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The Fed Cuts Rates - Again

The U.S. Federal Reserve took additional emergency measures to improve financial conditions on March 15th. For the second time in two weeks, the Fed announced an inter-meeting interest rate cut, this time dropping the Federal Funds Rate to zero. In a new measure, the Fed will also allow banks to borrow for up to 90 days, instead of the normal overnight loan. This should provide banks with ample liquidity to meet their day-to-day operations.

With rates at zero, the Fed has now exhausted its most effective policy tool, but don’t rule out negative interest rates over the coming months. In addition, there are other options at the Fed’s disposal to provide more stimulus to the economy.

As I’ve mentioned in the past, the U.S. Federal Reserve is in an envious position compared to other global central banks. Entering this economic slowdown, the Fed had raised interest rates to 1.5%, while other central banks were still zero-bound. This provided the Fed with more ammunition to fight a slowdown. Jerome Powell, the chairman of the Federal Reserve, recently messaged that the Federal Reserve is prepared to use all the tools at its disposal to protect the economy from the impact of the coronavirus pandemic.

Ben Jones analyzing data on screen

The Return of Quantitative Easing
The Federal Reserve also announced the return of quantitative easing (QE). The Fed’s initial plan includes purchasing at least $700 billion in government and mortgage-related bonds. By buying bonds, the Fed is attempting to lower interest rates across the entire curve, instead of only controlling the short-term Federal Funds Rate. QE can be an effective tool; however, the absolute size may need to increase over the coming months to provide the impact the Fed is looking for.

What This Means for Investors
The Fed is clearly concerned about the health of the economy, as is the team at Allegiant. A near-term slowdown is all but inevitable. No amount of stimulus will change that. However, the Fed is trying to make sure this slowdown does not become a financial crisis. By acting early and often, the Fed is trying to get ahead of the negative economic impact. Furthermore, when the dust finally settles with the coronavirus outbreak, the Fed wants to support the resurgence of economic activity. Lower interest rates will help.

The market reaction to both of the Federal Reserve’s emergency actions over the past two weeks was not positive. Lowering interest rates by 1.5% sends a powerful message that the Fed believes the near-term challenges are significant. While surprising to some, the Fed’s recent actions are a logical response to the steps businesses and households are taking to slow the spread of the coronavirus. With so many short-term headwinds, there is no reason to have interest rates at 1.5%. Inflation is certainly not a concern right now, leaving the Fed free to focus on the other side of its dual mandate - promoting maximum employment.

With the Fed choosing to act early, all eyes will now turn to the Fed’s upcoming regularly scheduled meeting on March 17-18. Whether or not they announce further support, we will surely receive a better description of their thoughts. In my opinion, both monetary and fiscal stimulus is necessary to aid the recovery. The next round of help may have to come from Congress.

Benjamin W. Jones, CFP®, AIF®
President, Chief Investment Officer, Principal

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