What’s Going On Here?After the US Federal Reserve’s (the Fed’s) emergency interest rate cut on Tuesday, some investors were left wondering if the central bank had used the right tool for the job. What Does This Mean?When central banks lower the cost of borrowing money, they’re trying to encourage companies to take out loans and use that cash to build plants, develop products, and create jobs – all of which would boost real-world economic activity.
Here’s the problem: businesses aren’t hitting pause on factory construction and product launches because they can’t get cheap loans. They’re doing it because workers are calling in sick or canceling travel plans for fear of contracting COVID-19 (tweet this). And while falling mortgage rates might leave homeowners with more cash in hand each month, it’s not much good if the places they’d normally spend it are all closed. Why Should I Care?For markets: Misjudgment day.
While a rate cut is theoretically good for stocks, investors didn’t buy them up as they normally would. That’s likely because, in a statement that accompanied the cut, the Fed acknowledged its decision wouldn’t actually fix the economy. What’s more, emergency rate cuts come at times of, y’know, emergency, which means there’s only so much enthusiasm the Fed can expect from investors. Maybe it should’ve seen this coming: after a similarly unscheduled cut back in 2008, stocks went on to fall another 50%.
The bigger picture: Fewer tools in the box.
Following the Fed cut, yields on 10-year US government bonds were pushed to a historically unprecedented low of less than 1%. That means the difference between yields on 10-year and 2-year debt is narrowing again – which is generally considered a warning sign for future economic growth. And if the US economy does start to slip into a recession, the Fed hasn’t exactly left itself much room for further cuts… | 