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Federal Reserve Rx: 50 basis points of rate cuts now, more possible later

03 March 2020 Ken Matheny, Ph.D.

This morning the Federal Reserve announced a half-point cut in the target for the federal funds rate, to a range of 1% to 1¼%. The situation surrounding COVID-19 is continuing to evolve rapidly, with difficult-to ascertain economic impacts, so the outlook for interest rates is also more uncertain. It is likely that additional monetary stimulus will be forthcoming in the form of further reductions in interest rates by the Federal Reserve.

The statement announcing this morning's decision to lower the federal funds rate by 50 basis points noted "evolving risks to economic activity" emanating from the coronavirus. Hinting at its intentions for coming weeks and months, the statement noted that "the Committee is closely monitoring developments and their implications for the economic outlook and will use its tools and act as appropriate to support the economy."

Shortly after the announcement, Chairman Powell held a brief press conference. The two most important takeaways are:

  1. A full response to the virus entails far more than monetary policy. Nonetheless, there is a role for monetary policy to provide a boost to the economy by "avoiding a tightening of financial conditions."
  2. Chairman Powell asserted that the FOMC likes "our current policy stance"; however, it is prepared to use its tools "and act as appropriate to support the economy."

The decision to lower rates is intended to "help the US economy keep strong in the face of new risks to the economic outlook." Policymakers expect that the virus and measures taken to contain the outbreak "will surely weigh" on economic activity "for some time." The magnitude and persistence of such impacts, however, "remain highly uncertain." Justifying a decision to cut rates at this time, the Federal Open Market Committee judged that risks to the US outlook had "changed materially" since the time of the last policy meeting in late January.

Implications for the forecast

Last week we had expected an aggressive Fed response based on the burgeoning risks to the outlook emanating from the coronavirus outbreak, so today's announcement was not unexpected. By acting quickly and aggressively, the Chairman implicitly signaled a high degree of concern about risks to the outlook, and that the Federal Reserve is prepared to provide additional accommodation, if appropriate. Given the ongoing tightening of financial conditions — in the US, broad equity indices did rise on the Fed's announcement but then declined anew, while risks spreads have widened over the past few weeks — additional Fed rate-cutting is likely. We expect the FOMC will consider a rate cut at either the upcoming meeting on 18 March or at the subsequent meeting on 29 April. The timing and magnitude of additional actions is highly dependent on subsequent developments, including developments in financial markets.

Posted 03 March 2020 by Ken Matheny, Ph.D., Executive Director, IHS Markit

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