Investors did not respond to the Fed’s surprise 50 basis points rate cut with a relief rally. To the contrary, markets closed almost 3% lower as investors interpreted the rate cut as a warning the macroeconomic situation is likely to worsen.
Fed president Jerome Powell stated shortly after Wall Street opened that the negative effects of the coronavirus are slowly becoming visible.
‘The outlook is very uncertain. We lowered interest rates with the goal of preventing worse,’ he said. The Fed president stressed, however, that the long-term outlook for the U.S. economy remains good.
Powell said there is no reason for concern about the state of credit markets, such as rising defaults. The Fed president denied he had been the subject of political pressure, although President Trump took to Twitter earlier on Tuesday to call on the Fed to lower interest.
….paying higher rates than many others, when we should be paying less. Tough on our exporters and puts the USA at a competitive disadvantage. Must be the other way around. Should ease and cut rate big. Jerome Powell led Federal Reserve has called it wrong from day one. Sad!
— Donald J. Trump (@realDonaldTrump) March 3, 2020
Market reactions
James McCann, investment strategist at Aberdeen Standard Investments, said in response to the interest rate decision that ‘while it may bring relief to the markets, it is not a panacea and risks leaving governments on their hands’. According to McCann, the Fed mainly responded to market panic, as economic data do not justify a rate cut at this stage.
According to Janus Henderson Investors, the interest rate cut will not be enough. Bond specialist Andrew Mulliner points out that the interest rate cut is the same size as in October 2008. ‘How bad can it get? The Fed’s move indicates that this is not the beginning of the end, but the end of the beginning of a growing shock,’ he said.
Ranko Berich, head of research at Monex Europe, agrees. He argues the interest rate cut has shocked the markets and that the coronavirus outbreak is much worse than initially assumed. At the time, central banks still believed the virus would be successfully contained and that the recovery could begin in the second quarter.
ING’s chief economist James Knightley said the coronavirus not only led to a supply crisis, but could now also lead to a demand crisis as companies and consumers around the world change their behaviour. ING expects this shock to come from the services and tourism sectors, with weaker exports and a possible recession in the second quarter as a result. A recovery may then begin in the course of the summer.
Esty Dwek, head of global market strategy at Natixis IM Solutions, expects other central banks will follow the Fed in cutting interest rates and support markets with more liquidity. US indices were down almost 3 percent at close after having gained some 5% on Monday.
