US stocks ended sharply lower on Monday, with the Dow Jones Industrial Average closing at 20,188.52, its worst point drop in history and falling to its lowest level in nearly three years. Hong Kong's Hang Seng Index also dropped by 4.03% on Monday closing at 23,063.57, it lowest level in six months.

This would consist of US$500 billion in Treasuries and US$200 billion of mortgage-backed securities (MBS). In addition, the Fed will begin reinvesting all maturing MBS rather than let them run off as is current policy. The Fed also took action related to the discount window, intraday credit, bank capital & liquidity buffers, and reserve requirements. 

“The sharp rally in stocks on Friday (March 13), following a 9.5% decline on Thursday, demonstrates that the market is willing to reward targeted policy action designed at mitigating the virus' spread and limit its economic impact, even if broad-brush measures like interest rate cuts have been poorly received,” says Mark Haefele, UBS Global Wealth Management chief investment officer. 

In the short term, the latest Fed action will unleash a flood of liquidity into the corporate credit markets which should calm these markets following last week’s dislocation when there were fears of liquidity tightening.

“The Fed is leading global central banks. The mixture of policy action exceeds market expectations and, importantly, will help corporate credit markets as it unleashes a flood of liquidity,” says Alicia Levine, chief strategist, BNY Mellon Investment Management. “The disquieting message from last week’s market moves in the credit and Treasury markets was the contraction of liquidity and this action should help calm that dislocation. Expect the Treasury yield curve to steepen on this action.” 

The latest rate cut follows a rare move by the Fed just over a week ago (March 3) when it cut the Fed Funds rate to a range of 1%-1.25% on in what Fed chairman Jerome Powell said was intended to provide a boost to the US economy in response to the “evolving risk” of the coronavirus epidemic.

However, US equities continued to tumble and bond prices soared after Powell’s March 3 statement. The market continued its fall into last week following a botched attempt by President Trump to address market fears over the coronavirus pandemic on Wednesday (March 11) but rallied on Friday (March 13) following another announcement by the Trump administration.

Eli Lee, head of Investment Strategy, Bank of Singapore says: “After underwhelming policy responses from the US government in the current limited window for effective action, the odds of a technical recession have risen considerably. The historic turmoil in equity markets last week, together with worrying signs of dysfunction in fixed income and credit markets despite the Fed expanding repo operations to US$1.5 trillion last week, has forced the Fed’s hand in deploying a bazooka approach.”

Lee argues that monetary policy is a blunt tool against the virus outbreak which is a medical crisis, but it will help in alleviating financial conditions for businesses facing cash flow shocks, and also reduce the risk of negative feedback loops triggered by a potential freezing in liquidity conditions that was seen during the global financial crisis (GFC).

Others are more sanguine but cautious with Kerry Craig, global market strategist, J.P. Morgan Asset Management, saying: “There are pluses and minus from today’s (March 15) surprise move. It may be a shot in the arm for risk assets and help to address liquidity concerns and presents a more unified front from the US on coordinated policy action given the stimulus action from the US government announced on Friday – something that had been missing and added to market woes earlier last week.”

Craig, however, points out that the latest rate cut also raises the question of whether the Fed has anything left in the tank should the spread of the virus not be contained.

“The US is seemingly at the very early stages compared to what has played out in some Asian economies. With little economic data to go on its not clear just how deep the economic impact will be. Our view is that the drag on the services sector from social distancing policies and shock from the fall of the oil price on the energy sector will be enough to tip the US into recession, but not necessarily a long one,” Craig says.