The European Central Bank is not moving to lower its policy rate. It appears as if the Federal Reserve acted on its own on Tuesday, something not expected by investors over the past weekend. As a consequence, the S&P 500 stock index responded on Thursday with a 106-point drop with the expectation that it will go lower.
Financial markets have gone through several swings this week. Some of them have been connected with central bank behavior or expectations about central bank behavior.
For example, over the past weekend, the word was circulating that central banks would move together and lower interest rates in order to combat the economic and financial uncertainties that the world is now facing.
On Tuesday, the Federal Reserve lowered its policy rate of interest and no one else followed.
Stock markets in the United States plunged. Investors interpreted this lone move as an indication that the United States economy was in a much worse shape than had been believed. That is why, it was believed, that the Federal Reserve moved all by itself.
On Wednesday, the US stock markets rallied as the results from Super Tuesday, the primary election date, indicated that Joe Biden was once again a viable candidate, and this meant that Bernie Sanders had a very serious competitor to become the nominee of the Democratic Party. The market response was a sign that investors were relieved that Bernie Sanders was less likely to become that nominee.
On Thursday, the US stock market began to “tank” again as more evidence accumulated that central banks were not going to move right now to follow the Federal Reserve move.
What Is Going On At The Central Banks?
The only real sign coming from any central bank is the one coming from Christine Lagarde, president of the European Central Bank.
Ms. Lagarde was interviewed by the Financial Times. In that interview, Ms. Lagarde stated that the ECB was not going to respond in the near term to the spread of the coronavirus, even though growth forecasts for the eurozone have been slashed as the virus moved through Europe.
The bank, she iterated, was watching the movement of the virus “very carefully,” but did not feel the need to respond as of this time.
The reason given by Ms. Lagarde: there is no indication that the spread of the virus will have any “lasting impact” on either the economies of the eurozone or on inflation.
The ECB has a meeting in two weeks, and Ms. Lagarde sees no reason at this time to make a move, even though the Fed has moved and others have called for an ECB move.
The deposit rate at the ECB is a negative 0.5 percent and some economists still have concerns about negative interest rates and the possibility of moving policy rates into even more negative territory.
So, it looks as if the ECB will hold tight for the time being, at least for two weeks.
The Euro Responds
The euro has responded to this change in central bank rates.
Last Thursday, February 27, it still cost less than $1.10 to acquire one euro. Since that time the euro has gotten stronger as the ECB failed to move after the Federal Reserve move.
Thursday morning, March 5, the cost of the euro went up to just under $1.12. The move by the ECB has certainly impacted the rate of exchange.
I still believe that traders would like to see a stronger dollar. Not long ago, I argued that the US dollar should be trading somewhere between $1.07 and $1.09 to one euro.
Obviously, this will not happen given the fact that the Fed lowered its policy rate and the ECB did not.
Need To Coordinate
Here we see how important it is to coordinate policy moves, especially at a time like this.
Maybe the Fed moved because of all the pressure that Donald Trump was putting on Fed Chair Jerome Powell and Federal Reserve officials to lower the policy rate.
In the past two years, Mr. Powell had not succumbed to the pressure that Mr. Trump put on him to lower the policy rate. This is one reason why I argued that investors had built up trust in him.
This solo move is not a good sign. Hopefully, going forward, Mr. Powell will redeem himself.
For an example, one only has to look at the way that central banks worked together during the Great Recession. There, coordination appeared to be a major goal achieved by the central bankers at that time. And, the world benefited by it.
Moving Forward
Where do we go from here?
The conclusion I provided in my earlier article applies:
The problem right now is still all the uncertainty that is hanging over world markets. We have a better chance of minimizing the effects of the virus spread if we work together, if all central banks work together. If we don’t work together, the picture becomes much more grim.”
Investors appear to want a coordinated effort on the part of central banks to fight the effects of the virus scare. It seems apparent from the market results this week that if policymakers around the globe don’t move together, investor expectations will be for harder times in the future. And, this will not be good for the stock market.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
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