MAKING SENSE OF THE FED’S AGGRESSIVE POLICY DECISION
In an unprecedented action, the Federal Reserve delivered a second emergency rate cut this month, slashing interest rates back to zero as coronavirus concerns continue to mount. They also unveiled additional programs (including QE-style asset purchases and repo operations) focused on providing stability to strained fixed income markets and bank balance sheets. Simply put, the Fed uncorked a policy bazooka aimed squarely at the coronavirus pandemic and related economic fallout.
At the risk of using overly-technical jargon: we’ll take it. Though many question the effectiveness of monetary policy in fighting a pandemic (and this is fair) the Fed acted proactively and aggressively to support the US economy. Financial textbooks would say that stock prices reflect discounted future cash flows, or in layman’s terms, that stocks do a decent job of predicting the future. Well, as you likely know, the stock market has suffered a lot of pain recently, more than likely reflecting the ever-increasing odds of virus-driven, oil-led recession. The Fed agrees, and decided to empty the holster.
The major concern is that quarantines, social distancing, and general anxiety will lead to a crash in demand for the economy. This is particularly worrisome for the services industry, which is a majority of US GDP – restaurants, bars, yoga classes, tattoo parlors, and so on. While multinational conglomerates (e.g. McDonalds, Starbucks) will struggle as demand wanes, the deli down the block may only survive a few weeks if no one is buying BLTs. Further, the oil price war has put US energy companies on the ropes. On the whole, lower rates could make it easier for businesses to keep the lights on in trying times.
Still, this is just a fraction of the medicine needed. Our friends at Strategas Research Partners have elevated the odds of a 2020 recession to 75%. Baird’s Chief Investment Strategist Bruce Bittles writes that while pandemics tend to be transitory, “temporary shocks can lead to bankruptcies, rising unemployment and other adverse effects on the economy before it bounces back.” The Fed’s action indicates that the risk of a recession is real, and much of the fight remains ahead of us.
While cutting rates may not be exactly what the doctor prescribed, we appreciate the speed and decisiveness of the Fed’s action. They’ve left no stone unturned. But as we’ve discussed before, this is a double-edged sword – lower rates on auto and business loans also mean lower rates for bond investors, putting additional strain on portfolios.
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