Still, the pressure to respond in a big way will grow as the anxiety persists.
The virus “is arguably the biggest risk to global growth since the Great Recession,” S&P Global Platts Analytics said in a note to clients.
Fed Chair Jerome Powell attempted to reassure markets on Friday afternoon by signaling the central bank would step in with a rate cut next month if necessary.
In some of the more severe hypothetical scenarios of how this could play out, the outbreak threatens to expose lingering dangers that the Fed and other regulators have long been watching — from the record-high level of debt held by businesses to the unpredictable behavior of ultra-fast automated stock traders.
“[Any] recession will stress things in the financial system that people see coming and will uncover stresses in the financial system that people didn’t know were there,” said Aaron Klein, policy director at the Brookings Institution’s Center on Regulation and Markets.
These are among the top concerns that regulators have cited:
Corporate Debt: Perhaps the biggest vulnerability to the financial system is the estimated $1.1 trillion that banks and other financial institutions have loaned to companies that are already highly indebted.
If the coronavirus starts to affect Americans’ everyday behavior that could be a crucial blow because healthy consumer spending has been the economy’s most powerful driver over the past year, even as business investment began to decline and the manufacturing sector contracted.
If people begin “going less to the movies, to bars, to restaurants,” said Torsten Slok, chief economist at Deutsche Bank Securities, that would be a “big deal” in economic terms.
For one thing, it could put further strain on U.S. companies in an environment where business debt is historically large compared to the size of the overall economy. If supply chain disruptions hurt some of those companies enough that they can’t make their payments, it could mean substantial losses for banks that are crucial to keeping money moving through the economy.
“There’s simply innumerable ways of counting the bad loans that you would be hit with in the banking industry if you had a severe recession driven by a pandemic,” said Dick Bove, a financial strategist at Odeon Capital Group.
If the virus starts affecting people’s ability to go into work, “banks will first lose the ability to make a lot of loans in a productive fashion because companies will be shuttering down,” Bove said. “The second thing that happens is existing loans start to go bad; in other words, companies that have taken out meaningful amounts of debt can’t repay the debt because they don’t have the revenues that allow them to do so.”
Problems on the business side would also blow back onto workers, he said. “If companies are not producing anything, then people are not going to get paid, and then they can’t pay their credit card loans,” Bove said.
Program Trading: The structure of the financial markets could also be tested amid investor turmoil over the virus. Regulators have expressed concern that new practices and products could increase market volatility and potentially amplify the pain of a market downturn.
As coronavirus fears ripped through the markets this week, some stock traders blamed algorithmic and high-speed trading for making prices whipsaw. That kind of trading involves using algorithms and processing data at high speeds — as fast as one thousandth or millionth of a second — to buy and sell stocks in response to price movements. The Treasury Department warned in 2017 that an expansion in high-frequency trading could dangerously increase volatility in a range of financial markets. Computerized trading makes up roughly half of stock trading volume, by some estimates.
There’s less data on how an algorithm responds in a downturn, given that the practice has risen in popularity during one of the longest periods of market growth in history.
“SEC rules that put a premium on speed created a dynamic where one headline can sink the market in an instant,” said American Securities Association CEO Chris Iacovella. “Computer-driven HFTs magnify market swings and create uncertainty for retail investors and retirement savers.”
The stock market had already plummeted 10 percent over six trading days as of when markets closed Thursday — its fastest drop in history.
Defenders of high-frequency trading say the practice helps grease the wheels of the markets by making it easier for everyone to buy and sell at more accurate prices.
And some think algorithms are being unfairly blamed, as Vanguard explained in an April 2019 blog post.
“There’s a long history of volatility in the marketplace that pre-dates HFTs,” said John Ameriks, global head of Vanguard Quantitative Equity Group.
Exchange Traded Funds: Another major unknown is how exchange traded funds — an increasingly popular financial product that allows people to indirectly invest in a group of stocks or bonds — will fare if markets drop precipitously. Advisers to the Securities and Exchange Commission warned the regulator that more research was needed to understand how the products might affect markets if both the fund tracking a stock and the stock itself are unraveling simultaneously. Put simply, the main concern is that a market event affecting two interrelated products — instead of just one — could amplify losses.
Chinese Accounting: Another risk has to do with failures in China’s accounting practices, which have forced regulators to struggle with how to verify the accuracy of financial statements from those firms that sell shares in U.S. markets. And there are a lot of them.
According to SEC data from December 2018, a total of 224 Chinese companies that were listed on U.S. exchanges, worth a combined $1.8 trillion, were not allowing inspections by the SEC as of that month. As coronavirus losses mount, regulators might not know if those firms are desperate to stem losses by leaving out certain information in their filings.
For now, Deutsche Bank Securities’ Slok said it “way too early” to tell whether the virus outbreak will seriously hurt consumers and businesses.
But, “there are scenarios where things could be very bad, and there are certainly also scenarios where we could have recession globally if things do go in the wrong direction,” he said.
Source: politico.com
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