What does the Fed hope to achieve with its first emergency rate cut since 2008? Frances Donald outlines the pressures prompting the Fed's move, the limitations of their policy tool, and the economic vulnerabilities that lower rates may help mitigate in the months ahead.
In response to growing concerns about the downside risks to growth and inflation from escalating coronavirus outbreak, the Federal Reserve has cut interest rates by 50 basis points outside of a regular scheduled meeting. This is the first emergency rate cut that we've seen since 2008. What will rate cuts accomplish in this environment? Well, they're certainly not going to help fix supply chains, which are increasingly disrupted by borders rising across many countries all over the world. They aren't going to fix the consumer demand shock, the confidence shock that we're seeing amongst households who are afraid to go outside for their personal safety. And they won't solve the underlying problem facing global growth, which is a health crisis. And yet the Federal Reserve had to cut, or you'd risk tightening financial conditions further. Cut, or you risk more strength in the U S dollar, which is painful for us companies and global growth. Cut, or you risk the equity market selling off further. And yet, following the 50 basis-point cut from the Federal Reserve, equity markets did sell off. Rates moved even lower. Why is that? In our view, it's because global markets were anticipating not just a Federal Reserve cut, but a globally coordinated cut. The ECB, for example, taking part. The Bank of England. Instead, the Fed went it alone. Now, we do expect that almost every major developed market central bank in the world will be cutting interest rates at their next scheduled meeting. How much probably depends on the future of this virus, and whether or not it escalates or dissipates from this point forward.
While we expect further easing from the Federal Reserve and most other major central banks, we still have sizable concerns about global and U.S. growth in the next quarter and possibly beyond that. We see evidence that supply chains are truly creating some sizable destruction and growth is contracting globally. As a result, we are concerned about some bleed through from the manufacturing sector into the services sector in the United States, and some evidence that consumers are less confident. That should weigh on retail spending and potentially, even hiring activity. Most importantly, we're concerned that this is a market that continues to price in a sizable amount of easing from the Federal Reserve. It's asking for a lot from Chair Powell. What we need to see from him to avoid a spike up in yields and a tightening of financial conditions is not just additional rate cuts, but giving a strong signal that those rate cuts won't be unwound over time.
Now, while we're concerned about growth in the next several months, on a 12-month forward-looking basis, we're actually more optimistic. We're seeing signs that most governments are looking to add some form of fiscal stimulus to the economy, including the UK, the United States, Germany. These are all countries that we expect to see fiscal packages contributing to growth. That's a more powerful form of stimulus than rate cuts by themselvesóit allows stimulus to be targeted to certain sectors or regions. We also realize that low interest rates will help households because refinancing will accelerate. That will lower the total amount that households have to pay each month towards their debt, put a little extra cash in their pockets. Lastly, there is very little evidence of any inflation in the U.S. or global economy. That implies the Federal Reserve can keep rates low for an extended period of time, and the U.S. economy can enjoy better growth without having to fear higher interest rates. Put that together, and what we're looking at is short-term pain, but longer-term gains time to get through this rough patch before we slingshot into a better economy.