• Joel

USD Slammed as Fed Conducts 50bps Emergency Rate Cut

In a move that caught everyone in the market completely off guard, the US Federal Reserve conducted a 50bps emergency rate cut, lowering their key lending rate to 1.00%-1.25%.

The Fed released a statement alongside the surprise rate cut, saying that the US economy remains fundamentally strong but the Covid-19 outbreak poses “evolving” risks to economic activity.

The most surprising aspect of the move was its timing; markets had actually already been pricing in over 50bps worth of Fed easing in the month of March (meaning a large cut was expected at some point in the month).

But no one had expected an emergency rate cut with under three weeks to go until the Fed’s 18th of March meeting. Or, more specifically, no one had expected the Fed would go it alone without other G7 central banks cutting alongside it.

Indeed, at the beginning of the week, there was some speculation that the world's major central banks might conduct a joint emergency rate cut. This speculation was fueled after an emergency G7 teleconference (at which central bankers were present) was hastily arranged; the post teleconference G7 statement was a disappointment, as it failed to commit to any specific monetary or fiscal easing.

Certainly, the Fed must have been disappointed by the outcome of the call. We now know that the Fed decided on its emergency cut late last night. Much of the call might have been dedicated to the Fed trying to persuade other central banks to cut alongside it to make the cut more impactful. But most of the other G7 central banks have much less policy ammunition than the Fed (i.e. their interest rates are already at much lower levels), so it is understandable that they may have been reluctant to cut rates in such haste.

Regardless, the Fed's move heaps enormous pressure on G7 central banks to cut at their next meeting. Market pricing is seeing it that way anyway; money markets now price a 50bps rate cut at tomorrow’s BoC meeting and a 25bps cut from the BoE later in the month. The ECB is seen easing rates by 10bps in April.

In other words, maybe the Fed lost the battle (persuading the G7 to cut rates today), but they will likely win the war (it looks like G7 central banks will all have to ease at their next meetings anyway).

Market Reaction

The hugely surprising dovish move saw USD get absolutely hammered; EURUSD shot above 1.1200 and DXY below 97.00. (As a reminder, when a central bank lowers rates this is usually a negative for the currency). Moreover, in a typically dovish reaction, US stocks, bonds, and gold also received a boost.

However, the stock market boost quickly faded. For one thing, the emergency cut struck many in the market as somewhat “desperate” or “panicky”. Moreover, many said that the Fed had wasted valuable policy ammunition, leaving it more exposed the next time it needs to lower rates to support the economy. As such, the move appears to have reduced the market's confidence, not boosted it.

Powell’s performance in the press conference did little to change this narrative. When questioned on the Fed’s plan going forward, he was unable to deliver a convincing answer. When questioned on what had changed in the last week, prior to which the Fed said it was monitoring the outbreak, Powell again had no convincing answer (he cited the increased pace of international spread of the virus).

Markets may also have been expressing some disappointment that the Fed's rate cut was not accompanied by simultaneous cuts from other major global central banks.

Was the cut a mistake?

For a few reasons, I believe this cut will do more harm than good.

Firstly, it has failed to deliver what I think was the desired effect; to boost the market's risk appetite. So the Fed has effectively thrown away 50bps worth of policy ammunition for no positive financial market effect.

Moreover, it damages the Fed's credibility. The Fed is supposed to pursue a mandate of price stability and full employment, not be concerned with the stock market. But what was the catalyst for this sudden shift in Fed policy? The stock market's crash last week.

The Fed can say all they want that it was the growth rate of the international spread of Covid-19, but it was the stock market crash. Why else would Fed members have been playing down the impact of Covid-19 all week? Because they hadn't yet been briefed on what those at the top of the Fed (Powell, Clarida and Williams) had decided to do; cut rates to support the stock market.


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