Virus spread prompts Fed to slash rates in surprise move

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Federal Reserve building in Washington DC, US. Close up of a top part of the building with eagle statue © Andrei Medvedev /123RF Stock PhotosIn a surprise move, the Federal Reserve cut its benchmark interest rate by a sizeable half-percentage point Tuesday in an effort to support the economy in the face of the spreading coronavirus.

Chairman Jerome Powell said at a news conference that the virus “will surely weigh on economic activity both here and abroad for some time.”

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 it’s the largest rate cut since then.  The move, which the Fed’s policy committee backed unanimously, lowered its benchmark rate to a range of one per cent to 1.25 per cent.

The Dow Jones Industrial Average, which had been down as much as 356 points shortly before the Fed’s announcement, initially jumped on the news when it was announced at 10 a.m. Eastern time. The surge was short-lived. By late morning, the Dow was down about 300 points. Still, on Monday, the Dow had rocketed up nearly 1,300 points — its largest percentage gain since 2009.

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

“The Fed obviously cannot address the virus itself by cutting rates, but they can hope to short-circuit the potential for a negative response in financial markets that could make the economic impact of the virus even worse,” said Eric Winograd, senior economist at AB.

At his news conference after the rate cut, Powell was asked what had changed from last week, when several Fed officials said they saw no immediate need to cut rates even as stock markets endured their biggest losses since the 2008 financial crisis. The chairman replied that “we have seen a broader spread of the virus. So, we saw a risk to the economy and we chose to act.”

“We have come to the view now that it was time for us to act to support the economy,” he added.

The chairman acknowledged that there are limits to the Fed’s influence on the economy. But he said he believes Tuesday’s surprise rate cut would provide a “meaningful boost to the economy.”

He acknowledged, though, that while central banks and fiscal policymakers can help mitigate the economic damage the “ultimate solution to this challenge will come from others, most notably health professionals.”

Paul Ashworth, chief U.S. economist for Capital Economics, said, “With financial markets in turmoil and evidence growing that the coronavirus is developing into a pandemic, the Fed’s change of heart is entirely understandable.”

Ashworth noted that the Fed’s statement Tuesday repeated language it has used in the past that it would act as appropriate. He said this may suggest that the Fed is leaning toward an additional rate cut, perhaps as soon as its next scheduled policy meeting in two weeks.

Across the world, business is slowing and in some places stopping altogether as a consequence of the virus. Factories in China have been struggling to grind slowly back to life. Many European vacation destinations have been all but deserted as leisure and corporate travel has diminished. And major companies around the world bracing for the risk that the economic landscape could worsen before it improves.

Indeed, Powell noted that “you are hearing concerns from people in the travel business, the hotel business and things like that.”

“We expect that will continue and probably will grow,” he said.

Google told its 8,000 full-time staffers and contractors at its European headquarters in Dublin to work from home Tuesday. Irish news reports have said that a Google staffer is being tested for coronavirus. But the company issued only a brief statement that said it was continuing to take precautionary measures to protect the health and safety of its workforce.

President Donald Trump, who has repeatedly attacked the Fed and Powell in particular for not cutting rates more aggressively, doubled down in a new tweet after the Fed’s announcement, saying, “More easing and cutting!”

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 per cent 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 per cent and said the figure could go as low as 1.5 per cent if the outbreak is sustained and widespread. There are signs that the outbreak has begun to ebb in China.

 

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