The US Federal Reserve has taken action. In an extraordinary meeting it cut the target range for the key interest rate by 50 basis points to 1 to 1.25% with reference to the new coronavirus posing risks to economic activity. The last time the Fed felt compelled to take such an emergency measure was more than ten years ago during the global financial crisis. So the signal could not have been clearer.
But the markets' reaction was probably not what Fed Chairman Jerome Powell and the other members of the Open Market Committee had imagined. Instead, the US stock markets went red again. The S&P 500, for example, lost 2.8 % compared to the previous day, which means that the index, the yardstick for global investor sentiment, is 7% lower than on January 1. The renewed setback on the stock markets was accompanied by a significant decline in long-term interest rates. Ten-year US Treasuries yielded less than 1% for the first time. At the beginning of the year, their yield was above 1.8%. The price of gold jumped by more than 3%.
First, it will get worse
This shows the great uncertainty of investors. The reason is the worldwide spread of the new coronavirus (Covid-19). According to Johns Hopkins University, around 93,500 cases of Covid-19 now have been registered in more than 80 countries. It must be assumed that the numbers will continue to rise in the coming days. This means that negative effects on public life and the economy will increase in more and more countries.
Despite the negative reaction on the stock markets initially, the Fed's decision sends out a strong psychological signal. The world's most important central bank is once again prepared to support the economy and financial markets. In our view, yesterday's move was probably only the beginning. The futures markets are already pricing in two further rate cuts by the Fed. The central banks in Europe and Japan are also likely to announce easing measures. Furthermore, support can also be expected from the fiscal policy side. We think that all this will help to ensure that the situation on the financial markets calms down over time.
Tactical decision
Against this background, we decided at today's extraordinary meeting of the Investment Committee to rebalance the asset management mandates and to bring the equity exposure back to its target weighting. As a result of the recent slump on the equity markets and the positive performance of bonds and gold, the equity exposure in the balanced Swiss franc mandate for example has fallen by 2.5 percentage points. We are correcting this effect by buying equities.
We have also decided to reduce the open dollar exposure in the euro and Swiss franc mandates. While we strategically hedge foreign currencies in the asset management mandates, we had tactically only partially done so in the case of the US dollar due to hedging costs. Yesterday's interest rate cut by the Fed narrowed the interest rate differential, the driver of hedging costs, and even if the European Central Bank or the Swiss National Bank also announce new measures, their room for manoeuvre compared with the Fed is limited. In addition, the narrative of higher interest rates, which spoke in favour of the US dollar, has become weaker. This also suggests that the US dollar should be hedged more strongly in the portfolio again.
We will continue to monitor developments closely in the coming days and adjust the portfolio as necessary. As a matter of principle, the portfolio should be well diversified and the risk budget closely controlled. The next ordinary meeting of the Investment Committee will take place on Tuesday, 10 March 2020.
