Update 454 — What’s Up in the Markets?
Less and Less, Pricing in Uncertainty, Fear
The dissonance between the real economy’s performance, measured in GDP and unemployment, and that of the capital markets, reflected in prices, trading volume, and IPOs, was never starker than in the second quarter that ended last Tuesday. Stocks had their strongest quarter since 1998 while the GDP’s contraction was the worst since 1958.
A deeper look at recent developments in the markets, their relation to the real economy, and their relative needs as regards relief going forward are covered below.
Good weekends, all.
The equity markets’ rally through the spring was a result of significant monetary and fiscal interventions by the Federal Reserve and Congress to avoid a 2008-like financial collapse. The Fed slashed interest rates to near zero in March and announced it could provide markets $2.3 trillion in lending support. Even before the Fed stood up its new facilities, Fed Chair Jerome Powell’s public assurances were enough to calm investors’ jitters.
But in the final weeks of the quarter, as COVID surged and cases rose in 32 states, investors’ economic outlook shifted and the spring market rally leveled-off. The investor perspective is starting to reflect the uncertainty and fear that the real economy has felt from the beginning. Is a harmonic convergence on the horizon?
Below, we examine how markets are performing and the implications of the Federal Reserve’s actions, as well as suggest relief measures tied to the real economy for the next relief package.
Market Rally Confronts Reality
S&P 500 6-month Performance:
More than three months have passed since markets rallied in response to a Federal Reserve corporate bond-buying program and passage of the CARES Act. Equity markets experienced a historic rebound, with the S&P 500 Index gaining more than 40 percent between March 23 and June 8.
This past month, the S&P 500 and Dow Jones indices stalled slightly as COVID-19 cases rebounded and investors accepted the pandemic’s long-term economic effects. But, NASDAQ continues to climb, hitting its twenty-fifth record close for 2020 on July 8. In search of shares insulated from the fallout of the pandemic, bullish investors increasingly turn to tech, pushing NASDAQ higher than pre-pandemic levels.
The Cboe volatility index (VIX), though flat, persists well above its historic average and twice its February low. The VIX futures curve will likely remain elevated as it continues to account for the pandemic’s effect on the real economy, expected delays in the November election, and liquidity threats. Despite these signals of continued market volatility, some investors remain undeterred, confident that fiscal and monetary policy will continue to prop up the market.
Fed Response Strong, but Inherently Inequitable
Unlike Congress, the Fed has been able to respond to market data quickly and call upon its unparalleled expertise when taking action during this crisis. It lowered rates and announced its first emergency lending facilities nearly two weeks before President Trump signed the CARES Act into law on March 27. The CARES Act further bolstered the Fed’s powers by giving it $454 billion to leverage for its new emergency facilities. This is on top of the Fed adding a staggering $2.2 trillion in U.S. treasuries and mortgage-backed securities to its balance sheet since March 11.
These actions have helped bridge banks, corporations, and investors through the first few months of the recession. The Fed and Congress instilled lessons from 2008 and prevented a collapse of the financial system. But these actions have still left many on the sidelines and have led to inequitable effects in our recovery.
- Lower Rates Lead to Reach for Yield: The Fed’s lowering of interest rates to near-zero through 2022 has moved investors into the equities markets, even during a pandemic, to realize better returns. While the rally has been great for investors, 48 percent of American families have no investments in stocks. And only 14 percent of American families directly invest in stocks according to Pew Research. As Mary Daly, President of the San Francisco Federal Reserve Bank, said last week, given the forward-looking nature of equity markets, wealth inequality tends to widen when coming out of a recession.
- Facilities Bridge Firms, Workers TBD: Unlike the Paycheck Protection Program or the airline bailout, the Fed’s $750 billion corporate bond-buying facilities have no requirements for recipient companies to maintain employment. SF Fed Bank President Daly defended corporate bond facilities structure as “… a direct way to help those companies by offering corporate debt market relief but that ultimately helps individuals, workers, and consumers…Us helping the ecosystem of the economy helps everyone.” This seems unsupported by recent evidence as just last week another 2.3 million Americans filed new applications for regular and pandemic unemployment benefits.
During Powell’s sojourns on the Hill, members often implored the Fed to do more and push the limits of its mandates. But Congress is putting too much reliance on a single institution that is not meant to act as a fiscal agent. The Fed’s tools are effective only within certain parameters. They are inherently geared toward helping illiquid markets and corporations — and their investors — but not unemployed workers and struggling families.
The more Congress relies on the Fed to carry out the recovery, the less equitable it will be. There’s recognition within the Fed that it can’t save the American economy alone. Federal Reserve Bank of Atlanta President Raphael Bostic said on Wednesday, “It is not always obvious that the Fed is the right body to be doing the response.”
Relief for the Real Economy
As the rally levels off and unemployment remains higher than at any time since the Great Depression, perhaps the marginal dollar is better spent on the real economy, supporting the middle- and working-class rather than relying on the Fed to target market liquidity. As Senate Majority Leader McConnell anticipates taking up another coronavirus package later this month, Congress should focus on help for the real economy:
- Expanded UI Benefits: The CARES Act’s $600 top-off to unemployment insurance benefits and its Pandemic Unemployment Assistance program are both set to expire at the end of this month. These increased benefits have been a lifeline for laid-off and furloughed workers, but the pandemic and the accompanying recession are far from over.
- Added Automatic Stabilizers: Automatic stabilizers, which tie fiscal programs to macroeconomic indicators, would be an immense boon for present and future economic crises. Such measures would provide immediate support during recessions and obviate the need for rushed, ad hoc relief.
- Wage Continuity: Rep. Jayapal’s Paycheck Recovery Act, H.R. 6918, would serve a double purpose in securing workers’ wages and business stability through the crisis. The bill would cover salaries up to $90,000 and provide additional funds for business operating costs.
While nearly 40 percent of households making less than $40,000 have experienced a job loss, the wealthiest Americans have been largely insulated from the economic downturn. The Fed can only take the recovery so far, and it may be nearing the limits of its powers. Equity markets finally seem to be pricing in this reality. An additional package of significant relief to put money in the hands of everyday Americans is necessary.