Federal Reserve Enacts 50 Basis Point Rate Cut

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Reacting to the growing demand- and supply-side impacts of the coronavirus, the Federal Reserve FOMC today reduced the target range for the federal funds rate by 50 basis points, lowering the target to 1 1/4  and 1 percent. This is the first time since 2008 the FOMC enacted a federal funds rate cut outside of the typical meeting schedule. It was adopted unanimously and just two weeks before their scheduled March meeting. The target rate is now the lowest since late 2017, completely unwinding the rate hikes of 2018.

 

 

On the supply-side, disruptions to international trade are the main concerns. For residential construction, these supply-chain issues concern products like lighting, resilient flooring, plumbing fixtures and household appliances, as well as materials like particulate filter face masks used for construction purposes.

On the demand-side, declines in consumer sentiment and expected decreases in economic activity like travel, tourism, conferences and business meetings would depress economic activity mid-year. However, past history suggests that declines in economic activity to black swan events, like natural disasters, are typically followed by a period of rebounding economic growth.

Despite the rate reduction, the Fed noted that the “fundamentals of the U.S. economy remain strong.” However, the Fed’s statement noted that the virus poses “evolving risks to economic activity.”

The Fed’s action was expected but perhaps not to this degree and timing. And the policy change was consistent with recent declines for interest rates in the bond market. These declines should push mortgage interest rates closer to a low 3% average for the 30-year fixed rate mortgage.

However, the virus poses supply-side and potential growing demand-side challenges that are not precisely addressed by monetary policy. In the case of widespread virus impacts, fiscal policy will almost certainly have to play a role in the form of financial support for public health infrastructure and perhaps tax policy to support both business and households, a payroll tax cut for example.

Fundamentally, this economic situation is one that must be addressed through public health and scientific institutions. The rate cut is supportive, both as a signal and as an insurance move for possible economic softening.  The economic impacts of the virus could be constrained given mitigation efforts, as well as a reduction in transmission given warmer weather in the Spring.

 



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