Disruptions to the U.S. and global economy brought about by COVID-19 have prompted the Federal Reserve to take a number of emergency measures. These include twice cutting the federal funds rate (to near zero), resuming its purchase of securities, and temporarily relaxing regulatory capital and liquidity requirements (among several other things).
Although the Fed’s actions take many forms, few things capture investors’ attention in the way emergency rate cuts do. Predicting how financial markets will respond to these cuts is a complicated undertaking. To help investors analyze how these events have affected markets historically, RiskSpan has developed a tool to help investors visualize how various market indices, commodities, currencies and bond yields have reacted to emergency Fed rate cuts in the wake of various market shocks.
Analyzing events in this way enables investors to more effectively manage their portfolio risk by monitoring market–moving events and identifying response patterns. We analyze a range of past market events to formulate scenarios for RiskSpan’s RiskDynamics market risk service.
Every crisis is unique, of course. But the Fed’s interest rate cuts this month are specifically reminiscent of seven actions it has taken in response to past economic threats, including the Russian Ruble crisis (2014), the bursting of the dot-com bubble (2000), the September 11th attacks (2001), and the subprime mortgage/Lehman Brothers collapse (2008).
The chart below compares the response of the S&P 500 to the Lehman collapse and COVID-19 and how long it takes the ensuing Fed rate cut to affect the market. The similarity in the shape of these two curves is quite striking. It also reflects the time required for Congress to pass stimulus following Fed action.
The tool displays the performance of several markets across three asset classes in response to each of the seven Fed cuts. In this version we have included stocks, rates and commodities. The two interactive charts specifically help to visualize the following:
- Performance of asset classes from 20 days before through 60 days following each rate cut.
- Performance indexed to the event date—helping to illustrate market conditions leading up to the rate cut and its subsequent impact.
- Daily returns enabling a cross-sector, cross-market comparisons to each rate cut.
Additional patterns also emerge when looking at how markets have responded to these seven prior cuts:
- Equity market collapses tend to stall, but the recovery (if any) is slow.
- The volatility index stabilizes, but it takes time to mean revert.
- Treasury bonds generally perform better than other asset classes. Long–dated bonds don’t perform as well.
- Crude oil continues to sell off in most cases.
We are continually expanding the list of asset classes and events covered by the tool. Our data science team is also working some interesting analytics for publication.
We welcome your feedback and requests for additional analysis. Please contact us to discuss further.
¹ In 2011-12, the market saw significant differences in buyout behavior, for example Bank of America was slow to buy out delinquent loans.
² On Bloomberg, the delinquency states 90 days onward are compressed into a single 90+ state.