FOMC Delivers an Unscheduled Rate Cut

March 3, 2020

The Federal Open Market Committee made an emergency 50-basis point cut of the federal funds target to 1.0-1.25%. The announcement was flashed at 15:00 GMT (10:00 local time) and was decided by a 10-0 vote. A rate reduction at the March 18th meeting had been priced into the market, and a further move then remains possible. The brief 3-sentence statement of explanation reads:

The fundamentals of the U.S. economy remain strong. However, the coronavirus poses evolving risks to economic activity. In light of these risks and in support of achieving its maximum employment and price stability goals, the Federal Open Market Committee decided today to lower the target range for the federal funds rate by 1/2 percentage point, to 1 to 1‑1/4 percent. 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.

Intermeeting policy changes were routine once upon a time. Thirty of the thirty-eight rate changes from 1987 through 1993 were not done on the day of scheduled policy meetings. Decisions to make U.S. monetary policy more transparent starting in 1994 transformed intermeeting rate changes into very rare occasions that happened only in the context of extreme developments such as the bankruptcy of LTCM in 1998, the  9-11 attacks in 2001, and the financial crisis of 2008, which was associated with intermeeting reductions in both January and October of that year.

In conjunction with rate reductions of 25 basis points last year in July, September and October, today’s action reverses all four of the hikes in 2018 plus the final of three hikes in 2017, which was done in December of that year. Today’s rate adjustment leaves the rate level at a mere 1.0-1.25%, underscoring a reason for investors to be very uneasy about the coronavirus threat to the economy. When the first rate cut needed to be made in the 2008 financial crisis, the fed funds target was at 5.25%, and the prior three big easing cycles began from 6.5% in 2000, 6.0% in 1995 and 9.75% in 1989. There just isn’t nearly as much interest rate room this time for the Fed to counter a shock to the economy in the traditional way, and while stimulus can be provided by quantitative tools, their effectiveness judged from the experience of Japan or even the United States isn’t as apparent as when using the interest rate tool.

It’s not surprising that markets are again showing risk aversion today. The impact of the global pandemic is unknown, and neither fiscal policy nor monetary policy is well positioned to combat at downturn. Moreover, a surprise rate cut on the day of presidential primaries in 15 states breaks another taboo and suggests panic among officials. Monetary officials ordinarily try very hard to ensure that the timing of changes in policy do not appear politically motivated. In 1980, for instance, the Fed waited until the day after Reagan was elected to do a matched sales operation that launched the big offensive against excessive inflation.

Copyright 2020, Larry Greenberg. All rights reserved. No secondary distribution without express permission.

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