Federal Reserve’s rate cut just a painkiller, demand shock worries remain
2 min read 04 Mar 2020, 10:45 AM ISTWhile the rate cuts are explicable, whether this will lead to a revival in growth is clearly in questionThe rate cut, interestingly, has sent global equity markets into a tailspin
PremiumThe US Federal Reserve’s emergency move of cutting interest rate by a sharp 50 basis points has done little to infuse confidence among investors. Global markets may still be staring at a huge slowdown in the economy. This is the eighth time in the last two decades that Fed has cut rates by 50 basis points in one go, suggesting that the impact of Covid-19 is much more acute than what was estimated earlier by the markets.
The rate cut, interestingly, has sent global equity markets into a tailspin. The Dow Jones Industrial Average index of the US tumbled 2.94% on Tuesday, while the Nifty 50 also corrected by 0.46% on Wednesday. Asian markets also remained weak.
While the rate cuts are explicable, whether this will lead to a revival in growth is clearly in question. Market experts are pointing out that the latest rate cut may not suffice as it will only just be lowering borrowing costs.
The bigger problem the global economy faces right now is demand contraction due to travel restrictions in wake of the spread of the coronavirus worldwide and supply chain disruptions. The concern now is that the change in behaviour towards the virus outbreak could lead to a demand shock and that cannot be addressed just by rate cuts.
Besides, the slowdown could get acute if the epidemic gets worse. “We see a 50 basis points risk to H120 growth if the coronavirus infection worsens. As it is, we see FY20 growth at 4.9% and FY21 at 5.6%," noted BofA (Bank of America) Securities in a note.
Besides, Fed’s actions to keep the liquidity taps flowing will eventually find its way to risk assets. “The rate cut will boost easy money for institutions, which will find its way to capital markets. This will help stabilise equity markets across the globe and find its way into the equity of new businesses through private equity and FDI route," said a chief investment officer of a leading fund house on condition of anonymity.
The markets could, however, remain jittery for some time as it is currently difficult to quantify the damage the epidemic would inflict on economies. Even gold, a safe haven asset, is gyrating wildly. Global institutions could also reassess their risks from Covid-19 and reorganize their portfolios.
“The dynamics of the global economies could change permanently once the full impact is known, which means that allocation to risk assets could also undergo a huge shift with certain sectors being preferred over others," noted the fund manager.
Risk assets are being repriced. The Nifty 50 index has lost more than 1,000 points from its highs on 20 January 2020, with FY21 price-earnings multiple down to about 17.5 times. Uncertainties around big events have never been easy to estimate as different risk assets will behave differently. As the final outcome is not yet known, the markets could stay on the edge for a longer time till the dust settles.
