Analysts Aren’t Sold On The Fed's Emergency Rate Cut

Analysts Aren’t Sold On The Fed's Emergency Rate Cut

almost 4 years ago3 mins

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The US central bank cut interest rates last week in a bid to stabilize the US economy amid the withering effects of coronavirus – but analysts aren’t convinced it was a good idea…

🕰️ Recap

  • In February, the Chinese central bank attempted to cushion the country’s economy from the impact of coronavirus
  • But as the virus spread west, European and US investors became increasingly nervous
  • On Tuesday, the Federal Reserve announced an emergency US interest rate cut
  • On reflection, however, analysts and investors weren’t convinced it’ll actually help matters

🔗 Connecting The Dots

Interest rates are the key tool central banks use to engineer economic stability. That’s because an economy which is on a downward trend due to, say, a spreading virus, stands to benefit from lower rates: it makes borrowing cheaper and usually promotes extra spending, which should in turn help to boost growth. It’s likely that’s what the US Federal Reserve (the Fed) was trying to achieve with last week’s emergency rate cut.

But the Fed might’ve missed the mark. Businesses aren’t hitting pause on hiring, factory construction, and product launches because they can’t get cheap loans. They’re doing it because workers are calling in sick, being told to stay home, or canceling travel plans for fear of contracting COVID-19. In other words, the economic disruption is primarily with supply, not with demand. And while falling mortgage rates – another byproduct of lowered interest rates – might leave homeowners with more spare cash each month, it’s not much good if the restaurants, bars, and theaters they’d normally spend it are shut.

The Fed acknowledged its rate cut wouldn’t actually fix the economy in the announcement itself, and that seems to have startled investors. So while the idea was that they’d start buying up stocks, they actually sold them. There are a couple of possible reasons why: for one, the Fed hasn’t left itself much room for further cuts when the US economy starts to slip into a demand-driven recession, which will make government “fiscal stimulus” the main recourse. For another, using history as a guide, stocks went on to fall another 50% after a similarly unscheduled cut back in 2008.

🥡 Takeaways

Much of the world dances to the US’s drumbeat, so investors might now be more likely to expect coordinated rate cuts from the world’s other major economies (think the UK, Japan, and the eurozone). Indeed, the G7 – an international economic organization – promised to do what it could to achieve “strong, sustainable” economic growth last week. But lower rates will make new bonds less attractive, which might explain why investors bought up existing government bonds (pushing their yields to new lows). And while stocks should be more attractive too, investors will have to balance that with tempered economic and earnings growth expectations.

The difference between yields on 10-year and 2-year US government bonds narrowed again last week, which is generally considered a warning sign of an impending recession. In a downturn – or when investors are afraid of one – stock market investors tend to opt for so-called “defensive” companies like consumer staples, telecoms, and utilities since people tend to buy food, use their phones, and switch on their heating no matter what. The hope is that those companies will fare better than their “cyclical” counterparts, whose products are among the first to lose out when spending contracts.

🎯 Also On Our Radar

Teleconferencing provider Zoom reported better-than-expected results across the board last week, giving its share price a boost. It’s one of several companies analysts had earmarked as a potential beneficiary of the coronavirus outbreak. Others include video-streaming companies like Netflix, and gaming firms like Activision Blizzard. Our analysts have looked at those industries – media, gaming, and telecoms – in more depth, and explored how to pick the potential winners tucked away within them, in our new Pack: Media, Gaming, and Telecoms.

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