The Credit Crisis

Fed Intervenes In Virus Scare, Lowers Funds Rate 0.5%

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Fed Chairman Jerome Powell, above, speaks to the press after an emergency meeting held via video conference to lower rates 0.5%.

Trump Fed follows in the footsteps of the activist Obama Fed in a renewed bid to support economic growth following the outbreat of the coronavirus.

After a week in which U.S. stocks suffered their biggest losses since the 2008 credit crisis, the Federal Reserve lowered its benchmark short-term interest rate 0.5 percent in an emergency meeting on Tuesday sending a strong message that it is prepared to use monetary policy to whatever means necessary to support a slowing U.S. economy in the face of a spreading coronavirus.

The 50 basis point decrease, the largest since 2008, will move the all-important Federal Funds rate, the rate used to price everything from savings accounts to mortgages, to a range between 1% and 1.25%.  The Fed's action was not well received by the market as the Dow Jones Industrial Average fell 785.9 points or 2.9% to 25917.41, a surprise result since a rate reduction usually provides a boost to the stock market.

The combination of a slowing U.S. economy and the sudden adverse reaction by investors to the uncertainty surrounding the coronavirus increased the pressure on the Federal Reserve to act even after it appeared as late as a week ago it would stay on the sidelines. "My colleagues and I took this action to help the U.S. economy keep strong in the face of new risks to the economic outlook," Fed Chairman Jerome Powell said in his opening statement at the press conference in Washington.

Just the day before the rate cut President Trump pressured the Fed even more by saying "our Fed should start being a leader not a follower.  We should have at least the same rates, and ideally lower rates, than other countries, we shouldn't be paying more," said President Trump who has consistently lobbied or lower rates.

When asked to further explain the reasoning of the Fed's actions in the Q&A session, Mr. Powell admitted the central bank's actions may have a limited effect. "Monetary policy can be a tool to support overall economic activity, we do recognize a rate cut will not reduce the rate of infection, it won't fix a broken supply-chain, we get that, we don't think we have all the answers, but we do believe our action will provide a meaningful boost to the economy," Mr. Powell said.

The bold half a percent rate cut comes at a time when inflation is on the rise even though the price of crude oil continues to fall.  The Consumer Price Index (CPI) rose 2.5% in January from a year earlier, according to the latest pricing data from February 13th, an increase from the 2.3% unadjusted figure in December.  The consumption-based PCE price index, the Fed's preferred measure of inflation, rose to 1.7% in January from the 1.5% figure in December. 

In the first question of the press conference, the Wall Street Journal's Nick Timiraos asked "what changed between last week when many of your colleagues seemed to indicate it was still too soon to tell how this might influence the economic outlook and today?"  Mr. Powell responded, "Over the course of the last couple of weeks we've seen a broader spread of the virus so we saw a risk to the outlook of the economy and chose to act." 

But the Fed's actions appear not only to be a response to the stock market but also a coordinated effort with other central banks.  When asked about central bank coordination Mr. Powell said he was "in active discussions with central banks around the world on an ongoing basis."  He also cited the G7 statement of finance ministers and governors as a reflection of "coordination at a high level in the form of a commitment to use all available tools."

The Fed chair alluded to consumer confidence as one of the reasons for the central bank's actions but the demand-side of the economy may not feel the biggest impact, according to Harvard economist and former IMF chief economist Ken Rogoff.  "I don't know if its a demand shock or a supply shock because it's still unfolding," said Mr. Rogoff in an interview on CNBC. "If it's a supply shock more that puts upward pressure on prices and we'll see supply shortages."

Three times during the press conference Mr. Powell said the U.S. economy is strong.  "The fundamentals of the U.S. economy remain strong," Mr. Powell said in his opening remarks.  "The unemployment rate has been near half-century lows for well more than a year, the pace of job gains has been solid and wages have been rising.  These strong labor market conditions have underpinned solid household spending, which has been the key driver of economic growth over the past year," said Powell.

When asked if policies played a role in the decision to cut rates Powell replied, "will will always make our decisions on the best thinking we have based on what we learn from our outreach to businesses, non-profits, and educational institutions that we get every cycle through the reserve banks."