It seems like each week just goes from bad to worse for stock markets. Last week saw the Dow Jones suffer its worst-ever points drop of over 2,350 points. That 10% single-day drop was the worst single-day loss since Black Monday in 1987. So what will this week bring?
All eyes are on the Federal Reserve, which has thus far made two emergency monetary policy moves in an attempt to shore up markets, to no avail. Two weeks ago the Fed rocked markets by making an emergency 50 basis point cut to its target federal funds rate, down to 1.00-1.25%.
Then last week the Fed announced a new round of emergency liquidity provision to repo markets, starting off with up to $1.5 trillion of funding last week. The total amount of outstanding liquidity in these operations could end up being up to $5.5 trillion, which is 34% greater than the expected level of federal government spending in FY 2020, 30% greater than the Fed’s current balance sheet, 50% larger than the entire German economy, and 50 times greater than the Fed’s repo market liquidity provision during the 2008 financial crisis. This is a big deal.
Now all eyes are on this week’s Federal Open Market Committee (FOMC) meeting. Many are expecting the Fed to cut rates at least 50-75 basis points, as the current daily yield curve for short-term debt is around 0.30-0.40% for debt maturities out to one year. That would indicate a potential target rate of 0.25-0.50%. But other analysts are expecting an interest rate cut down to zero this week. So what will the FOMC do?
If the Fed fails to cut by at least 50 basis points, markets will likely panic that the Fed isn’t doing anything. But even if the Fed cuts by 50, 75, or even 100 basis points, markets will still panic. There may be a minor short-term boost to stock markets in the initial aftermath of the FOMC’s decision, but the larger the rate cut, the worse investors will see the economy as performing. A large rate cut means that the economy is in poor shape, will get worse, and investors will need to buckle up for an even bigger crash.