Global risk assets continued to move lower on Monday, pushing the current selloff well into bear market territory and on pace with a level of volatility not seen since the market crash of 1987. To be sure, the S&P 500 index shed over 12% in another unpredictable day of trading and follows the surprise FOMC meeting on Sunday that slashed the fed funds rate by 100 basis points and saw the restart of its asset purchase programs.
What has become clear to many market participants and investors is that the precautionary measures used to slow the spread of the coronavirus (social distancing) will have broad and deep economic implications that are still not well understood. It can further be argued that today’s market activity reflects a sentiment that policymakers lack the tools to mitigate the economic pain that is likely to arise in the coming months.
Market closures in context
Considering the seeming failure of current policy to support sentiment, some market participants are now asking whether more direct measures can be taken to halt the selloff. More specifically, it has been suggested that financial markets could be shut altogether to help cooler heads prevail.
History, nevertheless, has shown that for more than 100 years, closures have sparingly been used to ease market routs. As illustrated in figure 1, there have been a few events over the past century that have led to market closures for more than a day. Some of those events include Hurricane Sandy, the 9/11 terrorist attacks, a Paperwork Crisis in the 60’s and the start of World War 1.
These periods reflect a handful of events that have occurred alongside numerous epidemics, wars, global recessions and financial crises over the same period. Therefore, what the data suggest is that there is little historical precedent for policymakers to outright halt trading in U.S. securities markets for more than a day at a time. What’s more, even during periods of heightened volatility, markets remained opened and largely in normal functioning order.
Figure 1: Days when the New York Stock Exchange was unexpectedly closed
When will they shut the markets?
An argument could be made that closing the markets for even a week or two could preserve household wealth while giving policymakers time to prepare a robust solution set that would help businesses and households navigate what is likely to be a tumultuous economic landscape in the coming months. Nonetheless, what has become clear to us is that the financial markets today act as an important signaling mechanism to policymakers.
For example, indicating a lack of liquidity and other systemically important market dislocations in the case of the Fed, and a lack of confidence in the currently coronavirus policy response to the White House. To shut the markets entirely, therefore, would mean cutting off the feedback mechanism that has helped guide and refine policy as events surrounding the spread of the coronavirus have unfolded. Besides closing the markets, what else can be done to ease market selling pressures?
To be sure, a number of tools exist today that can help prevent negative market sentiment from completely overwhelming asset prices. The New York Stock Exchange, for example, utilizes circuit breakers that halt trading at three different times throughout the trading day: 15 minutes when the S&P 500 index falls 7% and then again after 13% from its previous day’s close; and a complete halt in trading when prices fall more than 20% during the day.
Another tool used by policymakers to stem a market rout is a ban on short selling. This approach was utilized in 2008 to halt speculative selling pressures in financial stocks. And, this approach is being used today in a number of markets outside of the U.S.
In short, after weeks of policy disappointments, investors are eagerly awaiting some catalyst to quickly stop the bleeding and potentially set the stage for a move higher in the markets. While it’s very well possible that market closures could take place in the weeks ahead, their importance as a signaling mechanism suggest such an outcome would be a last resort among a number of other tools.
What this means is that events like today are likely to remain with us until it is evident that the fight against the coronavirus has reached a turning point. Until then, we provide a number of recommendations that households can take to weather this period of heightened market volatility and uncertainty.