Fed surprises markets with emergency rate cut

Fed surprises markets with emergency rate cut

Fears about the potential impact of the Coronavirus on the global economy have prompted the US Federal Reserve to cut interest rates by 0.5 per cent.

The action comes a day after the Organisation for Economic Co-operation and Development (OECD) warned that a period of prolonged disruption could lead to global GDP growth being half its previous estimate this year.

Outgoing Bank of England governor Mark Carney has warned that there is likely to be a “large economic shock” as a result of the Coronavirus. 

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In announcing its decision to cut rates, the Federal Reserve stated that while the economic fundamentals of the US remain strong, the decision to cut rates was in response to the risks from the Coronavirus. 

The immediate equity market response was mixed as investors attempted to make sense of the move. The S&P 500, which had been in negative territory prior to the announcement, was 0.6 per cent higher as of 15:45 GMT.

Neil Birrell, chief investment officer at Premier Miton said: "The move by the Fed comes as a big surprise but will be welcomed by markets. Cuts were already discounted, but not so much so soon. It’s likely that other central banks will follow. It won’t have much immediate impact on the economy but investors will be encouraged by the positive action."

The central bank meeting was unscheduled. Edward Park, chief investment officer at wealth manager Brooks Macdonald said: "Markets are trying to weigh up the unknown risk of the virus with the known stimulus efforts by governments and central banks, the decisive cut by the Federal Reserve provides an additional reason for investors to consider buying the dip."

In addition to equity markets falling sharply over the past week - prior to yesterday's rebound - US government bond yields have fallen. This is usually a sign that the market expects lower economic growth. 

The problem faced by policymakers is that it is not clear whether cutting interest rates will address either supply issues or the slump in demand already being witnessed in areas such as travel and hospitality.

Guy Monson, chief investment officer at Sarasin and Partners, said: “The virus holds particular risks for the world economy because it creates both a demand and supply shock to goods and services. A demand shock alone can be mitigated by interest rate cuts and central bank support. However, if labour is quarantined, critical supplies become unavailable and public gatherings are restricted, the impact of rate cuts will be muted at best.

"Monetary policy impact is also limited because many central banks are already ‘maxed-out’, with interest rates close to zero or negative, and bloated central bank balance sheets. Banking profitability in Europe is also particularly weak, making further rate cuts potentially self-defeating.” 

In his remarks to the Treasury Select Committee this morning (March 3) Mr Carney said the risk is that a supply shock turns into a demand shock which leads to recession.