Thoughts and implications
Today, the U.S. Federal Reserve (Fed), reduced its target range for its federal funds rate by half a percentage point to between 1 ‒ 1 ¼ percent. The federal funds rate is considered the central rate for domestic financial markets, influencing mortgage rates, savings rates, and the prime rate. When the Fed wants to increase liquidity and make credit more available, lowering this target rate is one of its deployment tools.
Today’s interest rate cut came as a surprise to many investors. First, it happened outside of a scheduled meeting; the Federal Reserve’s Open Market Committee (FOMC) formally meets eight times a year, with their next scheduled meeting slated for later this month. While many market observers expected the Fed to lower or cut rates during their regularly scheduled March 17-18 meeting, today’s announcement and press conference was impromptu. Second, the cut was announced just after a Group of Seven (G7) statement following a conference call on the COVID-19 coronavirus, where the G7 emphasized their diligence in monitoring developments but did not commit to any definitive steps or coordinated measures. Market participants initially appeared to take the lack of concrete steps in stride based on early trading this morning prior to the Fed announcement, but after some absorption post-announcement, equity markets turned sharply lower and bond prices have risen.
Low interest rates have been a hallmark of the post-Great Recession global economy. Many argue that central banks like the U.S. Fed have played a major role in keeping borrowing costs low, which can stimulate demand and consumption, and the Fed’s actions today may push borrowing costs even lower. As we write this, the U.S. 10-year Treasury bond’s yield fell below 1 percent for the first time in history. Bond yields move inversely with prices.
However, the Fed’s stated reason for cutting interest rates was the coronavirus, which has implications for both demand trends as well as for companies’ ability to supply goods. In the post-announcement press conference, Fed Chairman Jerome Powell acknowledged that an interest rate cut won’t impact the rate of virus infections or fix broken supply chains. Today’s interest rate cut is intended to address the demand side of the equation and bolster investor, business and consumer confidence in the ongoing economic expansion. The market reaction and expectations of additional interest rate cuts express investors’ current skepticism about the Fed’s ability to navigate virus-related disruptions through interest rate cuts alone.
What is apparent is that we are likely in a regime of ultra-low interest rates for some time. It is notable that all of the Fed’s Open Market Committee members voted in favor of today’s interest rate cut. However, the Fed has only so much room to cut interest rates further and remain above the zero bound. In the event that additional stimulus is warranted to support the economy, we are likely to see other policy tools employed.
Without sounding repetitious, we are believers in the adage that mental capital trumps financial capital. Market volatility can allow price to drive emotion, causing investors to take immediate action within their portfolio to improve their psychological well-being. While our current view is to maintain our current investment strategy, what are some actions you can take?
- First, engage with your U.S. Bank or U.S. Bancorp Investments professional and ensure that you are still comfortable with your financial plan, and if you don’t have one, work to establish it.
- Second, revisit your risk tolerance. While no one likes seeing prices move against them, if the current market downturn is particularly difficult to stomach, talk with your advisor about your ability to tolerate risk and perhaps revisit your asset allocation.
- Third, revisit your fixed income allocation. Bonds provide two functions in an investor’s portfolio: current income for cash flow needs and defensive characteristics to help mitigate capital market volatility. Government and high-quality municipal bonds of longer maturities are one way to shore up the defensive characteristics of your fixed income allocation.
Finally, you can always shift assets and move to cash, but that requires two decisions: when to sell and when to buy back. Countless academic and behavioral studies reveal how difficult that timing can be and how deleterious it can be to your long-term investment plan. Your U.S. Bank or U.S. Bancorp Investments representative can also discuss asset classes and tools that could dampen your overall portfolio volatility.
Our hearts and thoughts continue to be with those directly impacted, but volatility and down prices can lead to stress, and we are here to help you. We remain vigilant in our analysis and monitoring of the situation as it develops, and we will communicate updates as we have them. We encourage you to engage with your U.S. Bank or U.S. Bancorp Investments representative if you have specific questions about your unique financial situation and thank you for your trust and confidence.