Fed Emergency Rate Cut, March 3, 2020

In a Nutshell:  “The Fed’s emergency rate cut was supposed to boost confidence but it may wind up raising fears that the coronavirus is likely to cause a major economic downturn.”

Decision: Fed funds target range cut 50 basis points to 1.00% to 1.25%.

In an emergency action today, the Federal Reserve cut the fed funds rate by one-half percent.  The Fed noted in its statement that “…the coronavirus poses evolving risks to economic activity.”  In his press conference, Chair Powell indicated he knew that monetary policy would not change economic fundamentals, but he was acting to boost confidence. 

He was right in recognizing that monetary policy is limited in the current situation but may have been all wrong when he thought he was boosting confidence.

First of all, you cannot fight a virus with rate cuts.  The economy will slow because of the actions taken to fight the spread of the virus and those actions will not change because rates are lowered.  Indeed, it is hard to believe the Fed members actually think rate cuts will induce greater business or consumer spending.  I have no idea what the reaction function is that goes from rate cuts to better economic activity when the problem is an epidemic.

Instead, it looks like the Fed, as it did starting at the end of 2018 and all through 2019 when it reversed direction and started cutting rates, is targeting not the real economy but the financial economy.  For the past year, I have written that the Fed seems to have a triple mandate that includes not just growth and inflation but the equity markets.  This move seems to be targeted at the equity markets, as it is not likely to do anything to either growth or inflation. 

Since the late fall of 2018, I have argued that the Fed was wrong to consider cutting rates when the economy was solid and I continued that criticism all through the rate cutting process. 

My concern was that the actions were unnecessary to sustain the expansion and all it would do was make it difficult for the Fed to fight a real economic downturn.  In one respect, I was wrong: Investor confidence remained strong, even as growth moderated as most economists expected. 

But there were fewer arrows left to fire once the virus hit.  And after the current rate cut, which is once again occurring before the appearance of any weakening economic data, the Fed is largely out of ammunition.  Do the members actually believe that taking rates back down to zero will do anything more than it did in 2009? 

Even worse, the Fed may have botched the messaging.  If you cannot wait two weeks to cut rates, then why shouldn’t consumers, businesspeople and investors believe that the economy is on the verge of a recession?  An emergency cut means this is an emergency!

The message is that we are headed into real problems.  That is hardly the way to boost confidence.   

Where does the Fed go from here?  Once the softer economic numbers start coming in, and they we should start seeing them as we move through the spring, more cuts will be needed.  But there is only one percentage point left before we hit zero and that last percentage point is likely to do little. 

The Fed has botched it again.  When the markets tanked in 2018, the members should have looked at it as a resetting of overpriced markets because it was (my comment at the time was a correction is just that, a correction!).  Instead, they panicked and cut rates to support the equity markets.  They succeeded, but at a cost.  The markets surged and we were back into an overpriced situation, at least when you consider an economy that was growing by just 2.25%.  And the Fed wasted seventy-five basis points of ammunition. 

The only good thing to say is that it is a virus that is causing the economic problems and the only action that will turn things around is ending the epidemic.  This downturn was not caused by a bubble bursting or financial irresponsibility.  Instead, all it will likely require is people going back to living normal lives.  That may take a while, but once it does, we are likely to see a sharp recovery.