Fed Cuts Rates, Restarts QE as Economic Outlook Deteriorates - Butler Financial, LTD


Fed Cuts Rates, Restarts QE as Economic Outlook Deteriorates

Chief Economist Scott Brown discusses the Federal Reserve’s decision to cut interest rates to 0% and restart quantitative easing (QE).

In recent weeks, COVID-19 has led to escalating economic concerns. What started as a seemingly sharp, but likely temporary, reduction in Chinese activity, including disruptions to global supply chains, became more worrisome as the coronavirus moved to the rest of the world. Now spreading widely in the U.S., efforts to contain the virus have had a very sharp impact on travel, tourism, restaurants, sports and entertainment, almost certainly putting the U.S. economy into a recession. More troublesome still, credit market strains became apparent last week, threatening to further broaden the economic downturn.

To counter the downside economic risks of the virus, the Federal Reserve lowered short-term interest rates by 50 basis points between policy meetings on March 3. Last week, amid signs of credit market strain, the Fed provided $1.5 trillion in liquidity to the repo market. On Sunday, March 15, just two days ahead of the regularly scheduled policy meeting, the Fed lowered short-term interest rates further, bringing the target range for the federal funds rate to 0-0.25% (the lower limit reached during the financial crisis) and indicated that it would maintain this target range “until it is confident that the economy has weathered recent events and is on track to achieve its maximum employment and price stability goals” (in other words, for a long time). The Fed also announced further asset purchases (at least $500 billion of Treasuries and $200 billion of agency mortgage-backed securities).

In addition, the Fed has undertaken other actions to support the flow of credit to households and businesses. It lowered the discount rate (the rate the Fed charges banks for short-term borrowing) by 150 basis points, to 0.25%, and extended the period of loans offered to 90 days. The Fed eliminated reserve requirement ratios and encouraged banks to make use of intraday credit with the Fed and use their capital and liquidity buffers to support lending.

The U.S. dollar is important to the global economy. Strains in dollar borrowing abroad can disrupt financial conditions here. To address potential pressures in global markets, the Fed made a coordinated announcement with the Bank of Canada, the Bank of England, the Bank of Japan, the European Central Bank, and the Swiss National Bank to reduce the pricing of dollar swap lines. These long-standing arrangements “carry no risk to the Federal Reserve or to the American taxpayer.”

In his press conference following the March 15 move, Fed Chair Powell highlighted the good position the U.S. economy was in prior to the coronavirus. Growth was moderate. Labor market conditions were strong. Banks were healthy. However:

“Against this favorable backdrop, the virus presents significant economic challenges. Like others, we expect that the illness and the measures now being put in place to stem its spread will have a significant effect on economic activity in the near term. Those in travel, tourism and hospitality industries are already seeing a sharp drop in business. In addition, the effects of the outbreak are restraining economic activity in many foreign economies, which is causing difficulties for U.S. industries that rely on global supply chains. The weakness abroad will also weigh on our exports for a time. Moreover, the energy sector has recently come under stress because of the large drop in global oil prices. Inflation, which has continued to run below our symmetric 2% objective, will likely be held down this year by the effects of the outbreak.

Financial conditions have also tightened markedly. The cost of credit has risen for all but the strongest borrowers, and stock markets around the world are down sharply. Moreover, the rapidly evolving situation has led to high volatility in financial markets as everyone tries to assess the path ahead. In the past week, several important financial markets, including the market for U.S. Treasury securities, have at times shown signs of stress and impaired liquidity.”

The Fed has done a lot here, but can and will do more if needed. These efforts won’t prevent the economy from weakening, but should help to limit the downside and strengthen the eventual rebound. These efforts won’t directly aid those who need the most help, but should help to improve financial conditions in general.

Fiscal stimulus (tax cuts and government spending) is coming.

The scale of the virus’ spread is unknown due to inadequate testing. In turn, it is unclear how long social distancing will last and how much the economy will weaken. We’ll get a better idea as more information becomes available. In the meantime, we can expect heightened volatility to continue in the financial markets.

All expressions of opinion reflect the judgment of Raymond James & Associates, Inc., and are subject to change. 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.

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