Fed makes early cut amid virus fears, taking market by surprise

The Federal Reserve shocked markets on Tuesday when it cut its benchmark rate by a half-percentage point two weeks ahead of its next scheduled policy meeting.

The timing may have been unexpected, but the element of surprise can be advantageous when you’re running out of room to cut rates, according to Michael Greenberg, vice president and portfolio manager with Franklin Templeton Multi-Asset Solutions.

“When you have less ammunition at your disposal to fight these crises, it makes sense to go early and go big to try to surprise the market,” Greenberg said in an interview. “If you can do that, you’ll have to spend fewer bullets in the medium term.”

Greenberg noted the size of the cut wasn’t a surprise — the market had already priced in a half-point drop — but the timing provided a jolt.

“The market was kind of expecting a cut of 50 basis points in two weeks. If the Fed had waited and done that, it probably would have been a bit of a ho-hum reaction [from the market],” he said. “By doing it today, with the shock and awe of going early, they’re probably getting a bit more bang for the limited bullets they have left to support markets.”

While Greenberg acknowledged that a rate cut alone would not be enough to counteract the economic impact of Covid-19, he said it would help bolster consumer confidence, business confidence and financial conditions.

Greenberg predicted the Bank of Canada would cut its benchmark rate by between 25 and 50 basis points on Wednesday. He noted that Australia just cut its rate by a quarter point, and he expects the U.K., which also has room to cut, to make a similar move.

“Those [countries] that have room to cut rates have either done it or probably will do it,” Greenberg said.

In announcing the surprise cut on Tuesday, Fed Chairman Jerome Powell noted that the virus “poses evolving risks to economic activity.”

It was the Fed’s first rate cut since last year, when it reduced its key short-term rate three times. It is also the first time the central bank has cut its key rate between policy meetings since the 2008 financial crisis and the largest rate cut since then.

The Fed’s announcement of a steep rate cut signalled its growing concern that the coronavirus, which is depressing economic activity across the world, poses an escalating threat and could trigger a recession. Yet even before the Fed’s action Tuesday, economists had been cautioning that lower interest rates aren’t the ideal prescription for the threat posed by the coronavirus.

Lower rates can lead people and businesses to borrow and spend, which can boost economic activity. But they can’t directly address the problems that the virus has caused — from closed factories to cancelled business travel to disrupted company supply chains.

The Dow Jones Industrial Average, which had been down as much as 356 points shortly before the Fed’s announcement, was up only modestly a half-hour afterward. On Monday, though, the Dow had rocketed up nearly 1,300 points — its largest percentage gain since 2009.

Nearly every sector in the Standard & Poor’s 500 stock index was up Tuesday. A notable exception was bank stocks. Banks rely on interest payments from loans, which will likely shrink as a result of the Fed’s action. Shares of Bank of America and JPMorgan Chase dropped nearly 3%.

Earlier Tuesday, seven major economies had pledged to use “all appropriate tools” to deal with the spreading coronavirus but announced no immediate actions.

The group of major industrial countries, referred to as the G-7, said it was “ready to take actions, including fiscal measures where appropriate, to aid in the response to the virus and support the economy.” The joint statement from the United States, Japan, Germany, Britain, France, Italy and Canada followed an emergency conference call among the finance ministers and central bank presidents, led by Powell and U.S. Treasury Secretary Steven Mnuchin.

The G-7 has issued similar joint statements during periods of extreme market turmoil, such as the Sept. 11, 2001, terrorist attacks and the 2008 financial crisis.

Last week, the Dow plunged 14% from recent highs, its worst week since the 2008 global financial crisis.

“Given the potential impacts of Covid-19 on global growth, we reaffirm our commitment to use all appropriate policy tools to achieve strong, sustainable growth and safeguard against downside risks,” the G-7 said.

Global agencies have indicated this week that there will be a significant economic impact as the virus spreads.

On Monday, the Organization for Economic Cooperation and Development said that the coronavirus, which was first detected in China but has now spread to 60 nations in Europe, the U.S., Latin America and other parts of Asia, could cause the world economy to shrink this quarter for the first time since the international financial crisis more than a decade ago.

The OECD lowered its forecasts for global growth in 2020 by half a percentage point, to 2.4% — and said the figure could go as low as 1.5% if the outbreak is sustained and widespread. There are signs that the outbreak has begun to ebb in China.