Given the dramatic market volatility of the past week or so, it was widely expected that the Federal Open Market Committee, or FOMC (the policy-making part of the Federal Reserve) would slash interest rates when it is scheduled to meet later this month.
Well, the Fed surprised the market by doing it a little earlier than expected. On Sunday, the Fed abruptly cut the benchmark federal funds rate by 100 basis points to a target range of 0%-0.25%, which is as low as it can be without going negative (more on that later). This follows a 50-basis point rate cut just a couple of weeks prior.
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In addition to the rate cut action, the Fed also announced a $700 billion quantitative easing program to help the economy absorb the negative effects of the coronavirus outbreak.
If you aren't familiar, "quantitative easing" is a way for the Fed to inject money into the economy by purchasing assets -- in this case, $500 billion in Treasury securities and $200 billion in mortgage-backed securities. The purchases will begin right away, with $40 billion in purchases set to take place on Monday.
Quantitative easing is designed to help grow a sluggish economy or avoid a recession and can also help to help meet inflation targets. In fact, quantitative easing was a major part of the Fed's response to the financial crisis and is often credited with significantly helping to mitigate the effects of its aftermath.
Here's what Fed Chairman Powell said about it
In a press conference following the announcement, Fed Chairman Jerome Powell said that the new lower rate would be kept in place for as long as it needs to. As Powell said: "We will maintain the rate at this level until we're confident that the economy has weathered recent events and is on track to achieve our maximum employment and price stability goals."
Powell followed by saying "... we're going to be watching, and willing to be patient, certainly." In other words, Powell wanted to let investors know that this isn't just a quick rate cut that will go away as soon as the outbreak numbers start to fade.
What it means for investors
This move certainly will go a long way to ensure that our financial system weathers the storm, but it's not likely to stop any virus-related stock market volatility. After all, the mission of the Fed is to stabilize the financial system, so consumers will still have access to credit and banks will have access to capital, among other things.
As far as the stock market goes, stability is certainly better than uncertainty. However, stock market futures sold off sharply after the Fed's announcement (not necessarily because of it -- the announcement just happened to come right around the same time the futures market opened). The outbreak and the U.S. response to it jumped to another level this weekend, and until the numbers of new virus cases and deaths start to show that the efforts are working, the market is likely to remain a volatile place.
What if things get even worse?
One big question that remains is what happens if the Fed needs to do more in order to keep the financial system operational and stable. For example, let's say that the near-shutdown of the U.S. economy lasts for weeks longer than expected -- then what? After all, with interest rates now at zero, what else can the Fed do?
In its statement, the Fed said that it is prepared to use its "full range of tools to support the flow of credit to households and businesses and thereby promote its maximum employment and price stability goals."
One thing the Fed could try is negative interest rates. This isn't entirely unprecedented -- negative interest rates are quite common in several international markets (although it would be a first in the U.S.). For example, in Denmark you can even get a mortgage with a negative interest rate, meaning that you'll pay back less than you borrow.
However, Powell emphasized that negative rates are currently not on the table, saying that the Fed doesn't see such a move as appropriate for the U.S.
Other potential avenues could include the commercial paper market (short-term corporate financing), or the Fed could potentially start using a quantitative easing program to buy assets like stocks and longer-term corporate bonds, although Powell isn't entertaining these options yet. And the Fed could potentially expand its quantitative easing program. Sure, $700 billion sounds like a big number (and it is), but it's worth pointing out that the Fed accumulated nearly $4 trillion on its balance sheet after the financial crisis during three separate rounds of quantitative easing before the program ended.
The bottom line is that while the Fed certainly used up quite a bit of its ammunition in today's action, it could still have a few tricks up its sleeves if it needs them.
