The Fed is cutting its benchmark lending rate by 50 basis points, sending stock prices and bond yields lower, as investors reconcile with a potentially worse economic impact from the Coronavirus than previously expected.
The U.S. market flip-flopped. But after rising by a bit more than 0.7% Tuesday just after the announcement, all three major U.S. indices fell considerably, with the S&P 500 down 1.54%.
The rate cuts are a response to the Coronavirus which has decimated Chinese and global manufacturing activity, while keeping consumers at home, restricting spending. The U.S. market corrected lat week, to the tune of 14% from its all-time high, although it had started to climb Monday.
Stock investors, by selling were telling the Fed to cut rates. Bond investors, by buying bonds, were telling the Fed the same.
The 10-year treasury held fell to 1.03%, with the 2-year down to 0.78%, both still below the Fed funds rate. The 3-month yield is no longer inverted to the 10 year, at 0.99%.
Investors may be getting wary that the Fed sees economic growth coming in so poorly that the central bank is forced to cut rates quickly. Some only see U.S. GDP growth coming in a few basis points lower than previously anticipated. Most estimates were for 2% for 2020. Still, many say the virus could actually cause a U.S. recession.
But these rate cuts do not come without risk, as the fed has only so many cuts to use. Meanwhile, the virus may no cause a recession.
"Now that the benchmark federal funds rate target is 1 to 1‑1/4 percent, it must be noted that the Fed’s most reliable ammunition, meaning lower rates, are dwindling," said Bannkrate's Senior Economist Mark Hamrick. "The other challenge involves how the Fed may take back the rate cuts once the outbreak and economic damage is behind."
And while the rate cuts could support the housing market, which will in turn support GDP growth and inflation, Hamrick said, the rate cuts "cannot address the hobbled supply chains, including manufacturing capability in China and South Korea. Lower interest rates do little to make consumers and businesses feel substantially more confident about the future when a health crisis is spreading around the world."
Still, the Fed has it's valid reasons to cut rates.
By "providing additional liquidity-- it does stem some of the decline [economic decline,]"
Marc Pfeffer chief investment officer at CLS Investments told TheStreet. "The recovery, when it happens, will be stronger."
Also, "you had spreads widen," Leslie Falconio, Senior Strategist of UBS Global Wealth Management told TheStreet. She noted how financial conditions had tightened, as high yield bonds sold off (yields rise wen prices fall) as part of the risk-asset correction last week. There was also a 7-day drought in investment grade bond issuance. The Fed's loosening of financial conditions is "fantastic" for stocks, Falconio said, adding that the Fed is choosing to be proactive, rather than waiting for the market to rebound.
And although stocks are selling off Tuesday, as the Fed signals worse-than-expected economic turbulence, "U.S. stocks are going to be the only game in town," with bond yields incredibly low Pfeffer said.