The Fed is all in, but US stocks still hit limit down

The coronavirus outbreak is proving to be stronger than any measures taken by governments and central banks.

In another surprise move, the US Federal Reserve slashed its interest rates to zero on Sunday and added a sweetener by expanding its balance sheet by $700 billion to purchase Treasuries and mortgage-backed securities.

China’s PBOC also made a surprise move on Friday with a fresh round of liquidity injections. The central bank cut its reserve requirements for banks to free up $79 bn in funds to support companies hit by the outbreak. Meanwhile, the Bank of Japan was the last to join central bank action by announcing several measures to ease monetary policy.

It’s becoming evident that the major central banks across the globe are using all their available tools to prevent a crisis, but it seems the fear of the pandemic is taking control of investors.

At the time of writing, all three major US indices were trading at their lower pre-open limit, a decline of 5%.

When stocks futures reach their limit down in pre-market trading, they leave investors wondering how bad it can get when the market resumes normal trading hours. Markets will continue going through this phase of extreme volatility until they are able to assess the scale of damage caused by the virus outbreak.

The longer the outbreak persists and countries stay in emergency status, the harder the global economy will be hit. A recession seems almost impossible to prevent at this stage, but the question remains, how bad is it going to be? Equity strategists, especially bottom-up ones, will not be able to provide meaningful targets for stock prices. That’s because even companies themselves cannot project revenue targets in such situations.

From a macro perspective, economic data released by China today has provided a snapshot on how bad things could turn out to be. Industrial production plunged 13.5% in the first two months of the year; that’s the worst reading ever for the sector. Retail sales fell 20.5% as consumers were locked at home, fixed income investments dropped 24.5% and the jobless rate rose to a record 6.2%.

While China has started to recover from the epidemic, we do not expect to see a V-shaped recovery. The simple reason is that the rest of the world is sick now, with the majority of infections outside China. That means demand for Chinese products will remain low for the foreseeable future. Whether US and Europe will receive a similar economic hit remains to be seen. However, the biggest risk is if this health crisis turns out to be a debt crisis. The answer largely depends on the time and scale of the outbreak.

Confidence is exceptionally low at this stage and that suggests selling market rallies like the one we saw on Friday, may be a profitable strategy. However, traders should be aware and prepared for another week of extreme volatility.