Market Updates

Federal Reserve Makes Surprise Rate Cut

In response to the potential fallout from the ongoing Coronavirus outbreak, the Federal Reserve Open Market Committee (FOMC) made a unanimous decision to cut the Federal Funds rate by 50 basis points (0.50%) this morning. The Fed Funds target rate is now in the range of 1.00%-1.25%.

While the markets had been pricing in easing out of the Fed, this move came early and was more than markets expected. On the back of the move, the Fed sensitive 2-year yield plummeted down to 0.75%.

Despite the move, markets continue to price in more rate cuts ahead. After the announcement, market participants increased their outlook for further easing in the months ahead. As seen in the chart below, despite delivering the 50-basis point cut today, markets are still calling for a 0.25% cut in March and 0.675% worth of total cuts over the coming twelve months. If markets are correct, we may well find ourselves back at the zero lower bound we just recently escaped.

What are we watching:
• Risk assets, such as stocks and corporate bonds, continue to gyrate in response to the rate cut, the potential economic fallout and the impact on the pivotal presidential election. The Fed action is further complicated by the Super Tuesday action that seeks to provide clarity on the emergence of Bernie Sanders or Joe Biden on the Democratic ticket. The stock market rallied on Monday largely in response to the centrist support for presidential hopeful Joe Biden.
• Stresses appear to be re-emerging in the funding markets around repurchase agreements (“repo”). Recall it was just six months ago the Fed was forced to intervene to help clear the repo markets by purchasing Treasury bills and supplying repo financing to dealers who wished to finance Treasury positions.
• Forward-looking inflation markets had a muted response to the surprise rate cut. This will further challenge the Fed as they seek to regain credibility around their elusive 2% inflation targeting campaign. Normally a surprise cut would give rise to increased inflation expectations. We will continue to monitor this developing trend as this will loom large in future Fed decisions.

GPA’s recommendations: Maintain the discipline of your investment process. Highly volatile markets remind us of the difficulty of predicting future interest rates. The best investing approach to uncertainty is to remain diversified, both in maturity and in security types, with a focus on upcoming liquidity needs.