In recent years, investors have come to rely on central banks - and the Federal Reserve in particular - to ride to the rescue when markets turn lower.
In the late 1990s, this was known as the Greenspan Put - a shortcut reference to the then chairman of the Federal Reserve and an investment strategy designed to protect investors from falling markets. Subsequent heads of the US central bank have been just as quick to use interest rate cuts and other forms of monetary stimulus to stabilise markets at the first sign of trouble.
Yesterday the Fed turned to this tried and tested playbook, cutting US interest rates by 0.5 percentage points to a new range between 1% and 1.25%. It was the first time since the financial crisis that the US central bank had cut rates between scheduled meetings - a sign of how seriously the Fed is taking the current situation.
The initial market reaction was positive, but the mood quickly soured as investors questioned the likely effectiveness of further monetary easing in tackling the deepening coronavirus crisis.
Cutting interest rates is an effective way of tackling a demand-led downturn because it reduces the cost of borrowing and effectively increases the money in consumers’ pockets. By reducing the returns on safe investments like government bonds it also encourages investors to take more risks by investing in shares. Both of these can help to stabilise stock markets.
Where rate cuts are less obviously beneficial is in dealing with a supply-led reduction in activity in which fewer goods are able to reach the market because, as in the current situation for example, factories are closed for an extended period or travel restrictions limit the free movement of parts and finished products.
The coronavirus outbreak is particularly troubling for investors because it threatens both a demand-led and a supply-led slowdown at the same time. No-one knows the likely depth or the duration of what now looks to be an unavoidable reduction in economic activity.
This explains why investors have given the Fed’s decisive action such a lukewarm welcome. Not only are the world’s central banks dangerously low on monetary ammunition (with interest rates close to historical lows) no-one is even sure if cutting them further will make any real difference.
To compound the issue, a cut between scheduled meetings runs the risk of looking panicky. Investors are quite reasonably asking if the Fed knows something the rest of us don’t.
This does not mean the Fed chair Jay Powell was wrong to cut rates yesterday. If you have limited firepower, there is some merit in moving early and decisively to try and shock the market into responding as you hope. He cannot really be blamed that the move seems to have backfired.
What is likely to happen next? In the short-term, other central banks will probably follow suit. A co-ordinated response is more likely to be effective and the Banks of Japan and England have already indicated they stand ready to cut their own rates. The ECB is typically slower out of the blocks but with a scheduled meeting next week, Christine Lagarde is under pressure to add Europe’s weight to the global effort.
But the likely ineffectiveness of monetary policy will subsequently increase demands for governments to swing into action with their own spending measures - so-called fiscal policy support. Next week’s Budget is an opportunity for the UK government to set out plans to boost spending, measures that it was already planning as part of its ‘levelling up’ programme of investment in Britain’s more deprived areas.
While this process continues, markets will respond to each announcement in turn while at the same time keeping a wary eye on the spread of the disease itself. Investors will also factor in the now relentless stream of corporate messages about the impact of coronavirus on individual companies.
It is a recipe for volatility. Hopefully, however, the extreme movements of last week are now behind us. Investors have now priced in the initial shock of realisation that this outbreak is a global and not a China-only situation. The question now is more nuanced - how great will the economic impact be and how long will it go on for?
What is certain is that the effects will not be permanent. We should expect that the virus will at some point be contained and business will get back to normal. So, in due course, financial markets will regain their composure. Timing that recovery is impossible right now, so keeping an eye on the horizon and not over-reacting to short-term noise remains the most sensible approach.
At times like these, it is easy to sound like a scratched record. But maintaining a well-diversified portfolio and continuing to invest through the market’s ups and downs remains our mantra.
Important information: Investors should note that the views expressed may no longer be current and may have already been acted upon. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to an authorised financial adviser.