The Fed has previously cut interest rates in response to falling prices. This time, not
By Ann Saphir and Dan Burns
(Reuters) – A sharp decline in the U.S. labor market that sparked days of turmoil in global stock markets also fueled speculation that the U.S. Federal Reserve may not wait until its next meeting in September to cut interest rates.
In fact, an interest rate futures contract expiring later this month that tracks Fed policy expectations shot to a two-month high earlier this week based on the assumption that rates would be lower by the end of August.
The odds are against it. As Chicago Fed President Austan Goolsbee said earlier this week, “The bill doesn’t say anything about the stock market. It’s about employment and about price stability.” By this he meant the Fed’s dual mandate of promoting full employment and price stability.
More and more analysts are expecting the Fed to cut interest rates by half a percentage point at its September meeting. But hardly anyone believes that the Fed will act sooner.
“Current economic data does not justify an extraordinary rate cut between meetings, and doing so would only trigger a new wave of panic in the markets,” wrote Nationwide economist Kathy Bostjancic.
Even former New York Fed President Bill Dudley called on the central bank to cut interest rates last week, even before the latest data showed the unemployment rate rising to 4.3% in July. He wrote this week that a rate cut between meetings was “highly unlikely.”
In the days since the crisis began, global stock markets – which have also been plagued by concerns about a tightening of monetary policy by the Bank of Japan and a winding down of yen-financed operations – have recovered somewhat. A report released on Thursday showing that fewer Americans are applying for unemployment benefits added to the relief in U.S. markets.
Traders of short-term US interest rate futures have not only all but given up their bets on a rate move between Fed meetings, but have also scaled back their expectations for the size of the first rate cut. The odds of a half-percentage-point rate cut in September were nine to one, now they are about the same as the odds of a quarter-percentage-point cut, according to interest rate futures prices.
At the end of August, Fed Chairman Jerome Powell is expected to have the opportunity to provide new impetus on what he believes is needed when international central bankers meet for the Kansas City Fed’s annual economic symposium in Jackson Hole, Wyoming.
Currently, Powell is widely expected to overlook the stock market collapse and stick to his statement from last Wednesday after the Fed decided to keep the key interest rate in the range of 5.25-5.50 percent.
“If we get the data we hope for, then a cut in our key interest rate could be up for debate at the September meeting,” he said.
In the coming weeks, data on employment, inflation, consumer spending and economic growth could influence whether the cut is just a quarter of a percentage point or even more significant.
On each of the eight occasions over the past 30 years that the Federal Reserve has cut interest rates between policy meetings, the turmoil in markets has extended well beyond equity markets. The bond market in particular has shown clear signs of rapidly increasing disruptions to the credit flows that keep businesses afloat – a factor that has been conspicuously absent until now.
A look at each of them shows why times were different back then.
RUSSIAN FINANCIAL CRISIS/LTCM – 25 basis points
October 15, 1998 – The Fed, which had just decided to cut interest rates by a quarter of a percentage point at its meeting two weeks earlier, cut the benchmark interest rate by a further 25 basis points. The collapse of the hedge fund Long-Term Capital Management – shortly after the Russian default two months earlier – reverberated through the US financial markets and led to a widening of credit spreads that threatened to hurt investment and drag the economy into the abyss.
TECHNOLOGY STOCKS SOOON – 100 basis points
January 3 and April 18, 2001 – The Fed cut interest rates by two half a percentage point in a surprise move earlier this year after a sharp rally in dot-com technology stocks turned into a plunge that policymakers said would hurt household and business spending. What had been primarily a stock market event spilled over into the corporate bond market by the end of 2000, driving high-yield spreads to the highest levels on record.
The Fed’s two rate cuts came in addition to two other rate cuts of half a percentage point each at its meetings on January 31 and March 20.
September 11 attacks – 50 basis points
September 17, 2001 – Following the attacks and the days-long closure of U.S. financial markets, the Fed cut interest rates by half a percentage point and promised to continue to provide unusually high levels of liquidity to financial markets until markets returned to more normal functioning. High-yield bond spreads widened by more than 200 basis points before the Fed’s actions helped calm credit markets.
GLOBAL FINANCIAL CRISIS – 125 basis points
January 22 and October 8, 2008 – The Fed cut its benchmark interest rate by 75 basis points at an unscheduled meeting in January as the crisis that began the previous summer as the subprime crisis gathered steam and spread to global markets. High-yield bond spreads were at the widest point in five years.
Then, on September 15, the collapse of Lehman Brothers ushered in a new phase of the crisis. Although the Fed refrained from taking any monetary policy action at its meeting the next day, it met with other central bankers around the world in early October for a coordinated action that included a half-percentage point cut in the benchmark interest rate. Towards the end of the year, credit spreads finally reached their highest level, which is still a record for high-yield and investment-grade bonds.
COVID-19 PANDEMIC – 150 basis points
March 3 and 15, 2020 – The Fed cut interest rates by half a percentage point and then another full point less than two weeks later to ease monetary policy as global travel and trade suddenly ground to a near halt amid government shutdowns to contain the spread of COVID-19. While U.S. stock indexes fell more than 30%, a 700-point widening of credit spreads and disruptions to the functioning of the U.S. Treasury market caused even more concern.
(Reporting by Ann Saphir and Dan Burns; Editing by Andrea Ricci)
