An extraordinary $2 trillion injection into the short-term lending market announced by the Federal Reserve on March 12 didn’t help the U.S. stock markets quell concern about the economic slowdown stemming from the coronavirus, leading to a 10 percent drop and the worst day for the Dow Jones Industrial Average since 1987.
After plunging by more than 8 percent at the opening, markets sharply but briefly pared the losses to 3 percent in response to the New York Federal Reserve’s announcement of plans to offer a $500 billion short term bank-funding operation on March 12, to be followed by two $500 billion offerings on March 13.
But the recovery was brief, with all three major stock indexes tumbling by more than 9 percent at the closing bell.
The central bank also is broadening its ongoing $60 billion-a-month purchases of Treasurys to include longer-term bonds. The New York Federal Reserve in a statement explained its measures as necessary “to address temporary disruptions in Treasury financing markets.”
The stock market selloff is driven by a crash in oil prices and the outbreak of the Wuhan coronavirus, which was recently labeled a global pandemic by the World Health Organization (WHO). The March 12 losses are linked in part to the U.S. government announcement of a travel ban on some travelers from Europe. Similar restrictions, cancellations, and other preventative measures around the world are also suppressing demand and economic activity.
Airline stocks took a hard hit with Southwest Airlines closing down more than 15 percent, American Airlines down by more than 17 percent, and Delta Air Lines falling by 21 percent.
Meanwhile, major U.S. oil companies were hammered by the decline in oil prices driven by the fallout from a failed deal between Russia and the Saudi-led Organization of the Petroleum Exporting Countries (OPEC). ExxonMobil closed down more than 11 percent, Valero Energy fell more than 19 percent, and Chevron was down 8 percent.
The Fed’s announcement also caused Treasury yields to sink before they rallied.
The reaction in the markets suggested little faith that the Fed’s moves would do much to restore the confidence of investors and consumers in the face of travel disruptions, event cancellations, and business closures.
The March 12 action by the central bank, being led by the New York Fed, is intended to keep credit markets functioning and ensure that banks can continue to provide loans to businesses and other borrowers across the economy.
“The New York Fed fired its bazooka,” said Paul Ashworth, an economist at Capital Economics.
The action follows signs of stress in the bond market. On March 11, when the stock market plunged, bond yields actually rose. Typically, in circumstances like this, the two would move together: Investors would move en masse into the bond market, driving down bond yields as bond prices rose.
The disjointed move in prices likely signals a lack of liquidity in the bond market. That means there are too few buyers or sellers, causing prices to move violently and make prices less easy to pinpoint.
“There are massive concerns out there,“ said Tom di Galoma with Seaport Global Holdings. ”Market-making is under severe pressure. This is beyond the market’s current capabilities.”
In a note to investors, analysts at Bank of America said the U.S. bond market has “materially deteriorated over recent days” and now “requires a rapid and large near-term policy response from the U.S. Treasury or Federal Reserve.”
The market for U.S. Treasurys is the foundation of all other financial products on Wall Street. Because investors believe the U.S. government would never default on its debt, the bonds issued by the U.S. government are used to price every other asset. The market for U.S. government debt is enormous—roughly $17.5 trillion, the largest single pool of investment assets in the world.
Individual Treasurys are used to price key financial products that everyday Americans use. The 10-year bond is the underlying basis for the 30-year fixed-rate mortgage, while the 3-month note is used to price certificates of deposit (CDs) and money market accounts.
More than a decade ago, central banks around the world slashed interest rates and began pumping trillions of dollars into banks to combat a global financial crisis. The coronavirus is presenting them with a very different challenge—at a time when some policymakers have barely caught their breath from the last economic disaster.
The heart of the matter is that the coronavirus affects economies in ways far different from the bursting debt bubbles that afflicted markets and economies in 2008–2009. The virus has hit demand by canceling activity from manufacturing to trade shows to vacations to basketball games. No amount of cheap credit will reopen those events.
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