Central Banks Administer Their Meds
Central banks’ hands are being forced, perhaps not by the coronavirus, but by its market response. Following an emergency meeting, the Federal Reserve has cut interest rates by 50 basis points. The European Central Bank (ECB) looks set to follow.
The hope is to stimulate business investment by lowering the cost of borrowing. That’s a big relief not only for businesses, but for homeowners who can now refinance mortgages and live within their means now that 401ks aren’t so rosy. Fewer household overheads mean more cash to splash on the products and services sold by companies who’ve lost 10-15% of their share prices.
However, a knee-jerk rate cut is not a vaccine. If cases keep compounding and the fear of infection keeps growing, shoppers won’t head out to spend no matter how low monetary policy goes. This dilemma is now in the hands of the market. Man versus microbe!
If investors expect contamination to spread, Monday’s biggest Dow Jones single-day gain in history could prove to be a dead cat bounce. If markets drop another few thousand points today, what then? It’s no wonder Christine Lagarde of the ECB is waiting for the opening bell Stateside. With Europe on the brink, she can’t waste the little easing ammo she has left temporarily reflating a bubble!
If Lagarde goes unmoved, expect homebuilding stocks to pop. J.R. Horton and Pulte Group flew on news of a worsening coronavirus in the US. As treasury bond investors drove down yields 16% in their rush for safety, mortgage rates swooped to ever lower lows. People started refinancing, and it became competitive to buy a home. Build time!
If Lagarde does blink, however, European banks won’t take the news well. They make their money by paying less in interest payments to savers than they receive from others to whom they lend those savers’ deposits.
JP Morgan dropped 4% yesterday, Bank of America 5%, and Morgan Stanley 2%. When interest rates drop, banks get less for lending those savings out. Profit margins are slimmed, and stock prices go south.
It may be time to start to averaging down into undervalued stocks, but everyone’s waiting on each other to see the response to this monetary stimulus. Bullish? Bearish?