The Federal Reserve announced a rare inter-meeting emergency interest rate cut of 50 basis points this week. The accompanying statement said that the “fundamentals of the US economy remain strong” but the coronavirus posed “evolving risks to economic activity”. The statement was released after a conference call of G7 finance ministers and central bankers about a response to the virus failed to result in coordinated action. However, the Bank of Canada has since implemented a 50 basis point cut of its own. Following the Fed’s move, investors continued to anticipate further policy easing, sending the yield on a ten-year US government bond below 1% for the first time in history. Investors expect further interest rate cuts ahead. Can previous inter-meeting decisions shed light on the subject?
Refresh the chart in your browser | Edit the chart in Datastream
The Federal Reserve rarely announces policy moves in-between meetings. The last time it did so was in October 2008 at the height of the Global Financial Crisis. In total, there were three inter-meeting cuts during 2007 and 2008 as policymakers responded to a severe economic shock and turbulent financial conditions. Before that, the Fed enacted three emergency rate cuts during 2001 — two related to the fallout from the dot-com bubble and one in response to the 9/11 terrorist attacks. Meanwhile, in 1998, the Fed reduced its interest rate in response to Russia’s financial crisis. Looking back, history suggests that an emergency rate cut tends to be a sign of further easing to come. Interest rates continued to decline in 2001 and 2007/08, however, the Russia shock is a notable exception to this rule, with interest rates rising soon after the emergency cut. There has been one example of an inter-meeting policy tightening. In April 1994, the Fed increased its policy rate by 25 basis points, a move that was followed by further tightening.
Refresh the chart in your browser | Edit the chart in Datastream
Want more charts and analysis? Access a pre-built library of charts built by Fathom Consulting via Datastream Chartbook in Eikon.
A look at history suggests that investors are right to anticipate future Fed easing. However, there is a big difference between the economic impact of COVID-19 and the Global Financial Crisis. In the latter, the initial impact was a negative shock to aggregate demand. Easier monetary policy was the textbook response. With COVID-19, there is likely to be a hit to both supply and demand. The shock to supply comes as firms cannot produce as much before, due to factory shutdowns or staff sickness, implying shortages or price increases. Meanwhile, reduced confidence and increased uncertainty is likely to have a negative effect on demand. Further interest rate cuts would only really make sense if the negative shock to demand is larger than that to supply. So far, the official economic data suggest that coronavirus has yet to have a large impact on domestic demand. Indeed, the ISM non-manufacturing survey rose to 57.3 in February. Meanwhile, its manufacturing counterpart dropped by 0.8 points but remained above 50. Fed Chair, Jerome Powell, said the policy easing this week was in response to disruptions to trade and travel elsewhere and that there was no sign of a domestic slowdown yet. Signs of a change on that front will be decisive when it comes to the future direction of monetary policy.
Refresh the chart in your browser | Edit the chart in Datastream
__________________________________________________________________________________
Datastream
Financial time series database which allows you to identify and examine trends, generate and test ideas and develop view points on the market.
Refinitiv offers the world’s most comprehensive historical database for numerical macroeconomic and cross-asset financial data which started in the 1950s and has grown into an indispensable resource for financial professionals. Find out more.
Article Topics
Uncategorized
