Yesterday’s Federal Reserve action – slashing interest rates to a range of zero percent to ¼ percent, and initiating a $700 billion quantitative easing program with $500 billion in treasury purchase and an additional $200 billion in mortgage-backed securities purchases, did not have the desired effect. Futures on Sunday night traded limit-down, when the 5% limit was hit, and global stock markets plummeted, with the Asian and European markets seeing broad-based declines, some approaching double digits.
With supercomputers and artificial intelligence, researchers can synthesize new drugs rapidly. Further, the first to market with a viable vaccine stands to make billions of dollars, not to mention save thousands of lives, and gain worldwide acclaim. The stakes are high, and the potential rewards are compelling.
With that stated, the negative impacts of the coronavirus will linger for several quarters, even if a vaccine can be found relatively quickly (which is what I expect to happen). Estimates are for GDP growth in this quarter to be negative 5%, and next quarter may be worse, if a vaccine is not found quickly. Weak economic activity is certainly bad for stocks, and this is responsible for some of the downside we have seen (a significant amount of the downside is due to panic, but the underlying problem is that stocks were grossly overvalued prior to the outbreak.
The Fed is using their playbook from the financial crisis of 2008/2009 – lower interest rates and use QE to pump liquidity into the economy indirectly, though asset purchases. While there is some logic to this approach, it is an indirect approach, meaning that it does not directly place cash in the hands of consumers and businesses, but instead relies on a sort of trickle-down strategy. Because the financial crisis was just that – a financial crisis, this approach addressed the key issue which was a lack of liquidity throughout the banking system and financial markets that resulted from the crisis.
We are not having a financial crisis. We are having a health scare, which is dramatically reducing economic activity. Because companies are being forced to close, and consumers are not willing or able in most cases to go out and spend money on things other than bare necessities, companies are suffering. The result of that suffering will be a loss of jobs because companies on the margin will not be able to afford to keep some employees on their payroll. The longer the crisis lasts, the more people will lose their jobs. This will certainly have a significant, longer-term negative impact on the economy.
What can we do? A payroll tax cut would be a direct, positive step we could take that would address the key issue – lowering costs for companies to keep employees employed. While there are a number of employment tax rules and nuances, the main federal taxes are social security and Medicare. Both the employer and employee each pay 6.2% of gross income for social security, and 1.45% for Medicare. A payroll tax cut reducing the portion paid by the employer would certainly help those companies on the margin, that were already struggling before the crisis started, to keep employees on the payroll. A tax cut on the portion paid by the employee would put more cash in the pocket of consumers, who will be anxious to get out and spend money on things other than necessities, once the crisis is resolved. Leaving these tax cuts in place for the balance of 2020 would provide enough time for the cuts to have a meaningful impact, both on companies in terms of keeping employees employed, and on consumers that the economy needs to go out and spend money, once the threat has been contained.
If a vaccine is found quickly, the economy should snap back relatively quickly, along with the stock market. A giant, worldwide wave of relief and renewed optimism should sweep the globe. Happy people spend more money. I would also expect the short-term dip in the economy to provide a possible delayed effect on the pending recession that is clearly on the horizon. With a bounce back in the economy following the dip we are experiencing, we could push the recession out, probably by at least 2 quarters.
If a vaccine for the coronavirus is not found quickly, there can be no doubt that there will be lasting, severe impacts on the global economy. We are seeing expectations of that scenario reflected in the stock market action currently. The Fed’s move yesterday seems to have backfired in the sense that investors are viewing it as a hail Mary desperation move. Further, with rates at zero percent, the Fed doesn’t have many options left if this doesn’t work.
Regardless of whether an effective vaccine is found quickly or not, a more direct strategy to address the drastic interruptions in the economy, specifically to help both businesses and employees/consumers, is vital. Indirect approaches like QE and lowering interest rates take too long, and do not directly place cash in the hands of companies and consumers. A payroll tax cut, with a significant reduction in social security and Medicare taxes for both the employer and employee would have the desired immediate, positive impact on the economy that is needed. This tax cut should stay in place for at least the balance of 2020 to have a material impact, and the desired psychological impact on companies, consumers, and investors.