In a haste attempt to mitigate the economic predicaments caused by the coronavirus outbreak, the U.S. Federal Reserve has for the second time, performed an emergency rate cut and has reduced the target interest rate to near 0%, as well as introduced a quantitative easing package.
With the official meeting occurring on the 18th of March, most would regard this decision as extremely risk-averse and quite ahead of its time. Albeit being quick to decide, this action was inevitable at some point in time to most investors, who had extrapolated from the emergency meeting on 3rd March, which involved the central banks cutting rates to 0.5%, as well as the U.S. stock market tumbling into bear market territory over the past few weeks.
The effects of such a decision remain uncertain, but most believe it was to prevent the financial ramifications of the GFC from recurring, which is when the feds last cut rates to 0%-0.25%
Along with the interest rate cut, the federal reserve has also launched a $700B USD quantitative easing program. This purchase is split over Treasurys ($500B USD) and mortgage-backed securities ($200B USD), which is an extremely similar strategy the feds used during the 2008/2009 recession to help shore up housing and US government debt. However, investors are fearful that this simply may not be enough to prevent the economic damage already inflicted (and is soon to come) on the U.S. economy.
In another attempt to increase economic stimulation, the Fed also lowered the primary credit rate by 150 basis points to 0.25% in order to encourage banks to tap into their emergency discount lending window. The discount window is a tool used by U.S. Feds which enables banks to borrow short-term liquidity. By extending the loan period and reducing the rate, the feds hope that banks will borrow the liquidity and service their needs, i.e. providing it so small companies to keep their businesses afloat, and to replace the repayments that the bank(s) will not be receiving as a result of the Coronavirus.
With upcoming U.S. feds meeting coming up in 2 days as well as next month in April, investors believe that the U.S. feds have more tricks up their sleeve to alleviate the economic disruptions. Michael Gapen, Barclays chief economist, states that the action of cutting rates to 0 is a confirmation that the U.S. is in recession and believes that a further interest rate cut of 50bp is yet to come.
Nonetheless, the fate of the rate remains uncertain till date.
Blog article written by Divik Nigam, Research Analyst, Maqro Capital