In a surprise move, the Federal Reserve cut interest rates by 50 basis points on Monday. This was the first emergency rate cut since 2008 during the financial crisis. It's a sign that credit markets and the Fed are taking this coronavirus outbreak much more seriously than the administration.
While the timing of the move was a surprise especially given that the next Federal Open Market Committee (FOMC) meeting is scheduled for March 18, everyone knew that a rate cut was imminent based on plunging bond yields, falling inflation expectations, the inverted curve, fed funds futures, and the escalating impact and uncertainty of the coronavirus outbreak.
In fact, more rate cuts are on the way. Current fed fund futures show a 100% chance of another cut at the March meeting, and three more by the end of the year. Despite the Fed's aggressive moves, monetary policy has actually gotten tighter, and credit conditions have deteriorated. This is evident from indicators like credit spreads, LIBOR, and CDS markets. Not to mention that yields on all durations are at record-low levels that would have seemed unfathomable a decade ago with the ten-year yield under 0.80%, and the thirty-year yield at 1.5%.
Basically, the bond market is in panic mode. In contrast, stocks have been volatile but remain just 10% off all-time highs that were achieved about two weeks ago. Therefore from the stock market's perspective, the Fed's urgency is puzzling.
The stock market and yields briefly bounced on the Fed's cut, but these gains were given back by the end of the day. Many were quick to deem the Fed's actions a failure based on this reaction. However, this misses the point. Financial markets will continue to be volatile until it can discount the economic impact of the coronavirus, Further, fiscal policy will be necessary in order to make up for the lost economic activity.
The Fed's move and its rate path make it clear that the rest is up to Congress and President Donald Trump to enact effective fiscal policy in the form of targeted relief. The coronavirus outbreak is a complicated mess that involves supply chain disruptions, demand destruction, loss of economic activity, and a potential public panic and spiral in confidence.
The Fed's only power is to basically expand or contract the money supply. It's helpful but far from a solution. Markets are unlikely to decisively bottom until the scale and scope of the virus' impact become clear and/or a major fiscal package is proposed comparable to 9/11 or Hurricane Katrina. This seems far off as currently, in the U.S., many areas are still not able to test people.