On March 3rd, the Federal Open Market Committee (the Fed) cut its baseline interest rate range by 50 basis points to a 1.00% to 1.25% range. While the market had priced in expectations of a Fed rate cut, today’s decision occurred outside their normal cycle of meetings. The last time an inter-meeting cut happened was in October 2008 in response to the collapse of Lehman Brothers. Going back further in history, the Fed has also done inter-meeting shifts in monetary policy in September 2001, days after the 9/11 attacks, and in October 1998 in response to the Russian financial crisis and the collapse of Long–Term Capital Management.
The Fed issued a statement with the rate cut which reads, “The fundamentals of the U.S. economy remain strong. However, the coronavirus poses evolving risks to economic activity... 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.” This indicates the Fed rate cut is not a ‘one-and-done’ response to the economic disruption being caused by COVID-19.
Although the equity market immediately jumped higher following the announcement, the positive reaction was short-lived. The S&P 500 ended the day down -2.81% (pushing YTD returns to –6.74%) as markets await additional fiscal stimulus announcements from other Central Banks across the globe and clarity on earnings as many companies have lowered guidance due to the implications of COVID-19.
US Treasury yields continued to fall with the 30-year Treasury note ending the day at 1.61% which represents an all-time low yield for this security. Fixed Income securities gain in value when interest rates fall. In 2019, the 30-year Treasury returned +16.4% as the yield fell from 3.02% to 2.39%. For 2020 year-to-date, the 30-year has returned 17.9% through March 3, 2020. These positive fixed income returns provide a powerful hedge against falling equity values in multi-asset portfolios.
Along with the falling US Treasury yields, mortgage rates are also hitting all-time lows. For the week of February 27, Freddie Mac reports that the average 30-year mortgage rate was 3.45%. Their all-time low rate was 3.31% set in November 2012. As of this morning (3/3/20), a local Alaskan bank was showing a 30-year fixed rate mortgage at 3.00%. Although the impact is not as immediate, low mortgage rates put more dollars in the hands of consumers and provide support for a growing economy.
Many economists now expect a stall in GDP growth in the 1st half of 2020 for the US economy followed by a return to growth in the 2nd half. The magnitude of the stall will depend on the severity, length and spread of the virus. The Coronavirus is impacting economic growth in many different ways. However, most of these are expected to be temporary interruptions. In addition to the direct impact from people who get sick and the small percentage for whom the illness is fatal, there will also be an effect as travel and public activities are curtailed. A number of US corporations have already cited logistical issues across the supply chain as the global inter-connected economy experiences the effects of factories being shut down in China.
Going forward, the market is pricing in additional Fed rate cuts, perhaps as soon as their regularly scheduled meeting on March 18. Other Central banks across the globe are expected to follow suit and more fiscal stimulus for the global economy is expected. While these actions will provide support to the global economy, we continue to expect ongoing volatility in both the equity and fixed income markets so long as the number of COVID-19 cases continue to rise.
Paul Hanson, CFA®