The decision of the US Federal Reserve to cut interest rates once more and restart QE was expected by investors. But not on a Sunday afternoon. Asset managers characterise the sudden decision as ‘a defining moment’, for more than one reason.
‘We had expected this outcome [by 100 basis points to a range of 0 to 0.25%], but thought they would wait until the planned meeting on Wednesday,’ said ING’s chief economist James Knightley in a market report Sunday evening. ‘But with the news flow about the virus getting worse and economic disruption set to increase, the Fed clearly thought it wise to be ahead of the market opening.’
Moreover, the bank had expected a restart of QE, but had previously counted on an amount of about $75 billion a month. ‘By stating they are going to buy at least $500 billion of treasury paper and $200 billion of mortgage-backed securities in the coming months, the Fed has given a more general end goal,’ Knightley said. ‘That will give them more flexibility to load or react to any market disruption.’
The bank expects GDP to fall by 8% year-on-year in the second quarter, down from an expected -4.4% in the first quarter. This is all due to the supply crisis in the manufacturing industry, the panic in the financial sector and the collapse of air travel.
The Fed’s action will not save the U.S. economy from recession, according to Knightley, but it will help mitigate the risks of financial tensions that could make growth and job prospects much worse. It will also provide breathing space before an expected fiscal stimulus.’
Out of ammunition
‘This is a very, very important moment’, writes macro-economist Edin Mujagic of OHV Vermogensbeheer in the Netherlands, noting the Fed basically used almost all the remaining resources at its disposal at once, and has now pretty much run out of ammunition.
‘If this step does not substantially remove the uncertainty and fear in financial markets and in the economy, then a Minsky moment (…) might be just around the corner! A Minsky moment happens when prices suddenly drop sharply. Last week’s fall, despite its intensity, was not such a fall,’ he said.
Mujagic finds the initial reaction of US stock markets to the Fed’s measures ‘at least worrying’. Wall Street opened deep in the red on Monday morning.
The macroeconomist thinks the central banks’ action is more likely to succeed if governments swiftly follow in their footsteps. Only with budgetary measures of a similar magnitude would there be a good chance that the negative economic effects of the coronavirus will be neutralized. This does not mean that Q1 and Q2 will not be bad quarters, macro-economically speaking. That is unavoidable. But with equally impressive action by the fiscal authorities, it is likely that the economy will recover from the corona crash in the near future.’
Fed independence
Chief economist Philippe Waechter of Ostrum Asset Management notes on his blog that the Fed’s drastic measures followed a White House alarm call. ‘Like in Europe, it is now up to fiscal policy to reduce risk and control the reduction in economic activity that’s now taking place in the US. The US have limited room to escape a recession.’