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The Fed Makes Its Coronavirus Cut

By Dan Caplinger - Updated Mar 3, 2020 at 4:40PM

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The central bank made a typically kneejerk reaction in reducing short-term rates. Will it work?

The Federal Reserve cut the target range for its short-term federal funds rate by half a percentage point on Tuesday morning, setting the new range at 1% to 1.25%. The unanimous move from the central bank came as economists weigh the threat of the Covid-19 coronavirus outbreak to the global economy, both in terms of the short-term potential for massive disruptions and the longer-term implications for future growth.

Yet despite the Fed's assertion that the move will support its broader policy goals, it's unclear how reducing short-term rates on an emergency basis will avoid any of the harm that the coronavirus could do to the economy. If anything, the reduction leaves the Fed with fewer tools to avoid future economic problems for which rate cuts could be much more effective.

Top of Federal Reserve building, showing eagle and engraving.

Image source: Getty Images.

What the Fed said

The Fed's statement was short and to the point :

The fundamentals of the U.S. economy remain strong. However, the coronavirus poses evolving risks to economic activity. In light of these risks and in support of achieving its maximum employment and price stability goals, the Federal Open Market Committee decided today to lower the target range for the federal funds rate by 1/2 percentage point, to 1 to 1-1/4 percent. The Committee is closely monitoring developments and their implications for the economic outlook and will use its tools and act as appropriate to support the economy.

The move came shortly after an emergency conference call of the G-7 countries to discuss potential responses to the Covid-19 outbreak. Treasury Secretary Steven Mnuchin said that he would work with lawmakers on Capitol Hill in Washington on procuring emergency funding in an effort to add fiscal stimulus to the economy. Longer-term moves could also include passage of the long-discussed infrastructure development program.

During the news conference, Fed Chair Jay Powell elaborated on some of the arguments in the statement. He pointed to tourism and travel as already seeing disruptions, and businesses that rely on global supply chains are starting to see problems as well.

Was anyone surprised?

Part of the value of an emergency rate cut is the shock effect it can have on markets. Yet in this case, the market had largely already anticipated movement from the Fed. Rates on 10-year Treasuries had already fallen by more than half a percentage point in the last couple of weeks alone, and short-term Treasury rates had similarly already anticipated a move. Indeed, rates on two-year Treasuries suggest investors believe that more extensive rate cuts are imminent due to the coronavirus.

Some critics have argued that a rate cut will do nothing to prevent economic disruption from the coronavirus. The typical reason for reducing interest rates is to encourage investment and to put more money in the hands of debt-ridden consumers. However, the nature of the coronavirus problem has economists wondering if consumers would actually spend more money even if they had it, given the rising reluctance for consumers to spend on things like travel, entertainment outside the home, and other activities that require going out in public.

What's next?

Even Powell admits that the outbreak defies prediction. "The magnitude and persistence of the overall effects on the economy," the Fed chair said, "remain highly uncertain, and the situation remains a fluid one."

Investors had a brief positive reaction to the announcement, but once the Fed chair's news conference started, major market benchmarks quickly lost ground. That represented a vote of no confidence from investors in the central bank's ability to have much of an impact on what happens to the global economy if the coronavirus crisis continues to worsen. Unfortunately, the only thing that will really determine how bad things get is how widely the outbreak spreads -- and only time will answer that key question.

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