The Federal Reserve intended to send a clear message of support to financial markets by slashing its key interest rate on Tuesday morning. Instead, the U.S. central bank propelled investors’ anxiety levels into the stratosphere.
The flagship S&P 500 Index of big U.S. stocks provided the most obvious gauge of money managers’ drum-tight nerves over the economic effects of the coronavirus. The market benchmark jumped after the Fed announced it was chopping the federal funds rate by half a percentage point, to between 1 per cent and 1.25 per cent.
Only minutes later, though, the market began losing ground as people started to ponder the deeper implications of the surprise cut. The S&P finished the day down a stinging 2.81 per cent.
So much for soothing words from the Fed. Rather than reassuring investors, the central bank’s dash to slash is making some market observers wonder if the Fed itself is panicking.
“We believe the announcement by the Fed today to cut interest rates was premature given the lack of data suggesting a significant drag on the economy,” wrote Roger Aliaga-Diaz, chief economist for the Americas at the giant money manager Vanguard. He described the Fed’s move as a “high-risk bet” unwarranted by actual evidence on the state of the economy or the spread of the virus.
At the very least, the cut undermines those who hope the crisis is coming under control. It screams that the Fed regards the coronavirus as a massive and imminent economic threat. That is deeply unsettling.
“The Fed’s emergency rate cut was supposed to boost confidence, but it may wind up raising fears that the coronavirus is likely to cause a major economic downturn,” Joel Naroff of Naroff Economics LLC wrote in a report.
The Fed usually moves interest rates only at its regularly scheduled meetings, and it typically adjusts its key federal funds rate in modest 25-basis-point nudges. (A basis point is one hundredth of a percentage point, so a 25-basis-point adjustment works out to a quarter of a percentage point, while 50 basis points is equivalent to half a percentage point.)
The last time the central bank cut the federal funds rate by a full 50 basis points outside of a regularly scheduled meeting was in October, 2008, during the depths of the financial crisis. It acted then because of growing panic over the collapse of the financial-services company Lehman Brothers. The Fed’s willingness to administer the same strong dose of medicine now indicates how seriously it is taking the coronavirus threat.
So does its sense of urgency. Futures markets had been betting on a 50-basis-point cut by the end of the regular Fed meeting on March 18. On Friday, the Fed hinted it would be prepared to move before the meeting. The extremely short time between those hints and the actual rate cut indicates how swiftly the coronavirus crisis is developing.
However, the central bank’s rush to act also adds to concern that the Fed’s messaging may be spreading jitters. “If you cannot wait two weeks to cut rates, then why shouldn’t consumers, business people and investors believe that the economy is on the verge of a recession,” Mr. Naroff said.
The cut also raises questions about how much further the Fed will go to support markets. Futures markets are already banking on another 50 basis points of rate reductions over the remainder of this year.
Politics may have something to say about whether that comes to pass. Donald Trump, the market-watcher-in-chief, tweeted his support on Tuesday for even more cuts. For months, the U.S. President has been firing abuse at the Fed over its reluctance to slash rates and goose the economy. The central bank’s latest move comes only a few months ahead of November’s presidential vote.
The Fed may have rushed to act now because it wants to stand pat in the run-up to the election and avoid accusations of caving in to the President. However, if economic data worsen, its hand could be forced.
Of course, that is assuming rate cuts will cushion the blows from the coronavirus outbreak. That is not a sure thing.
Lower rates can’t repair busted supply chains, encourage frightened consumers to go out to restaurants, or get more virus-wary vacationers on board airlines to foreign destinations. If schools were to close for a couple of weeks to prevent transmission of the virus, lower rates couldn’t cover for parents who may have to stay home to look after their kids.
Even if rate cuts are effective at supporting parts of the economy such as home building, there is not a lot of room left to trim. Over the past three decades, central banks have typically slashed their key interest rates by 500 basis points to deal with recessions. After Tuesday’s cut, the Fed has only 100 basis points left to cut before it hits zero.
That leaves nervous investors with a couple of dismal takeaways: The Fed is clearly worried. It is also clearly running out of ammunition.