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There would be risks in relying on the Fed to bail out the economy from a potential pandemic.
On Monday evening, Apple warned its shareholders about the effects of the new coronavirus outbreak. Production of iPhones has been slowed because of quarantined workers, and the company expects to sell fewer products in China as the country grapples with the problem.
Revenue, Apple said, will take a hit, though it wasn’t ready to estimate just how big. It seemed the kind of warning, from a company worth $1.4 trillion and a mainstay of investors’ portfolios, that might inspire quite a sell-off on Wall Street. After all, if the supply chain wizards at Apple can’t keep things going because of coronavirus, what other problems might emerge that ripple through the global economy?
But Wall Street, in the end, mostly ignored it. The S&P 500 fell a mere 0.3 percent Tuesday, only to recover all of that ground and more Wednesday. By the close of trading Wednesday, even Apple stock recovered to nearly where it had been before the announcement.
It fits a pattern: The stock market has barely reacted despite the idling of countless factories in China as workers are quarantined, and despite fears that the virus could spread more widely and create further economic disruption across Asia and beyond. The S&P 500 is actually up 4.6 percent from its levels at the end of January, when the World Health Organization declared coronavirus a global health emergency.
Even shares of American companies with the most direct exposure to the Chinese economy are holding up fine. The Dow Jones travel and tourism index, which includes airlines and hotel chains that would suffer from a drop in Asian tourism, is down a mere 1 percent since mid-January, when the coronavirus fears started to become widespread.
This buoyant mood in the stock market has continued even as economic forecasters have downgraded their projections for global growth in 2020 and warned that in less likely but more grim scenarios, the world economy could face a major hit as commerce sputters in affected regions.
For example, Moody’s Investors service this week described a baseline scenario in which the virus was contained in the first quarter. If that were the case, the economic damage would probably be limited to temporary disruptions and to supply chains and tourism. But the firm also raised the possibility of something more damaging.
“The toll on the global economy would be severe if the rate of infections does not abate and the death toll continues to rise,” Moody’s analysts wrote. “Extended closures in China would have a global impact given the importance and interconnectedness of China in the global economy. The financial market reaction seems to have been to mostly shrug off the impact, which may underestimate the risks.”
At first glance, it might seem as if there are only two possibilities: Assessments like that one are too gloomy, or the stock market has failed to incorporate a major risk to the outlook. But when you look at the full range of data, there is another way to reconcile things.
Bond markets have appeared markedly more pessimistic than the stock market, with the yield on 10-year Treasury bonds falling to 1.52 percent Thursday from about 1.8 percent in mid-January. That suggests bond investors envision lower growth, and hence lower interest rates, over years to come.
And two-year Treasuries are yielding a mere 1.39 percent, below the Fed’s current target for overnight interest rates of between 1.5 percent to 1.75 percent. That implies investors think it increasingly likely that the Fed will cut interest rates again this year.
Coronavirus is part of the reason. Minutes of the Fed policy meeting in late January that were released Wednesday said that “the threat of the coronavirus, in addition to its human toll, had emerged as a new risk to the global growth outlook, which participants agreed warranted close watching.”
In effect, stock investors seem to be betting that the Fed will bail them out of any damage that the virus might to do to corporate profits and the world economy. A Fed rate cut or two would make money cheaper, and therefore support high stock valuations even in an environment in which major companies that do business in China or other affected countries had to shutter production or absorb lost sales.
It’s a plausible story. But it also points to one of the big worries about the valuations of all sorts of financial markets in the 11th year of the economic expansion.
The stock market keeps hitting new highs, but it has required repeated shifts toward easier money by the Fed to make it happen — most recently, last summer and fall. Back then, the trade wars and other global factors seemed at risking of tipping the United States economy into a slowdown, and the Fed cut its key interest rate three times.
The rate cuts did their job, financial markets rebounded after some summer turbulence, and now the United States economy seems to be cruising.
But the Fed is also facing the very real problem that interest rates are so exceptionally low even in good times that it has little room to maneuver if the economy takes a significant turn for the worse.
Its target interest rates are barely above 1.5 percent, and if the Fed has to cut further to protect the United States economy against a shock from a virus that emerged in Wuhan, China, it has less capacity to deal with some potentially larger disruption closer to home.
Using the power of monetary policy to combat a potential pandemic, in other words, would leave the central bank with less capacity to fight some future, unknown challenge.
So stock investors who remain bullish despite the coronavirus risks are in effect making two big bets rather than one.
First, they are betting that the Fed can and will act if necessary should the virus start to do real damage to the economy. Second, if that were to happen, they are betting that the Fed’s diminished capacity to deal with future shocks won’t be a problem.
If you think the world is full of risks in the years ahead, the economic disruptions from coronavirus ought to be only the beginning of your worries.