U.S. Fed cuts interest rate to near zero to support economy

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The U.S. Federal Reserve is taking emergency action to buoy the American economy, as the disruption caused by the novel coronavirus raises fears of recession and a credit freeze in financial markets.

The United States central bank announced Sunday a series of sweeping measures, chief among them a reduction in its benchmark interest rate by a full percentage point to effectively zero, its second surprise rate cut this month – with the Fed saying interest rates will remain there until the economy “has weathered recent events.”

The bank will also renew quantitative easing, as it buys US$700-billion in Treasury and mortgage securities, as well as eliminate the requirement for commercial banks to hold reserve funds from the amounts they loan out.

And in co-ordination with the Bank of Canada and four other central banks, the Fed is shoring up the liquidity of U.S. currency by reducing the amount it charges other central banks to purchase U.S. dollars, who then provide those funds to domestic financial institutions.

The moves in the U.S. follow similar efforts by the Bank of Canada to quickly cut interest rates to levels previously seen during the 2008 financial crisis. Ottawa has also rolled out $1.1-billion in emergency funding to fight the virus, has promised to unveil this week a major fiscal stimulus package and moved to significantly increase lending capacity in the Canadian economy.

Those measures have been enacted since equity markets began their steep decline in late February, driven by fears of massive economic disruption from the coronavirus. In Canada, the drop on Thursday was the steepest in eight decades, worse than even the Black Monday crash of 1987.

Economists said the Bank of Canada, which reduced its own key rate to 0.75 per cent with an emergency half-percentage-point cut on Friday, could now come under pressure to cut even deeper – and soon – to keep pace with the Fed. Ian Pollick, head of North American rates strategy at CIBC Capital Markets, said the Bank of Canada had been expected to cut rates soon, but it is now unlikely to wait until its next scheduled meeting on April 15. "The question now becomes one of timing,” he said.

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Bank of Nova Scotia economist Derek Holt said the U.S. central bank’s goal is not necessarily to support equity markets, but rather to ensure that the financial system functions properly. “They really went all out here,” he said, adding that it is possible the Fed’s monitoring flagged growing risk in the financial system.

In a conference call with reporters, U.S. Federal Reserve chairman Jerome Powell said the bank acted Sunday after having decided to meet this weekend ahead of its regular policy committee meeting later in the week. Mr. Powell said the Fed decided not to issue its usual quarterly projections for the economy and interest rates this week because the coronavirus is altering the economic picture too quickly to make such projections useful.

The central bank’s reduction in its benchmark rate to a range between zero per cent and 0.25 per cent did not seem to comfort equity markets.

U.S. stock futures began falling after the Fed’s announcement. Futures for the S&P 500 index dropped 4 per cent, while futures for the Dow Jones Industrial Average fell 3.7 per cent. Prices for gold, a traditional safe haven for investors, rose 3.5 per cent.

David Rosenberg, head of Rosenberg Research in Toronto, said the co-ordinated move among global central banks is designed to bolster liquidity and that it should also help support investor confidence.

However, Mr. Rosenberg said he is concerned about how much more the Fed, the world’s most powerful central bank, can do from here, as the COVID-19 crisis in the U.S. continues to deepen and Washington politics remains fractured.

“Let’s face it – the Fed was already pretty well out of bullets, and after this bazooka, it is completely out of bullets. That’s a big problem, to have going forward an impotent central bank at a time when there is such a partisan divide that is frustrating a fiscal solution,” he said.

Scott Clark, who was deputy minister when Paul Martin was finance minister, echoed that sentiment, saying massive fiscal stimulus is needed in Canada and other countries to deal with a global economy already contracting.

“We have already entered into a global recession and I call this a global-virus recession,” he said in an interview, urging Finance Minister Bill Morneau to take “really major, really significant measures.”

On Friday in Ottawa, there was co-ordinated action to boost liquidity, with the Bank of Canada cutting its benchmark rate by 50 basis points to 0.75 per cent, its second reduction in less than two weeks. Mr. Morneau said two Crown lending agencies, Export Development Canada and the Business Development Bank of Canada, would boost their lending by $10-billion. And the Office of the Superintendent of Financial Institutions loosened capital reserve requirements for large banks, creating $300-billion worth of new lending capacity.

Mr. Clark said Ottawa must provide much more credit to small business than the $10-billion, as well as significant funding for employment insurance to deal with mass layoffs, funds for possible industry bailouts and billions more to the health care system to cope with the coronavirus.

Prime Minister Justin Trudeau is to have a telephone call with Group of Seven leaders – the U.S., France, Germany, Italy, Britain, Japan – on Monday. Mr. Clark said the G20, which includes China and Russia, need to be involved as they were during the 2008 financial crisis.

In its statement, the Fed said the effects of the coronavirus will have a negative impact on the U.S. economy in the near term and that it is ready to use its “full range of tools” to support the flow of credit to households and businesses.

The U.S. central bank said the reduction in the cost for other central banks to buy U.S. currency – the swap-line mechanism was put in place during the 2008 financial crisis – will take effect this week. The Fed’s move was made in co-ordination with the Bank of Canada, the Bank of England, the Bank of Japan, the European Central Bank and the Swiss National Bank.

In a statement, the Bank of Canada said the swap line is not needed at this time, but that it provides flexibility “to address rapidly evolving developments in financial markets.” The bank also said Canadian financial institutions do not appear to be having difficulties with U.S. dollar liquidity needs in North America.

With reports from Associated Press

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