to financial markets. As I detailed on Friday, before the Fed stepped in, there are two ways to look at this. One, it would be an important signal to the market to cut early and aggressive. The Fed has the chance to say 'we got your back' - something everyone assumes but Jay Powell can walk the walk and not just talk the talk. There is definitely an argument that the Fed should step in to stop the rout on Wall Street as this will eventually create a negative feedback loop that feeds into the real economy whatever happens with the virus outbreak itself. The worry is that the collapse in equity markets leads to problems in the real economy, such as tighter financial conditions, that creates a recession even if the impact from the virus is limited.

On the other hand, how can lower rates really fix the double supply and demand side shock that the market is pricing for? Money is not short right now, albeit there has been a tightening of financial conditions. And all the Fed would do is confirm the view that the stock market is driving monetary policy and by dint the real economy - the tail is wagging the dog. The truth is the Fed is really short of ammo for the sort of crisis that this could become because they were too worried about placating the president and looked for inflation in all the wrong places.

China’s PMIs were an absolute horror show but no one can really say they are surprised given the situation in the country and the government response. The manufacturing PMI came in at 35.7 and the services at 29.6. We know that the economic hit in China in Q1 is massive – the question is not how bad it was but how bad will it be in Q2 – how long does this last.

Joe Biden easily won the South Carolina primary, setting him up for a potentially key Super Tuesday vote. Pete Buttigieg has pulled out.

It’s ding-ding on round one for the UK-EU trade talks. The two sides are both talking tough and there is clear divergence on key points. Sterling will be exposed to significant headline risk as we get rumours and briefings as the talks evolve. The start of these talks are bound to be rocky. GBPUSD has rallied off the lows at 1.2750 hit last week but faces near-term resistance at 1.2850, where we saw the rally this morning run out of legs. Expect plenty of the ‘we will walk away if we don’t get the deal we want’ type chatter.

Oil has rallied along with futures and Asian stocks – the OPEC meeting due this week will be crucial but it seems hard to imagine that the cartel and Russia can do anything like enough. Nevertheless, the market will be looking for something from OPEC+ to help steady the ship. WTI has rallied from a $43 handle back to $46 – anything under $47 leaves the bears in charge still. The firm

In FX, the dollar remains under a degree of pressure as market participants up their expectations for the Fed to cut. It’s now almost 100% certain to cut this month, according to Fed funds futures. The euro is facing near-term resistance at 1.1080 area as the V-shaped recovery enters the neckline. Anything up to 1.11 is still not instructive – need to see a break north of this neckline area.  The latest CFTC report from Friday showed a huge over-extended net short euro position in the market – the snapback suggests this market positioning was completely overdone and EURUSD is ripe for a decent pullback. Going back to the earlier point, so far the ECB has been very quiet on any kind of policy response to deal with the coronavirus. A major positive for the euro would be a fiscal response as Italy is doing.

Neil Wilson is chief markets analyst at Markets.com