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Portfolio > Economy & Markets

Fed’s Surprise Rate Cut Fails to Calm Markets

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If the intention of the Federal Reserve was to calm financial markets in the face of the spreading coronavirus, which threatens U.S. and global economic growth, it failed badly.

After an initial rally following the surprising 0.50% cut in the federal funds rate, U.S. stocks whipsawed. The Dow Jones Industrial Average and Nasdaq ended the trading day down 3%, and the S&P 500 slipped 2%. The 10-year Treasury yield fell to 1%, its lowest level ever and 174 basis points from its yield a year ago.

Vanguard’s chief economist, Roger Aliaga-Diaz, criticized the rate cut as “premature given the lack of data suggesting a significant drag on the economy” and said it “could send the wrong signal to market participants.”

He called the cut — made weeks before the scheduled Federal Open Market Committee meeting — a “rare measure” last used during the global financial crisis in 2008 and a “high-risk bet” that could put the Fed in a “difficult position should conditions deteriorate further,” requiring forceful intervention then.

Economist and money manager Gary Shilling said of the Fed move, “If this doesn’t foretell a global recession and further big declines in equity prices, I don’t know what would. … Lower rates will probably not do anything to help the economy, and the whole exercise may backfire on the Fed by telling the world that it has panicked over the coronavirus.

Mark Haefele, global chief investment officer of UBS Global Wealth Management, suggested that “even though lower interest rates should be fundamentally positive for stocks,” investors “may be concerned about what [the cut] signals for economic developments in the months ahead.”

Given the Fed’s close contact with the business community, it “may already have evidence of economic disruption.”

Should that disruption lead to an economy sinking into recession, the federal funds rate could go back to zero and the Fed could “likely restart its quantitative easing program,” said Kathy Jones, chief fixed income strategist of the Schwab Center for Financial Research. “It’s too soon to say if that will happen, but it is a possibility longer term.”

Tuesday’s rate cut lowered the fed funds rate to a range between 1% and 1.25%. It was the first cut to occur between a regularly scheduled Fed policymaking meeting and followed an aggressive rate cut by Australia’s central bank. The next Fed policy meeting is set for March 17-18.

In its statement the Fed noted that “the fundamentals of the U.S. economy remain strong. However, the coronavirus poses evolving risks to economic activity.” The Fed added that it is “closely monitoring developments and their implications for the economic outlook and will use its tools and act as appropriate to support the economy.”

The Fed’s rate cut follows a warning by the OECD on Monday that the coronavirus’ spread would slash economic growth in the global economy and governments should act immediately to address the impact.

It also follows a morning teleconference with G-7 financial ministers and central bank governors led by Fed Chairman Jerome Powell and U.S. Treasury Secretary Steven Mnuchin that ended with a statement affirming their coordinated commitment “to use all appropriate policy tools to achieve strong, sustainable growth and safeguard against downside risks.”

When asked at his mid-morning news conference whether the Fed’s rate cut was part of a coordinated effort with other central banks, Powell said that each bank and each national government were setting their own monetary and fiscal policies but that the Fed was continuing active discussions with other central banks on an ongoing basis. It’s possible there will be  “more formal coordination as we move forward,” he said.

He explained that U.S. economic fundamentals remain strong but the coronavirus has “materially” changed the risks to the U.S. economic outlook. “The magnitude and persistence” of the virus and its “overall effect on the economy remains highly uncertain and the situation remains a fluid one,” said Powell.

The spread of the coronavirus requires a “multifaceted response” from health care experts, fiscal authorities if determined appropriate and from the public and private sectors, said Powell, adding that monetary policy plays a role, too, supporting the overall economy. It “won’t reduce the spread of infection or fix a broken supply chain,” but can provide a “meaningful boost to the economy” and to avoid tight financial conditions, he said.

Carl Weinberg, chief economist, and Rubeela Farooqi, chief U.S. economist, of High Frequency Economics aren’t so sure. In their morning note, they wrote they don’t believe “that cutting interest rates is at all constructive in resolving the supply shock induced by the coronavirus outbreak and the policy responses to it…. “A Fed rate cut was expected in the markets, but no one expected it today.”


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