In a move in which the timing was more compelling than the decision itself, the Federal Reserve (Fed) announced this morning that it unanimously decided to cut its policy rate by 50 basis points (0.5%) from the 1.5-1.75% range to the 1-1.25% range. The surprise move marked the Fed’s first rate action outside of a regularly scheduled meeting since October 2008.
As concerns over the impact of the coronavirus on global economies and markets have intensified, investors’ expectations of policy stimulus increased dramatically. “The Fed’s perspective on the evolving crisis has changed quickly,” said LPL Financial Senior Market Strategist Ryan Detrick. “Even after the emergency action, the bond market is still pricing in more cuts by July.”
The surprise move was likely calibrated to increase the impact of the decision, one in which we believe would be more aptly compared to the rate cut in 1998 in response to the Russian financial crisis and failure of the hedge fund Long-Term Capital Management, rather than the recessionary cuts of 2001, 2007, and 2008. Keep in mind that before 1994, the Fed did not change policy around a meeting schedule, so effectively all rate changes were unannounced.
Stocks historically sold off ahead of these moves, before getting a short-term bounce on the day of and the month following these announcements (see chart). However, performance over other periods shown has been mixed.
We believe the Fed is acting out of appropriate caution to help the economy through what is likely to be an economic soft patch before a potential rebound in the second half of the year, with more room to ease if needed.
The Fed’s action has helped to steepen the yield curve, or the spread between short and long-term interest rates. As shown in the next chart, the spread between 2-year and 10-year Treasury yields has risen sharply to around 30 basis points (0.3%), reversing this negative economic signal that has historically been a good predictor of recessions, though with widely varying lag times.
In our Outlook 2020: Bringing Markets Into Focus published in December 2019, we provided a year-end 2020 forecast for the 10-year Treasury yield in the range of 2-2.25%. With today’s aggressive Fed policy action, more rate cuts being priced into the bond market, the 10-year having broken the one percent barrier for the first time ever, global yields remaining very depressed, and inflation well contained, the downside risk to our yield forecast has increased significantly. All of our forecasts are currently under review based on the developments over the past week, in particular those tied to the bond market. Stay tuned.
This material is for general information only and is not intended to provide specific advice or recommendations for any individual. There is no assurance that the views or strategies discussed are suitable for all investors or will yield positive outcomes. Investing involves risks including possible loss of principal. Any economic forecasts set forth may not develop as predicted and are subject to change.References to markets, asset classes, and sectors are generally regarding the corresponding market index. Indexes are unmanaged statistical composites and cannot be invested into directly. Index performance is not indicative of the performance of any investment and do not reflect fees, expenses, or sales charges. All performance referenced is historical and is no guarantee of future results.Any company names noted herein are for educational purposes only and not an indication of trading intent or a solicitation of their products or services. LPL Financial doesn’t provide research on individual equities. All information is believed to be from reliable sources; however, LPL Financial makes no representation as to its completeness or accuracy.This Research material was prepared by LPL Financial, LLC.Securities and advisory services offered through LPL Financial (LPL), a registered investment advisor and broker-dealer (member FINRA/SIPC).Insurance products are offered through LPL or its licensed affiliates. To the extent you are receiving investment advice from a separately registered independent investment advisor that is not an LPL affiliate, please note LPL makes no representation with respect to such entity.If your representative is located at a bank or credit union, please note that the bank/credit union is not registered as a broker-dealer or investment advisor. Registered representatives of LPL may also be employees of the bank/credit union.These products and services are being offered through LPL or its affiliates, which are separate entities from, and not affiliates of, the bank/credit union. Securities and insurance offered through LPL or its affiliates areNot Insured by FDIC/NCUA or Any Other Government AgencyNot Bank/Credit Union GuaranteedNot Bank/Credit Union Deposits or ObligationsMay Lose ValueFor Public Use – 1-959621