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What does the emergency Fed rate cut tell us?

US debt

In a surprise move, the US Federal Reserve lowered interest rates 50 basis points on the 3rd of March in response to the Coronavirus. The Fed’s rate will be set between 1.25% and 1% to tackle “the evolving risks to economic activity.”[1]

Insights from the investment industry have highlighted the sudden movement towards interest cuts, they emphasise the importance of fiscal policy, and air concerns over global recession and the state of the Fed.

Adrian Lowcock, head of personal investing at Willis Owen, highlighted that the emergency meeting by Federal Open Market Committee demonstrated “they are very concerned about the impact coronavirus could have on the US and global economy.” Christian Scherrmann, DWS U.S. economist called the move “somewhat drastic” but echoed the Committee’s sentiment that the state of the US economy is strong. Mike LaBella, Head of Investment Strategy at Legg Mason affiliate QS Investors, said, however, the “bold mood is likely premature,” and that “monetary policy is an unlikely cure for the Coronavirus.”

There was certainly a  consensus among the investment professionals, monetary policy won’t be enough, and fiscal policy is needed to combat the Coronavirus impact. LaBella highlights, “Easing will have a positive impact on sentiment in the short term but until the contagion rates peak, expect uncertainty and volatility to continue.”

Lowcock suggested that cutting interest rates has “done nothing to quell market worries.” Lowcock also stated, “Interest rates will not change the fact companies’ supply chains are being disrupted, nor will it encourage people to go out and spend.” This was strongly agreed on by Scherrmann

David Roberts, co-manager on the Liontrust Global Fixed Income Team went so far to say, “it is nigh on impossible to see how monetary policy can change the course of [the Coronavirus] impact.” Going further Roberts said, “We need aggressive fiscal policy.”

Karen Ward, Chief Market Strategist for EMEA at J.P. Morgan Asset Management aligned with the sentiment that monetary policy would prove more effective with targeted fiscal measures. This would prevent “a vicious cycle of demand weakness leading to job cuts and further weakness.” Ward emphasized that “interest rates will help, so long as they are playing the supporting act to pro-active government stimulus.

Within the industry there were shared concerns over recession:

Roberts suggested, “If monetary responses reduce the propensity for political/fiscal action, as they have done since 2009, then we may find a recession looming.”

Scherrmann echoed this sentiment explaining the concern that if “the Fed sees more risk than markets do,” the action of the committee would be “basically adding fuel to the prevailing uncertainty.”

Ward proposed that the cut in interest rates “is highly likely to be followed by other major banks, including UK  and European Central Banks.” However Lowcock disagreed, suggesting the “action of the US cannot be followed by Europe or Japan, or indeed the UK, where rates are much lower.” Regardless LaBella saliently highlighted “what is certain is the Fed’s already low level of ammunition to fight the next recession just got a lot lower.”

Concerns towards the state of the Fed were also posited, Scherrmann suggested, “Markets are now losing faith in the independence of the Fed.” LaBella classed the move as “unilateral,” and that it may be a sign of the times, with “less faith in international institutions, and less coordinated global response.”

Silver lining?

The move could pose support to asset prices, Ward suggested, as investors are forced to search for yield, and encourage governments to spend given they can finance larger deficits at cheap interest rates. Roberts stating that, for bond investors, the direction is uncertain but short-dated and inflation-linked bonds should do better than the rest.

[1]https://www.federalreserve.gov/newsevents/pressreleases/monetary20200303a.htm

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