The Federal Open Market Committee (FOMC) cut the federal funds rate by 50 basis points after an emergency session. In a short-worded press release, the FOMC stated "...the coronavirus poses evolving risk to economic activity. In light of these risks...the FOMC decided today to lower the target range...to 1 to 1-1/4 percent."
This move came on the heels of a G-7 Finance Minister and Central Bank Governor's joint statement earlier in the day where they said, "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. Alongside strengthening efforts to expand health services, G-7 finance ministers are ready to take actions, including fiscal measures where appropriate, to aid in the response to the virus and support the economy during this phase."
Although some market participants had been calling for an emergency cut, and interest rates had largely been pricing in two cuts at the FOMC's regularly-scheduled meeting on March 18, the FOMC's actions caught the market off-guard. Ironically, while the FOMC was clearly trying to calm markets with their rate cut, it actually had the opposite effect. Stocks sold off and interest rates fell precipitously, with the ten-year Treasury rate closing below 1.00%.
Although it would be easy to say the market's reaction to the FOMC was due to disappointment, it appears the exact rationale for the risk-off move is a bit more complicated. Given the cut wasn't anticipated for another couple of weeks, and this would have been on the full side of what the market expected later this month, the math just doesn't add up. Instead, it appears the bond market is now pricing in one more cut by year end than it was expecting pre-announcement, possibly because the FOMC chose to cut quickly and aggressively, foreshadowing similar behavior in the future, up to and including additional rounds of QE.
In "normal" markets, this should be a positive for risk assets. However, these aren't normal times. Teasing out the specific message from the price movement is difficult, but it affirms:
- Nobody knows what the economic impact will be from the coronavirus. Given the stock market's reaction over the past week, people thought it would be somewhat bad, possibly even really bad, but nobody knew exactly how bad. Today, the FOMC clearly agreed with the market that it would likely be somewhat bad, which added anxiousness to investors who were already shell-shocked from last week's rapid decline in equity prices and interest rates.
- The rapid resumption in equity prices and interest rates after some positive news indicates we haven't achieved risk-off capitulation yet. This means things could get worse before they get better. This is relevant given we are in uncharted waters and emotions are driving things far more than rational fundamental valuations (since rational fundamental valuations don't exist).
- The economic data will likely get worse before it gets better. While it is difficult to predict how the market will react to the inevitable erosion in economic data that comes out in the coming weeks/months, a good signal of a market bottom will be a positive market reaction to bad news; be that economic news or coronavirus-specific news. Until then, hold on tight and be prepared for more volatility.
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