Fed Surprises With Rate Cut

The Federal Open Market Committee (FOMC) cut rates by .50% in preparation for potential coronavirus impacts.

For the first time since 2008, the Federal Open Market Committee (FOMC) opted for an unscheduled, 50-basis-point rate cut on Tuesday, bringing the target range for the federal funds rate (the overnight lending rate) to 1.00-1.25%. The FOMC cited evolving risks to economic activity posed by the coronavirus, explains Raymond James Chief Economist Scott Brown. While economic fundamentals remain solid, the FOMC will continue to monitor developments and “will act as appropriate to support the economy.”

The move was sooner and larger than anticipated, and further rate cuts are possible. The spread of COVID-19 appears to have slowed in China, and the country’s manufacturing sector has begun to recover; however, supply chain disruptions and lower sales into the Chinese market have presented issues for U.S. firms, Brown added. As Americans prepare to deal with the spread of the virus, we can expect to see more “social distancing” in the form of reduced travel and dining out, as well as possible school closings, which could lead to a drop in economic activity stateside.

Of course, no one knows quite what will happen. Judging by the sharp drop in the equity markets last month, the stock market seems to have already factored in a worst-case scenario. The market’s reaction to the rate cut was to be expected, according to Kevin Giddis, chief fixed income strategist. The bond market had already priced in three cuts this year (75 basis points total) so the immediate impact is likely to be small, explains Doug Drabik, managing director for fixed income research. The spread between the 3-month bill and the 10-year note, which had been negative for several weeks, is now positive.

The Fed’s rate cut – and promise to do more if needed – should help to insure against downside risks and bolster household and business confidence, Brown noted. The People’s Bank of China and Reserve Bank of Australia also lowered interest rates, and Chief Investment Officer Larry Adam believes the Fed, along with other foreign central banks, will proactively use available tools to support economic expansion and offset any potentially negative repercussions. However, we caution that lowering rates may not do much to keep the public from acting irrationally. Until this virus is contained or public fear subsides, we are likely going to see periods of high volume and volatility as investors look for protection and opportunity, Giddis added.

© Raymond James

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