March 3, 2020\u2014The US Federal Reserve cut its policy rate by 50 basis points today, highlighting the serious challenges facing the global economy. Still, we don\u2019t believe investors should cut risk. Very few have an informational edge regarding COVID-19\u2019s market impact, and investors could be left underexposed when and if markets rebound.<\/p>\n
Is the emergency rate cut good news or bad news? It\u2019s a bit of both. The good news is that the central bank has aggressively cut borrowing costs to support the economy, even as the spread of COVID-19 within the United States has been limited so far. The bad news is that this first inter-meeting cut since 2008 telegraphs the Fed\u2019s fears of near-term recession risk. Additionally, the Fed has limited capacity to further cut rates and it\u2019s not obvious that even-lower borrowing costs will inoculate the US economy.<\/p>\n
The Fed\u2019s preemptive strike may appear aggressive, given that most US economic data still paint the economy as robust. However, US consumer and business activity appears to be changing as the virus spreads beyond China. US consumers are emptying store shelves of hand sanitizer, and businesses are throttling back travel. A significant increase in US cases is likely this month as testing efforts accelerate. Will school closings, postponed meetings, and canceled sporting events follow? Also, what about the global economic impact of China\u2019s shutdown? Chinese purchasing managers\u2019 index (PMI) data released last week revealed a huge hit to the domestic economy, one that dwarfed the US PMI impact in October 2001 following the September 11 attacks. China now accounts for about one-fifth of global economic activity, and over the past five years it has driven more than one-third of real global GDP growth.<\/p>\n
Is the United States at an elevated risk of falling into a recession this year? Arguably, yes. Is a recession priced in to US markets? Yes, for the bond market (the ten-year Treasury yield is at historic lows), but probably not for the stock market.<\/p>\n