The Fed cut its benchmark interest rate and instituted largescale asset purchases

Looking at the implications from the Fed's surprise rate cut.

Mar 16, 2020 | David Chao






In a surprise move, the Federal Reserve cut its benchmark interest rate to 0 – 0.25% on Sunday and instituted largescale asset purchases.

Although the initial criticism may be that the Fed has done a combination of the right things at the wrong time – I argue that by making as much finance available as possible makes sense in this market.

An “ounce of prevention is worth more than a pound of cure”

As financial conditions have recently tightened, with MNCs drawing down letters of credit, investment-grade credit spreads widening and cashflows starting to seize up for small businesses – it all makes sense that the Fed took an “ounce of prevention is worth more than a pound of cure” course of action – although in this instance, it was a tone of prevention.

What I’m most concerned about is COVID-19’s damage to the real economy – Main Street. Time will tell what the negative impact the COVID-19 will have on businesses and workers in the US and EU.

I argue that investors should care less about what the market’s response to the Fed’s recent actions but instead tune in to what specific policies are being implemented to buffer the economy against the downward COVID-19 shock.

The Fed’s recent aggressive actions will have a more significant impact on the average worker and Main street businesses affected by the coronavirus.

The important thing is for governments and central banks to protect household and corporate cash flows. By cutting interest rates close to 0 and re-starting quantitative easing, the Fed is ensuring that financial institutions have the cash and liquidity to lend support to businesses and people affected by the outbreak. This is critical and both the Fed and Bank of England are helping with this.

More fiscal stimulus needed

In addition, governments need to give corporate tax holidays/rebates and improve safety nets for workers (sick pay etc). Again, both UK and US are moving in this direction - we expect the Congress to pass a strong fiscal stimulus bill shortly that addresses many of these issues – which should be a boost to the markets.  

Keep in mind that COVID-19 is an exogenous, systematic shock to the entire global economy - that’s why credit and asset markets are in such turmoil. This is reflected in collapsing bond yields and inflation expectations, widening credit spreads and volatile equity markets. Investors are right to look for a strong fiscal and monetary response, globally, since we are all in this together.  

In order for confidence to be restored to the markets, we are watching for the US and EU governments to employ the following policy prescriptive: 

  1. Collaborative public health measures to get the outbreak under control, ramping up testing, ventilators, mobile ICUs and vaccination efforts;
  2. More monetary easing to keep banks liquid and markets functioning, including dollar swap lines to other major central banks as in the GFC;
  3. More fiscal – dollops of dollars financed by quantitative easing in the short term, to keep people, SMEs and major corporations liquid enough to survive.

Investment implications

I think that predicting short term moves in markets is difficult and becoming a fool’s errand. The looming increase in new infection cases in the US and EU will ultimately overwhelm the Fed and other central banks’ announcements in the near-term.

The COVID-19 has a serious threat in pushing the global economy towards recession levels if governments do not enact strong containment and economy policies. I still think that it’s possible for the US economy to have a V-shaped recover given the recent aggressive monetary and fiscal policies.

Lower oil prices and interest rates will be supportive to consumers around the world. Risk assets such as US high yield and equities are becoming more attractive as they have come down sharply from their premium multiples just a month ago.     

David Chao is Global Market Strategist for Asia Pacific at Invesco. 

Related articles

Important information

This document has been prepared only for those persons to whom Invesco has provided it for informational purposes only. This document is not an offering of a financial product and is not intended for and should not be distributed to retail clients who are resident in jurisdiction where its distribution is not authorized or is unlawful. Circulation, disclosure, or dissemination of all or any part of this document to any person without the consent of Invesco is prohibited.

This document may contain statements that are not purely historical in nature but are "forward-looking statements", which are based on certain assumptions of future events. Forward-looking statements are based on information available on the date hereof, and Invesco does not assume any duty to update any forward-looking statement. Actual events may differ from those assumed. There can be no assurance that forward-looking statements, including any projected returns, will materialize or that actual market conditions and/or performance results will not be materially different or worse than those presented.

The information in this document has been prepared without taking into account any investor’s investment objectives, financial situation or particular needs. Before acting on the information the investor should consider its appropriateness having regard to their investment objectives, financial situation and needs.

You should note that this information:
•    may contain references to amounts which are not in local currencies;
•    may contain financial information which is not prepared in accordance with the laws or practices of your country of residence;
•    may not address risks associated with investment in foreign currency denominated investments; and
•    does not address local tax issues.

All material presented is compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. Investment involves risk. Please review all financial material carefully before investing. The opinions expressed are based on current market conditions and are subject to change without notice. These opinions may differ from those of other Invesco investment professionals.

The distribution and offering of this document in certain jurisdictions may be restricted by law. Persons into whose possession this marketing material may come are required to inform themselves about and to comply with any relevant restrictions. This does not constitute an offer or solicitation by anyone in any jurisdiction in which such an offer is not authorised or to any person to whom it is unlawful to make such an offer or solicitation.