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Wealth Management: Strategy blog – What does the Fed know?

Strategy team - Kevin Gardiner (Wealth Management)

The Federal Reserve (the Fed) has unexpectedly cut its main policy rate - the Fed funds rate - by 0.5% (50bp), taking the targeted range to 1-1.25%. It is a surprise because the FOMC's next scheduled meeting is two weeks away.

It has cut interest rates between meetings before, most recently in 2008, 2007, 2001 and 1998 - times of significant market turbulence. It would seem that the Fed thinks things now are comparably serious, and for this reason the market response may be a relatively measured one.

We'd been in two minds about the Fed's likely move, and our wariness is amplified by the "emergency" timing.

Arguably, if tackling the coronavirus requires an interruption to business, then perhaps the Fed can't - or shouldn't - be doing much anyway. If US manufacturers' supply chains are missing components from China, lower US rates are hardly going to magic them into being.

Maybe the Fed sees some companies facing financial distress - but if so, the more logical response might have been the direct provision of liquidity, not a cut in borrowing costs (from levels which were low, and widely fixed, to begin with). Credit spreads have certainly widened, but not yet to extreme levels, and the same is true of the short-term money market spreads that can signal a widening liquidity squeeze.

But apart from encouraging investors psychologically to rely on Fed support even more than they already were, the move may not do much damage.

We still suspect that the collective response to the virus is an over-reaction to the objective threat, albeit an understandable one (in a world that has never been safer from violence or pestilence, any revival in danger is alarming: our thoughts are with the affected families). It will take time for this to become apparent, however, and patience is clearly in short supply.

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