Thoughts on the Surprise Fed Rate Cut
'Oh ok, so what? It isn’t a vaccine'
In light of the Fed’s recent ‘emergency’ rate cut, we have to ask: Does this action do anything to help fight the public health crisis presented by COVID-19?
No.
The Fed’s action does nothing to solve the underlying problem we are facing. That is, getting to grips with the virus’ spread, testing, containment, and developing an effective vaccine.
Rate cuts don’t help on the ground with the real issues people are facing and are likely to face in the coming weeks.
What’s needed is quick medical and scientific progress in treating the disease. Inflamed and misleading political rhetoric, a distrust of science, and Fed panic in relation to short-term market reactions don’t help.
This appears to be the view of other experienced investors, including Dr. Mohammed El-Erian, (Chief Economic Advisor at Allianz) and Dr. Komal Sri-Kumar (CEO of Sri-Kumar Global Strategies), so I feel like I’m in good company.
(Note: Dr. El-Erian also makes the salient point that the Fed can’t have it both ways: It can’t say that the economy is strong, then turn around in the same breath and say that we are in an emergency situation. Mixed messages to be sure, and food for thought about whether the Fed knows something that nobody else knows. It also raises questions about the Fed’s independence - an issue I refuse to address right now!)
Another way of putting it is:
A rate cut will not help people if they are home sick and afraid;
A rate cut won’t help businesses that can’t open because their employees can’t come in to work;
A rate cut won’t help people that are living month-to-month pay their bills or feed their kids;
A rate cut won’t help uninsured or under-insured people get the medical care they may need;
A rate cut won’t help identify existing cases of COVID-19, prevent future cases, or treat people that get ill;
A rate cut won’t provide testing kits and facilities that work as required; and
A rate cut won’t develop a vaccine.
It might help refinance a mortgage, or allow a business to refinance long term debt. But I’m pretty certain that there is no Fed rate cut in any possible universe that can convince people that they are not at risk of getting sick. And I’m pretty sure that if they are already sick, or afraid of getting sick, their first thought isn’t going to be that they can get a pretty attractive fixed rate refi right now.
However, reasonable questions might include,
Will this move prove to have been economically wise and far-sighted, or will it be viewed as a case of the Fed being mis-guided by market volatility and twitter storms?
Was it wise to shoot irreplaceable bullets now when they might be more useful in the future when the true economic situation is known?
And in any case, what’s the harm?
Whether the emergency cut was wise or a mis-use of scarce policy resources remains to be seen. We’ll know at some point in the future. It’s clear that folks who earn their daily bread from trading the markets think it’s great.
The fact is, however, that the Fed didn’t have much dry powder last week to address serious longer term challenges. It has even less today.
As Joe Briner, Principal at Vertical Capital Advisors noted, “...they [the Fed] literally have one tool in their toolkit: the fed funds target rate. They implement policy through open market operations which affects a lot of other things, but when all you have is one hammer, every problem can only be a nail.”
Dr. El-Erian points out that there are actually three reasons that this move could cause harm: First, the Fed’s gamble has reduced the number of available options for the future no matter what the economic outcome. That can’t be good. Second, Governments need to use the right tool for the problem. Not only is the Fed the wrong agency but the fed funds rate is the wrong tool. It’s like the Braves calling a plumber to close out the 9th inning. Finally, it’s unclear what this move does to the Fed’s credibility. Clear forward guidance is an important policy tool, and it’s not certain that Chairman Powell and the Board have enhanced their credibility or not.
As for fiscal policy options, those seem limited as well. With deficits on pace to exceed $1 trillion per year over the next decade (!!) and limited tax receipts, it is unlikely that the Government can follow South Korea’s excellent lead by announcing a significant stimulus.
For clarity, the South Korean government just announced a $9.8 billion stimulus to help counter the economic impact - the funds will go to real services and meet real needs in the on-the-ground economy by focusing on health system, child care, and outdoor markets. An equivalent stimulus in the US on a per capita basis would need to exceed $51 billion.
Also - virus testing in Korea is both free and very widespread… something that is necessary to control pandemic illnesses, but isn’t likely to happen here. It may not seem like much, but the South Korean response is far more pragmatic and focused on real problems. The Fed, on the other hand, speaks in abstractions like ‘economic activity,’ ‘solid growth’ and ‘labor market.’ Contrast that to Finance Minister Hong Nam-ki who speaks about vulnerable sectors, small- and medium-sized businesses and business owners, and self employed people.
The difference may be subtle, but it’s there.
More positive is the news that Congress is working to pass a bill providing almost $8 billion in funding to fight this outbreak. It’s a good start, and it will definitely help. Even better, it’s bi-partisan (a bit of good news we all need right now).
But because I’m a bit of a curmudgeon, I am compelled to question whether the cows have already left the barn, and whether it’s better to think of this bill to be an amuse-bouche or appetizer rather than the main course.
Even the World Bank has just announced a $12 billion commitment to help countries battling the virus. Throwing money at a problem never makes it go away, but it can help if it’s used the right way.
As Bridgewater Associates’ CIO Ray Dalio says:
“...as far as central bank policies are concerned, interest-rate cuts and increased liquidity won’t lead to any material pickup in buying and activity from people who don’t want to go out and buy, though they can goose risky asset prices a bit at the cost of bringing rates closer to hitting ground zero… So, it seems to me that containing the economic damage requires coordinated monetary and fiscal policy targeted more at specific cases of debt/liquidity-constrained entities rather than more blanket cuts in rates and broad increases in liquidity.”
Two final thoughts:
Use the right tool for the job. Don’t use a hammer when a scalpel is needed. But if you insist on using a hammer, be realistic about the results you can expect.
When it comes to dealing with this emerging public health crisis, let’s agree that we should be focused on people - not markets.
James Cooper
Vertical Capital Advisors
March 4, 2020