The Fed Takes Swift Action

The Fed Takes Swift Action

The Fed's surprise rate cut has implications for markets, the economy and future policy, with the final outcomes hinging on the path of the COVID-19 impacts in the U.S.


Today the Federal Reserve cut its benchmark interest rate by 50 bps. The FOMC's accompanying statement said that the committee is "closely monitoring" developments and will "act as appropriate" going forward. In the subsequent press conference Chair Powell reviewed all of the obvious reasons for today's action, but he refrained from giving any guidance on where things are headed from here.

Looking forward we'd make the following three observations regarding Fed policy and markets.

First, the speed and decisiveness of today's Fed action reflect both the economic seriousness of the ongoing coronavirus/COVID-19 situation, as well as the Fed's proactive stance when it comes to supporting the US economy. With regard to COVID-19, we believe it is now clear that there will be a significant impact on global economic activity. Most forecasters have lowered expectations for global growth to close to zero in 1Q20, and the outlook for 2Q20 remains quite unclear. We think it is straightforward that the Fed should respond to such a sizeable shock to economic activity. (While some observers may complain that monetary policy is ill-suited to respond to a "supply shock," it seems that there is an element of demand shock going on as well. The Fed rightly isn't waiting to find out which one is dominant.)

With regard to the Fed's proactive approach, its messaging on this point has been clear for a while. As the Fed understands, the risks are elevated when growth, inflation and interest rates are all at low levels. In such an environment, we believe monetary policy should be proactive and aggressive in order to support growth and avoid levels moving even lower. Today's actions are evidence that the Fed believes this argument and the FOMC is unanimous in supporting the actions that this argument demands.

Second, the relationship between Fed actions and the market outlook may be weaker than normal in the very near term. The market's response to today's Fed action was telling. The Fed's cut came earlier than most expected and at least met expectations in terms of sizing. What's more, nothing in Powell's comments could be considered disappointing or hawkish. To the contrary, Powell struck a dovish tone in terms of the risks to the outlook and he refrained from suggesting that today's cuts would be immediately taken back should the threat of the virus subside. In short, today the Fed met or even exceeded expectations, and any arguments to the contrary are difficult to credit. And yet, by the end of the day risk markets had moved lower, breakeven inflation moved lower and bond yields moved sharply lower across the curve. Needless to say, this is not the normal behavior for markets in response to the Fed meeting or the Fed's actions exceeding expectations.

The reason for the abnormal market response is that investors are struggling to assess the outlook for COVID-19, and the risks of either further spreading or further economic impact. As long as the COVID-19 risks remain front and center, the relationship between Fed actions and market responses may remain difficult to predict.

Third, and perhaps most importantly, while the Fed may not be the most important factor in determining near-term market moves, we do believe that the Fed is taking meaningful actions that will, over time, have a real impact on the economic outlook and therefore on markets. In particular, the Fed's proactive move to a more accommodative stance will support economic growth, and could even be decisive for the inflation outlook.

The precise way in which this plays out depends crucially on the path of the COVID-19 impacts. Should the COVID-19 impacts prove deeper or more prolonged than currently anticipated, the Fed will likely continue to cut rates, perhaps as early as the March or April FOMC meeting (the market is already priced for another 50 bps of cuts through June). In that case, the Fed's lower rate policy will support sentiment and financial markets, not to mention real activity through increased liquidity and lower lending rates. On the other hand, should the COVID-19 impacts turn out to be more moderate, the Fed's rate cuts could leave monetary policy in an accommodative stance at the same time that a recovery from the COVID-19 slump is propelling growth to above-trend levels. Above-trend growth and easier monetary policy could in turn lead to a quicker recovery in inflation toward the Fed's 2% target. This would be an entirely new environment for markets, or at least an unfamiliar one for investors now accustomed to a steady drumbeat of ever-lower growth and inflation forecasts.

A lot hinges on which of those two paths the COVID-19 impacts take. Today's market moves suggest this will be the most important thing for markets in the near term. But, over the longer term, the real economic impacts of the Fed's actions will matter. And accordingly, markets are more and more likely to be influenced by a proactive and accommodative Fed, especially if that is eventually combined with an economic rebound.


Definitions:

The Federal Reserve Board ("Fed") is responsible for the formulation of U.S. policies designed to promote economic growth, full employment, stable prices, and a sustainable pattern of international trade and payments.

The Federal Open Market Committee (FOMC) is a policy-making body of the Federal Reserve System responsible for the formulation of a policy designed to promote economic growth, full employment, stable prices, and a sustainable pattern of international trade and payments.

One basis point (bps) is one one-hundredth of one percentage point (1/100% or 0.01%).

COVID-19 is the World Health Organization's official designation of the current coronavirus.

Top

Important Information

 

All investments involve risk, including possible loss of principal.

The value of investments and the income from them can go down as well as up and investors may not get back the amounts originally invested, and can be affected by changes in interest rates, in exchange rates, general market conditions, political, social and economic developments and other variable factors. Investment involves risks including but not limited to, possible delays in payments and loss of income or capital. Neither Legg Mason nor any of its affiliates guarantees any rate of return or the return of capital invested. 

Equity securities are subject to price fluctuation and possible loss of principal. Fixed-income securities involve interest rate, credit, inflation and reinvestment risks; and possible loss of principal. As interest rates rise, the value of fixed income securities falls.

International investments are subject to special risks including currency fluctuations, social, economic and political uncertainties, which could increase volatility. These risks are magnified in emerging markets.

