Broker Check

The Federal Reserve Is Also Trying to 'Flatten the Curve' (Of Asset Prices)

| April 13, 2020

By now everyone has probably heard a lot about "Flattening the curve" as it relates to the COVID-19 coronavirus. The whole purpose of the stay-at-home orders and social distancing measures is to "flatten the curve" as it relates to the number of cases of those contracting the virus. This is with the intention of not overwhelming our hospital systems which could lead to a greater number of deaths as our healthcare system would be unable to manage such a large number of patients at one time.  

The below graph illustrates the concept of flattening the curve. With the number of cases exceeding the healthcare system capacity, it risks increasing the number of deaths. As can be seen, while this may extend the duration of the crisis, it should help reduce the severity.

So how might this relate to what the Federal Reserve has been doing?  As the market tried to digest the impact of the growing coronavirus outbreak, the Federal Reserve quickly started to implement measures in response such as reducing the Federal Funds rate to near 0% and purchasing government bonds. You might think of that as when the government started to encourage social distancing measures. As things escalated and markets continued to fall the Federal Reserve began taking more extreme measures such as removing the limit to the amount they were willing to buy, as well as later extending purchases to assets they hadn't been involved in before including high-yield or 'junk' bonds. You might think of this like the stay-at-home orders and the closure of non-essential business as it relates to the measures taken for the coronavirus. 

While the aim of the Federal Reserve has nothing to do with reducing the number of coronavirus cases, I believe it would be fair to say their aim (whether explicit or not) is to put measures into place which prevent a panicked fall in asset prices at a pace greater than the financial system is capable of dealing with. The financial system is comprised of many interconnected pieces which may not always be apparent and when one part comes under undue stress it can have ripple effects throughout the rest of the system and the economy as a whole.

The below chart is how you might think of the Federal Reserve's response to flattening the curve in asset prices.

While it appears that these measures have so far helped, these artificial interventions into the market do run the risk of extending the duration of any recovery. In addition, just as governments need to be mindful of when they end stay-at-home orders at the risk of new spikes in coronavirus cases, the Federal Reserve runs similar risks as it relates to their intervention and it's impact on asset prices. This relates not only to ending measures too soon but also the unintended risks of intervening too long.

Prepared By:

Adam Jordan, CIMA®, AAMS®
Director of Investments/ CCO
Registered Principal*

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