Market Overview

4 March 2020

Does Fed Pretend to "Save the World", or Just the Opposite, will a Falling Market Give the Fed a Chance?

An emergency rate cut by 50 basis points at once from the US Federal Reserve (Fed) yesterday seemed to strengthen rather than calm fears over the spreading of the coronavirus and the impact it had on global economic realities.

Some piquancy of the situation is that the Fed's brave action came just two weeks ahead of a scheduled FOMC meeting, when the market "crowd" had fully priced in a similar 50-basis-point cut. The mixed and even confusing reaction of many investors until now is probably due to the haste of the Fed's decision.

After all, only a few days ago, several representatives of the American monetary regulator threw up their hands and rested their horns on a seemingly unshakable thesis that the fundamentals of the US economy are strong, the potential damage from the virus to the economy is too early to be assessed and so the monetary policy is accommodative and appropriate enough. Suddenly the Fed made an action based on consultations in the framework of the G7 group, at least that's the way it looks to be chronologically, although they declined that there is a connection. Fed officials decided to take urgent measures during the course of the day when the stock markets were significantly above last week's bottom and did not behave in a very volatile manner.

What could be the deeper meaning of such action given that the last time the Fed resorted to cut interest rates outside of scheduled meetings was in 2008 during a period of hard-core economic crisis? Naturally, many market participants have become suspicious that things may still go from bad to worse. The shares initially jumped more than one percent on the news, but then quickly turned to negative amid fears that just pumping more money into banks or financial markets may not address the core problem that is a contraction of business activity as workers and consumers could stay at home.

It is noteworthy to mention that the news was not received with any enthusiasm by the banking sector. Vice versa, the S&P financials index tumbled by 3.7%, reflecting banks' difficulty in making profits in low-interest rate environment.

"The Fed panicked which they're very good at doing and it was a mistake," said Michael O'Rourke, a strategist with Jones Trading in Stamford, Connecticut. "It is not going to get people to go to the movies or to conferences, sporting events or any large gatherings," he concluded.

"Normally, markets would welcome a rate cut, and they were hoping for it. Now that we've got it, the question is, what's next?" said Peter Kenny, founder of Kenny's Commentary LLC and Strategic Board Solutions LLC in New York.

The trading volume was extraordinary on the U.S. exchanges on Tuesday as 14.7 billion shares changed hands compared to a 9.8 billion-shares average turnover over the last 20 days. People were in doubt about what they should do with shares. Today world indexes are struggling to make some gains but investors are still trading actively in both directions.

There may be some other reason why the highly experienced Fed officials were in such a hurry to cut the rate. US President Donald Trump already tweeted: "The Federal Reserve is cutting but must further ease and, most importantly, come into line with other countries/competitors. We are not playing on a level field. Not fair to USA. It is finally time for the Federal Reserve to LEAD. More easing and cutting!" In the autumn of 2019, just before his famous official meeting with the Fed's chair Jay Powell, Trump in his tweet once called the Fed's to put rates at zero, or even better, for the rates to be on a negative side as it is in Europe, so that America could be the champion of low interest rates on public debt.

"The Federal Reserve should get our interest rates down to ZERO, or less, and we should then start to refinance our debt. INTEREST COST COULD BE BROUGHT WAY DOWN, while at the same time substantially lengthening the term," Trump wrote in Twitter. And he added the main sentence: "....The USA should always be paying the lowest rate. No Inflation! It is only the naïveté of Jay Powell and the Federal Reserve that doesn't allow us to do what other countries are already doing. A once in a lifetime opportunity that we are missing because of "Boneheads."

Given the immense amount of more than 22 trillion in the US Treasury's governmental debt, the problem does look flashy, and lowering the Fed interest rates to almost zero looks like a beautiful solution. However, it is rather difficult to explain to the American people and world investors why interest rates are being lowered at a time when America has, fundamentally, the world's strongest economy.

The Fed is looking for excuses. The last time it lowered rates was when trade tensions with China were at their peak and so a cut was supposable called for. After a showdown with negotiating partners in August and then again in October of 2019, the Fed cut the rates three times. The Phase One deal was signed, some tariffs were postponed or cancelled, but the Fed interest rates were still there. Now the virus could serve as another excuse. Investors vote on the Chicago Mercantile Exchange (CME) with Fed rate futures that the rate could be cut again in April and in June. But the moment after a strong stock market fall now looks to be an ideal situation for the Fed to waist no time and to make a long planned interest rate reduction. Even in two weeks the stock indexes may have a chance to extend their recovery, and in that case there would be no reasonable virus excuse for the Fed's action.

Therefore, the Federal Reserve use their "lifetime opportunity" now to perform some kind of a heroic act. The benchmark ten-year Treasury yield fell below one % for the first time ever as nervous investors withdrew money from the stock market. The yield was 0.999% by the end of Tuesday trading hours and even at lower 0.935% today, during the hours of the European afternoon. The yield on this benchmark bond was 1.9% in the middle of December 2019, not to mention 3.2% in the fall of 2018.

The US financial system has already managed to halve payments on the new Treasury bonds for the last two months, and they continue to refinance the public debt in such an aggressive manner. The coronavirus will be left behind, but the interest rates and the Treasury's yields may remain low or even close to zero if the Fed takes another several months to cut the rates once again. This is where the puzzle seems to come out easily. All talks about creating immunity for the economic maybe just a side effect but, most likely, the markets will have coped with the virus problem on their own.


Analysis and opinions provided herein are intended solely for informational and educational purposes and don't represent a recommendation or investment advice by TeleTrade.

Indiscriminate reliance on illustrative or informational materials may lead to losses.

Lysakov Sergey
Market Focus

Material posted here is solely for information purposes and reliance on this may lead to losses. Past performances are not a reliable indicator of future results. Please read our full disclaimer.

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