Coronavirus crisis: what Boris Johnson can teach Donald Trump about calming investors’ nerves

Unlike in 2008, this year’s turmoil is not rooted in the banking sector and sentiment is less bearish, but the current threat is harder for policymakers to counter
Like the UK, the US must act decisively with both a monetary and fiscal package

Nicholas Spiro

Published: 2:00am, 13 Mar 2020

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After Monday’s bloodbath in financial markets, it is hard to believe that as recently as February 19 the benchmark S&P 500 equity index stood at an all-time high.

While sentiment had steadily deteriorated over the past several weeks as investors began to fret about the economic effects of the coronavirus outbreak, the abruptness and severity of Monday’s sell-off stunned investors, prompting many analysts to draw parallels with the peak of the 2008 global financial crisis.

While such comparisons are misleading, for reasons outlined below, the magnitude of the moves in asset prices was staggering, showing the extent to which markets have moved into a new and more dangerous phase.

In stock markets, the S&P 500 lost more than 7.6 per cent on Monday, its sharpest fall since December 2008. The VIX Index, Wall Street’s “fear gauge” which measures the implied volatility of the S&P 500, surged to its highest level since the financial crisis. Global stocks are now on the verge of a bear market, having lost more than 18 per cent since their peak on February 19.

A scarier sell-off occurred in corporate bond markets, exacerbated by the crash in oil prices as Saudi Arabia launched an all-out price war. According to data from Bloomberg, an index that measures the perceived risk of corporate debt surged the most since the collapse of Lehman Brothers in 2008.

Yet, what was most worrying about Monday’s carnage was that it showed the speed at which financial conditions have been tightening. Another index from Bloomberg, which measures financial stress in the US, deteriorated at its fastest pace since the 2008 crisis, fuelling concerns about a full-blown credit crunch.

These fears stem from the increasing likelihood of a global recession, best reflected by the dramatic moves in government bond markets.

The benchmark 10-year US Treasury yield plunged to 0.5 per cent on Monday as investors priced in a recession and, just as worryingly, doubted whether policymakers could deliver the “shock and awe” response required to stabilise markets and support businesses worst affected by Covid-19.

A trader reacts as he works on the floor of the New York Stock Exchange on March 11. Photo: Reuters

To be sure, this week’s market mayhem differs sharply from the 2008 crash. The turmoil does not have its roots in the banking sector – the lifeblood of capitalist economies and the most important conduit for financial contagion – and is not yet comparable to the dramatic declines in asset prices in 2008, particularly in credit markets.

What is more, sentiment is not half as bearish as it was 12 years ago, when investors and traders had given up all hope, leading to capitulation.

Indeed, the fact that markets are extremely volatile – on Tuesday, the S&P 500 shot up almost 5 per cent on hopes of coordinated fiscal and monetary stimulus measures – suggests there are still plenty of investors who believe markets will bounce back.

Coronavirus threat should spell the death of fiscal austerity

This is the good news. The bad news is that the current threat to the global economy is much harder for policymakers to counter, partly because of the nature of the menace – an international public health emergency that can only be properly addressed through successful containment of the virus and, at some point, the availability of a new vaccine – but also because of insufficient policy ammunition and a lack of political leadership.

The starting point for managing and resolving the crisis is significantly worse than in 2008. Back then, the world’s leading central banks had plenty of firepower, governments were not as heavily indebted as they are now and, crucially, America could be relied upon to provide leadership.

Federal Reserve Chairman Jerome Powell (left) and Bank of England Governor Mark Carney walk together after Powell's speech at the an economic policy symposium in Jackson Hole, Wyoming, on August 23, 2019. With interest rates already low, central banks can only go so far with monetary stimulus. Photo: AP

The contrast between the speedy and aggressive recapitalisation of the US banking sector in 2008 and the indecisiveness on the part of US President Donald Trump’s administration in tackling Covid-19 – the US remains woefully behind the curve in testing its citizens for the disease – is striking.

While policymakers were able to stun markets and turn sentiment around following the demise of Lehman Brothers, and later during the acute phase of the euro zone debt crisis, the political and technical challenges in responding to the virus – now officially labelled a pandemic – are much more acute.

The bar to pacifying markets and shoring up growth is considerably higher today than it was in 2008. While the global economy may not be facing a debilitating banking crisis, it is suffering a crisis of political leadership, making coordinated and credible stimulus measures much more difficult to implement.

There is now a significant risk that investors lose faith in governments’ ability and willingness to do what it takes to cushion the economic blow from Covid-19. Fear of policy impotence, or ineffectiveness, could be the catalyst for a 2008-style financial crisis.

Still, while markets continued to suffer heavy losses on Wednesday, at least one major economy delivered the decisive and coordinated monetary and fiscal response that is sorely needed. An aggressive interest rate cut from the Bank of England, followed hours later by a massive spending package from the UK government, showed that even Brexit Britain can be bold.

Unfortunately, investors are relying on policy action from the vacillating Trump administration to help restore confidence. No wonder the turmoil in markets endures.

Nicholas Spiro is a partner at Lauressa Advisory

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