Fed hits the panic button with 50 bps Fed Funds cut to 1.00-1.25% - some quick thoughts
1) Motivation? Primarily the sharp tightening in US Financial conditions - take a look at the attached chart of GS US Financial Conditions Index vs. mid-point of the Fed Funds target, and how it plays into Fed policy. Early 2016 - sharp spike prompts Fed to pause rate hikes for a year after the initial Dec 2015 hike (conditions were a lot tighter then). Then the Fed was taught a harsh lesson at the end of 2018, when it was so determined to get the Fed Funds Target to the 2.25-2.50%, it ignored the sharp tightening in financial conditions in Q4 2018 (The ECB was guilty of a similar error in its determination to end QE) . It then had to reverse course with its proverbial tail between its legs. But the renewed sharp tightening in financial conditions over the past fortnight has clearly prompted it to hit the panic button. As noted earlier today, equities may have rallied sharply yesterday, but Treasury yields did not (in any significant way) and nor did credit spreads.
2) Will it help with the fall-out from the Coronavirus on the US and global economy - no, though it may alleviate pressure on weaker credits, above all in the energy sector - note how Dallas Fed's Kaplan was voicing a lot of concern last week about widening credit spreads. But as noted this morning in respect of an ECB Coronavirus targeted special LTRO - 'central banks offering incentives for high credit risk arenas is at best dangerous, if not incendiary', and 'fiscal policy would be rather a more appropriate tool'.
3) Remember that observation about extended periods of economic growth 'not dying of old age', but all too frequently of policy mistakes - sort this into that category. This is a supply side shock, it will along with the array of trade tensions sharpen the minds of the corporate world in terms of their supply chains and 'just in time' processes, but there is a structural shift, interest rates and monetary can do little to change that. Indeed following decade in which central bank has fuelled chronic asset price inflation, and sanctioned a shockingly high level of financial engineering, this may In the long run be judged by historians to be a 'straw that broke the camel's back' type of error.
4) in the meantime, FOMO and TINA would appear to have their hands on the gear stick of financial markets, but volatility is likely to remain elevated, even if lower than in recent days. Markets will be expecting the Bank of Canada to follow in the Fed's footsteps tomorrow.
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MARC OSTWALD
Chief Economist & Global Strategist
ADM Investor Services International Limited
