Everybody gets so much information all day long that they lose common sense. ~ Gertrude Stein
Question: Could you explain the Federal Reserve rate cut last Tuesday, March 3rd?
Answer: Imagine the “economy” as a human being that uses currency or money as a food source to maintain and sustain itself. If there is global uncertainty, it follows that confidence and might be increased; and it might be easier to understand why lowering the cost of this commodity is intended to increase overall confidence. The Federal Reserve Open Market Committee (FOMC) reduced the target range for the federal funds rate by 50 basis points or 0.50% by a unanimous vote to lower the range to 1.00-1.50% effective March 4th, 2020. This occurred two weeks ahead of the regularly scheduled policy meeting on March 17-18. The FOMC stated that “the fundamentals of the U.S. economy remain strong,” while referencing the evolving risks to economic activity due to Coronavirus.
At a press conference on March 3rd, Federal Reserve Chairman Powel said that the Fed will “use all tools available and act appropriately” to keep the economy strong. Powel acknowledged that coronavirus is already affecting tourism, travel and industries relying on global supply chains. He further stated that coronavirus and the measures taken to contain it “will surely weigh on economic activity, both here and abroad, for some time.”
Lowering interest rates reduces the “cost” of money for businesses and borrowers. Easy monetary policy is intended to help the economy and enhance business confidence, not reduce the rate of infection or fix a broken supply chain.
Some investors fear that the Fed is out of ammunition. The Fed is in the process of reviewing its monetary policy tools, strategies, and communication policy, and is expected to announce possible changes around the middle of this year. It has another 100 bps or 1.00% to work with on the federal funds rate. Given we are close to zero already, the Fed should move more aggressively (sooner, larger moves) if it thinks it has to. That thinking was probably a big part of the March 3rd, 2020 decision.
Once we get to 0-0.25% on the federal fund’s target rate, the next step is forward managing expectations and sentiment through forward guidance. The Fed’s action is a conditional commitment to keep short-term interest rates low for the time being. It appears that if the economic slowdown continues and uncertainty remains, the next logical move could be further quantitative easing (QE). QE is the large-scale asset purchases of treasuries and possibly mortgage-backed securities. The Fed has strongly hinted that they are opposed to negative interest rates, but that could be a possible last resort to promote and support economic activity. Money goes where it is treated best, or where the return is believed to be effectively balanced with the risk.
Typically, monetary stimulus via rate cuts is quick and easy to implement but the effects and impact on the economy may lag up to a year or more. In contrast, fiscal stimulus—tax cuts, increased government spending—has an immediate effect, but is usually difficult to achieve. It’s tough to get Congress to agree on anything, especially leading up to the Presidential Election.
Note that no Republican in the House voted for the Obama stimulus, even though we would have had a similar proposal if John McCain had been elected president. The federal budget deficit is already over $1 trillion, but borrowing costs are extremely low—and getting lower. Republicans in Congress will favor tax cuts while Democrats will favor additional spending. We could see a combination—as with the Obama stimulus. Aid to states will be critical, as most have balanced budget requirements—policy becomes contractionary during a downturn.
In the meantime, lawmakers should support greater efforts to contain the virus. That means identifying the infected, isolating them, and informing the appropriate health authorities (the three “I’s”). These efforts could lead to a greater “social distancing;” that is, reductions in tourism and travel, avoidance of restaurants, shopping centers, theatres, and sporting events, but the economic impact would be temporary so long as a more widespread outbreak is avoided.
There are two elements of the coronavirus—the human element and the economic impact. The uncertainty is unsettling on both sides, especially when the markets recorded such strong total returns during 2019. History shows that disruption is common and disturbing, no matter what the cause of the inexact doubt. Stay focused and wash your hands.
This material is being provided for informational purposes only and has been obtained from sources considered reliable, but we do not guarantee that the material presented is accurate or that it provides a complete description of the securities, markets or developments mentioned. Any information should not be deemed a recommendation to buy, hold, or sell any security. There is no assurance any of the trends mentioned will continue or that any of the forecasts mentioned will occur. Economic and market conditions are subject to change. Investing involves risk including the possible loss of capital. Past performance may not be indicative of future results. The opinions expressed are those of the writer as of March 3, 2020, but not necessarily those of Raymond James and Associates, and are subject to change at any time based on market conditions and other factors. “Certified Financial Planner Board of Standards Inc. owns the certification marks CFP®, CERTIFIED FINANCIAL PLANNER™, CFP® (with plaque design) and CFP® (with flame design) in the U.S., which it awards to individuals who successfully complete CFP Board’s initial and ongoing certification requirements.” This article provided by Darcie Guerin, CFP®, Vice President, Investments & Branch Manager of Raymond James & Associates, Inc. Member New York Stock Exchange/SIPC 606 Bald Eagle Dr. Suite 401, Marco Island, FL 34145. She may be reached at 239–389-1041, email email@example.com Website: www.raymondjames.com/Darcie.