The Fed’s action of lowering the refinancing rate from 1.75% to 1.25% in early March is intended to prevent a collapse in financial markets that could have disastrous consequences for the economy. At the moment, everyone is basically trading on borrowed funds, so, in the event of a decline in stock indexes, many traders will be forced to close their positions to avoid forced closing due to revaluation. The worst thing about this is that all companies, whose shares are traded on the stock markets, have huge debts. Therefore, if the value of their shares go down sharply, banks will be forced to demand early repayment of the loans, which the companies would not be able to pull. As a result, in the event of a stock market crash, many companies may go bankrupt, and the consequences of it are easy to imagine. The Federal Reserve is lowering interest rates in order to reduce this cost of borrowed capital, and support primarily stock market players, who, due to cheaper funds, become less susceptible to growing risks and begin to behave more actively in terms of buying shares. However, the very fact that an emergency meeting was required already inspires many fears, making us think that the real situation may be much worse.
The Federal Reserve held another emergency meeting over the weekend and lowered the refinancing rate from 1.25% to 0.25%. However, the meeting is originally scheduled on March 18, so this early meeting is not just critical, but catastrophic. It indicates that the previous reduction was not enough, and that the situation is so critical that American companies began to fall. Even Friday’s rise in the US stock indexes is probably a temporary and accidental rebound. Moreover, everyone continues to write off the coronavirus, which is only a trigger mechanism. The panic over the coronavirus only started the process of flight from risk, while the problem itself is much deeper. Even if the coronavirus does not exist and there is no media hysteria about it, nothing would have changed because the collapse was bound to happen anyway, due to the structural economic problems. We can say that all this hysteria only highlighted the extremely low stability of the US and global economy, which means that the growth shown by the United States is in many ways simply illusory. After 2008, during a period of extremely low interest rates, the financial sector swelled so much that the real sector became dependent on the mood of stock speculators, which made the economy even more vulnerable to various fluctuations in financial markets. This dependence should be reduced, but, to be able to do this, we need to raise interest rates, which will lead to mass bankruptcies of companies that live only on cheap loans and constant injections of funds. It is not clear how effective these companies are, but their bankruptcy will lead to mass layoffs and the growth of the unemployed. So, in order to avoid a disaster, it is necessary to make the economy even more dependent on the financial sector, thereby aggravating the situation. It is just a vicious cycle that no one knows where the end is.
Given that serious downturns in financial markets occur with enviable regularity, the world economy will now permanently balance on the brink of recession, and the monetary authorities will have fewer and fewer opportunities to regulate the situation. In addition, the actions of the Federal Reserve System over the past two weeks actually further undermine the confidence in the financial system, because in the context of emergency and unplanned actions, it is simply impossible to engage in even medium-term planning, which means that investors will tend to go into protective assets in the form of government debt securities, while the real sector of the economy will experience more and more lack of investment. In such conditions, there can be no question of any development. Large developing countries will work with a vengeance to develop a parallel financial system that will be more reliable and predictable, so the role of the dollar will be reduced.
Refinancing rate (United States):
The panic in the financial markets are not going away. Only Germany’s inflation remained unchanged as France’s fell from 1.5% to 1.4%, and Spain’s fell from 1.1% to 0.7%. At the same time, in Germany, there are all signs that inflation will go down again, because wholesale prices, which recently grew by 0.3% per year, suddenly showed a decrease of 0.9% in the same year-on-year.
Wholesale price index (Germany):
The measures of the Fed only scared the markets, precisely for the reason that the reduction of the refinancing rate has become erratic. Asian stock indexes, which were the first to meet the next reduction in the Federal Reserve’s refinancing rate, continue to decline. The price of oil is also going down, which means that it is only a matter of time before American oil companies go bankrupt. After all, American share companies live off loans that were issued to them as collateral for future oil production, so, if the price of oil has fallen significantly, these companies will not be able to fulfill their obligations to creditors. Moreover, the shares of many of these companies are traded on stock exchanges, so the above situation may provoke an even greater overall drop in stock indexes.
The actions of the Fed did not have the desired effect because they undermine the confidence in the existing financial system. At the same time, the talk that the coronavirus is to blame for everything is actually not true, as it is only related to the hype that the mass agitation and disinformation media have created. According to the Johns Hopkins University, 6,513 people have died from the coronavirus worldwide so far. The common flu virus, on the other hand, kills at least half a million people every year. Journalists must be blamed for all the panic and hysteria.
Nevertheless, negative data continues to be received from Europe, as Italy, which is already considered the most affected by the coronavirus, reported a slowdown in inflation from 0.5% to 0.3%. Such a large-scale reduction in the Federal Reserve’s refinancing rate has spooked investors, and so far we are seeing a rebound in the single European currency.
Inflation (Italy):
However, judging by what is happening in the markets, we need to talk about the fact that the growth of the euro is only temporary. Most likely, while market participants are under serious impression, the growth of the dollar will resume, since the situation does not change fundamentally. Capital flight continues, and the probability that the European Central Bank may reduce the refinancing rate to negative values increases significantly. On the market’s mood though, the euro may still end the day at 1.1275.
The pound is not showing any signs of growth. This is due to the fact that market participants are currently lowering the value of the pound, due to the possible reduction of the refinancing rate by the Bank of England. Moreover, the decline may be quite strong, and the BoE is unlikely to keep its promise not to reduce the refinancing rate below 0.1%. Thus, while the pound is consolidating around 1.2275, the medium-term forecast is at 1.2100.
The material has been provided by InstaForex Company – www.instaforex.com
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