Commodities and currencies contain heightened risk that include market, political, regulatory, and natural conditions and may not be suitable for all investors.

Past performance is no guarantee of future results.  Please note that an investor cannot invest directly in an index. Unmanaged index returns do not reflect any fees, expenses or sales charges.

The opinions and views expressed herein are not intended to be relied upon as a prediction or forecast of actual future events or performance, guarantee of future results, recommendations or advice.  Statements made in this material are not intended as buy or sell recommendations of any securities. Forward-looking statements are subject to uncertainties that could cause actual developments and results to differ materially from the expectations expressed. This information has been prepared from sources believed reliable but the accuracy and completeness of the information cannot be guaranteed. Information and opinions expressed by either Legg Mason or its affiliates are current as at the date indicated, are subject to change without notice, and do not take into account the particular investment objectives, financial situation or needs of individual investors.

The information in this material is confidential and proprietary and may not be used other than by the intended user. Neither Legg Mason or its affiliates or any of their officer or employee of Legg Mason accepts any liability whatsoever for any loss arising from any use of this material or its contents. This material may not be reproduced, distributed or published without prior written permission from Legg Mason. Distribution of this material may be restricted in certain jurisdictions. Any persons coming into possession of this material should seek advice for details of, and observe such restrictions (if any).

This material may have been prepared by an advisor or entity affiliated with an entity mentioned below through common control and ownership by Legg Mason, Inc.  Unless otherwise noted the “$” (dollar sign) represents U.S. Dollars.

This material is approved for distribution in those countries and to those recipients listed below. Note: this material may not be available in all regions listed.

All investors and eligible counterparties in Europe, the UK, Switzerland:

In Europe (excluding UK and Switzerland), this financial promotion is issued by Legg Mason Investments (Ireland) Limited, registered office 6th Floor, Building Three, Number One Ballsbridge, 126 Pembroke Road, Ballsbridge, Dublin 4, D04 EP27. Registered in Ireland, Company No. 271887. Authorised and regulated by the Central Bank of Ireland.

All Qualified Investors in Switzerland:
In Switzerland, this financial promotion is issued by Legg Mason Investments (Switzerland) GmbH, authorised by the Swiss Financial Market Supervisory Authority FINMA.  Investors in Switzerland: The representative in Switzerland is FIRST INDEPENDENT FUND SERVICES LTD., Klausstrasse 33, 8008 Zurich, Switzerland and the paying agent in Switzerland is NPB Neue Privat Bank AG, Limmatquai 1, 8024 Zurich, Switzerland. Copies of the Articles of Association, the Prospectus, the Key Investor Information documents and the annual and semi-annual reports of the Company may be obtained free of charge from the representative in Switzerland.

All investors in the UK:
In the UK this financial promotion is issued by Legg Mason Investments (Europe) Limited, registered office 201 Bishopsgate, London EC2M 3AB. Registered in England and Wales, Company No. 1732037. Authorized and regulated by the Financial Conduct Authority. Client Services +44 (0)207 070 7444

All Investors in Hong Kong and Singapore:

This material is provided by Legg Mason Asset Management Hong Kong Limited in Hong Kong and Legg Mason Asset Management Singapore Pte. Limited (Registration Number (UEN): 200007942R) in Singapore.

This material has not been reviewed by any regulatory authority in Hong Kong or Singapore.

All Investors in the People's Republic of China ("PRC"):

This material is provided by Legg Mason Asset Management Hong Kong Limited to intended recipients in the PRC.  The content of this document is only for Press or the PRC investors investing in the QDII Product offered by PRC's commercial bank in accordance with the regulation of China Banking Regulatory Commission.  Investors should read the offering document prior to any subscription.  Please seek advice from PRC's commercial banks and/or other professional advisors, if necessary. Please note that Legg Mason and its affiliates are the Managers of the offshore funds invested by QDII Products only.  Legg Mason and its affiliates are not authorized by any regulatory authority to conduct business or investment activities in China.

This material has not been reviewed by any regulatory authority in the PRC.

Distributors and existing investors in Korea and Distributors in Taiwan:

This material is provided by Legg Mason Asset Management Hong Kong Limited to eligible recipients in Korea and by Legg Mason Investments (Taiwan) Limited (Registration Number: (98) Jin Guan Tou Gu Xin Zi Di 001; Address: Suite E, 55F, Taipei 101 Tower, 7, Xin Yi Road, Section 5, Taipei 110, Taiwan, R.O.C.; Tel: (886) 2-8722 1666) in Taiwan. Legg Mason Investments (Taiwan) Limited operates and manages its business independently.

This material has not been reviewed by any regulatory authority in Korea or Taiwan.

All Investors in the Americas:

This material is provided by Legg Mason Investor Services LLC, a U.S. registered Broker-Dealer, which includes Legg Mason Americas International. Legg Mason Investor Services, LLC, Member FINRA/SIPC, and all entities mentioned are subsidiaries of Legg Mason, Inc.

All Investors in Australia and New Zealand:

This document is issued by Legg Mason Asset Management Australia Limited (ABN 76 004 835 839, AFSL 204827).  The information in this document is of a general nature only and is not intended to be, and is not, a complete or definitive statement of matters described in it. It has not been prepared to take into account the investment objectives, financial objectives or particular needs of any particular person.

Forecasts are inherently limited and should not be relied upon as indicators of actual or future performance.