Policymakers are racing to try to blunt the coming economic shock related to COVID-19. Despite their best efforts, however, market volatility has been unrelenting in the face of unprecedented uncertainty. The Fed has rapidly cut rates to the zero lower bound and added liquidity in a variety of ways, and fiscal policymakers are framing out a stimulus package. And yet, on Monday, investors had to contend with another punishing sell-off. We dig into the Fed’s latest move, what to watch as economic data reports start to reflect COVID-19-related activity, and why investors could have to contend with volatility for months to come.

The return of ZIRP (zero interest rate policy)
The Fed slashed interest rates 100 bps to 0.00%–0.25%, returning its primary policy tool to the zero lower bound for the first time since the financial crisis, just days ahead of the FOMC’s regularly scheduled meeting on March 18. Faced with unprecedented volatility and liquidity concerns creeping into markets, policymakers clearly decided they couldn’t wait. The Fed’s statement addressed both the “disrupted economic activity” and deterioration in “global financial conditions” caused by COVID-19.

Monetary policymakers didn’t stop at the rate cut. The Fed initiated a fresh round of quantitative easing – here and forever to be known as QE4 – to the tune of $700 billion, with a combination of fresh purchases of $500 billion in Treasuries and $200 billion of mortgage-backed securities, as well as reinvesting all maturing assets currently on the balance sheet. A back of the envelope estimate puts the balance sheet at approximately $5.1 trillion by June. This could fluctuate further because of additional liquidity added for expanded repo operations – another tool to smooth underlying funding concerns.

It is clear from this reaction that the Fed is throwing whatever liquidity it can at markets to try and calm this dreadful volatility and to allay underlying funding concerns. Liquidity concerns are creeping in from the municipal bond market, which experienced severe dislocations last week, and commercial paper, where there is concern that companies will draw down credit lines to stockpile cash. To me, the Fed’s actions are more likely to address these liquidity concerns – the stuff of nightmares – rather than provide immediate support for the underlying economy. Rate cuts are supportive of economic growth, but the impact on real GDP occurs over a longer time horizon with a multi-quarter lag.

The corrosive consequences of volatility
It is noteworthy that for the second time in two weeks, when the Fed surprised with more monetary stimulus than the market was expecting, equities suffered a sharp sell-off the next day. On Monday, the Dow dropped -2,997 points and the S&P 500 fell -12.0%, now 29.5% off its peak.1 Over a year of equity gains have evaporated in less than a month. The VIX surged to 82.6, an all-time high – even more than at the peak of the financial crisis.

Let’s pause here and consider how extraordinary volatility has been. The S&P 500 slipped into a bear market – typically characterized as falling 20% – in only 19 days. The average daily move over that time has been more than twice the prior bear market episodes. Over the past decade, there have been five days where the S&P 500 has moved more than 5%, and four have been in the past three and a half weeks. This is even more jarring because we are coming off of two recent years – 2017 and 2019 – that experienced exceptionally low volatility. Indeed, 2017 was the lowest-volatility year in the history of the S&P 500 dating back to 1928.


Volatility hasn’t just impacted equity markets. The bond market, which investors typically view as an oasis of calm in times of equity market stress, has also experienced skyrocketing volatility. The MOVE Index, which tracks implied Treasury market volatility over the coming month, has also surged to levels not seen since 2009. We have long noted the trend of traditional fixed income funds to lengthen duration to increase yield. Higher duration, however, means higher price sensitivity to changes in interest rates.

The Barclays Agg, for example, went from a duration of 4.1 years in 2010 to 6.1 at present. Last week, as volatility in benchmark yields skyrocketed, the 10-year Treasury whipsawed from a low of 0.33% on Monday to a high of 1.00% on Friday. This caused the Barclays Agg to lose -3.17% last week, the largest weekly loss since 1980. All told, the 60/40 portfolio lost -6.54% last week, the worst week since October 2008. We are used to seeing volatility through the lens of equity markets. But unfortunately for investors, volatility seems to be coming from everywhere at once, even affecting traditional fixed income investments that are often billed as adding stability and diversification.

Economic data will start to catch up to COVID-19 news
Economic data comes out with a lag, so as concerns about COVID-19 have flared in the U.S., the news and activity have not yet been reflected in the data. That will change over the next two weeks, however. We are watching several groups of economic data very closely. For the household – the largest engine of our economy that drives 70% of total GDP – confidence will be key. This will likely be tied directly to the labor market. Finally, business confidence will be critical, as it ties directly to hiring and firing decisions.

On March 17, retail sales for February will be released. The consensus expects a 0.2% gain, and for sales to rise 0.4% in the “control” group that excludes autos, building materials and gas stations. Ironically, this report may include an upside surprise, particularly for the control group, as we have seen widespread news coverage of a surge in shopping at big-box and grocery stores.

Job market data now becomes critical. At the top of our watchlist is initial jobless claims, released on March 19 (and every Thursday). This measure is one of my favorites, as I wrote in my two favorite recession indicators blog. It is exceptionally timely and will give us a clear sense of whether companies are retaining workers or letting them go. So far claims have stayed exceptionally low, but I would expect them to start rising as businesses cut back and workers are laid off and file for state unemployment benefits. On April 3, the March payroll employment report will be released. February was a blowout month with 273,000 jobs added. It is hard to imagine the robust pace of job growth continuing with such heightened uncertainty.

Consumer confidence is closely tied to the labor market. One reason why consumer confidence has stayed close to expansion highs, even in the face of a two-year trade war, is because the unemployment rate at 3.5% is an indication of a strong labor market. Put simply, it all comes down to confidence, and on March 31, the Conference Board measure will release the March consumer confidence data. In February, confidence was at 130.70, close to the average of the past two years and an elevated level historically. How fast this corrects down will indicate whether the consumer is simply concerned or panicked.

Finally, look for the ISM manufacturing and non-manufacturing March reports to be released on April 1 and April 3, respectively. ISM manufacturing had been consistently below 50 (the expansion/contraction threshold) in the second half of 2019 as the trade war with China intensified. The green shoots of recovery were visible in January, but February had a reading of just 50.1. It is hard to imagine this going anywhere but back down, given that the manufacturing sector would have already been dealing with supply chain shocks from China’s COVID-19-related lockdown. The low from late 2019 was 47.8, for reference. In February, the ISM non-manufacturing rose to 57.3, a more convincing bounce at the start of 2020. Given our economy’s greater reliance on the services sector, this number will only increase in importance. Watch the employment sub-index, in particular.

Volatility could be the new normal for some time
As markets plummet and economic uncertainty surges, we understand that this outbreak presents a unique challenge. The fact that this is not only an economic or a financial crisis, but a health crisis, presents an added layer of risk to the outlook. Fear is a powerful motivator, and the wild swings in financial markets reflect how real that fear has become.

Policymakers are working hard to provide needed liquidity to markets and to ease volatility, but they are crashing against a wave of uncertainty about the impact of COVID-19. Even for the most seasoned veterans, market movements since mid-February have been unprecedented in many ways – just like the outbreak that has caused them. Even if policymakers are successful in quieting this most extreme market turmoil, this crisis is unlikely to come to an abrupt end in the near term. Investors are likely to face uncertainty and volatility for months to come.


1 On February 19, 2020.


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