As more and more regions in developed economies have been put under a dramatic total lockdown amid growing concerns over Covid-19, central banks have started to cut rates aggressively in order to avoid a complete market meltdown. We saw in the previous week that both the Fed and the BoE held emergency meetings and cut rates by 50bps, the most since the Great Financial Crisis, benefiting from their positive benchmark interest rate to act faster than the rest of central banks. Economies already experiencing a NIRP policy (i.e. Sweden, Euro area) will probably implement or expand asset-purchase programmes in order to fight against a significant economic shock and therefore implicitly reduce their ‘shadow rate’, a rate first introduced by Fischer Black (1995) that can measure the effects of QE, to lower levels.
However, it is important to note that a significant reduction in benchmark policy rates globally has been associated with sharp equity sell-offs. This chart shows that in the previous two downturns, the GDP-weighted G10 policy rate was cut by approximately 4 percent and coincided with a global equity sell-off of 45% to 55%. Are we set for a similar story in 2020?
Chart. G10 policy rate vs. World equities (source: Eikon Reuters)