Separately, like everyone else I have had to develop my understanding of the Covid-19 economic downturn as time passes, because we can’t compare it with experience.
Policymakers around the world have been doing the right things in response to the coronavirus crisis. They may not have done it in a coordinated fashion, and they may not have done it as emphatically as they might have done, but they have been doing broadly the right things.
Cutting interest rates, providing liquidity to the banking system, protecting households and small businesses by various measures, and providing more resources to healthcare systems, while simultaneously trying to shut down parts of the economy.
It would not be possible to time all these factors to perfection, especially the implementation of them, and this may have caused them to act conservatively. I know that sounds strange, given the trillions of dollars being thrown at the problem globally, but they were unlikely to use all their ammunition in one go.
But if they have been doing the right things, why have markets continued to fall?
Difficult to answer. I can think of a number of contributory factors, but I come back to two big ones. The absence of enough QE for buying financial assets, and the complete uncertainty about how long the economic downturn will last.
I would like today to focus on QE. As each day passes, so the Covid-19 impact outside China and South Korea seems to be deteriorating, increasing the probability of a very steep decline in economic activity. When this happens, government bonds should do well, but they haven’t over the last 10 days.
In early January the US Treasury 10-year bond yielded 1.87%, and the yield fell daily until 9th March, when it was 0.54%. Since then it has risen every day except yesterday, and now yields 1.19%.
Since bond prices peaked (their yields reached their low point), governments have started talking much more about raising money (implicitly by selling new bonds into the bond markets). Promises of many hundreds of billions of dollars may have caused bond investors to pause and ask, “who is going to buy all these new bonds?”
It will have to be the central banks. Hence the need for substantial amounts of further QE, because it would be used to purchase a sizeable proportion of these and other bonds. They might even consider intervening where there may be a risk of systemic breakdown, which would be a departure from their previous practices.
There have been positive responses from the Bank of England, the Federal Reserve, the European Central Bank and others in the course of the last few days. Bond markets seem to have stabilised again as a result. More will be needed, in addition to all the other strategies policymakers employ, until we break free from Covid-19.