In an emergency move to protect the economy from the fallout of the coronavirus outbreak, The Federal Reserve announced on 15 March 2020 that it would drop its target interest rates to near zero. In addition to this, it pledged to buy at least $500 billion in Treasury and at least $200 billion in mortgage-related bonds.

This measure was taken to avoid a repeat of the credit crunch and financial market disruption that happened during the global financial crisis when the Fed had to bottom out the interest rates. Further, the emergency rate cut is directed at lowering down the borrowing costs and reviving the struggling financial markets as businesses close and the US economy is moving towards a recession.

The Fed had already given an emergency interest rate cut on 03 March 2020 by half a percentage point on the fears of the paralysing economy due to the coronavirus pandemic.

COVID-19, that originated in the district of Wuhan, China, has already spread in more than 100 countries infecting over 1,70,000 individuals and killing more than 6,500 people. In the US, there have been 3,802 cases with 69 fatalities (As at 16 March 2020 10:05 PM AEDT).

The futures market plunged with all major index futures - S&P 500, Nasdaq and Dow Jones down after the rate cut announcement. These indexes fell into the bear market in the second week of March.

The economic outlook for the US Economy

With significant supply disruptions, grappling financial markets and falling yields, the coronavirus pandemic has affected economic activity in many countries, including the US. The US economy was on solid ground with low unemployment rates and high consumer confidence until the hit of coronavirus that has significantly bruised the economy.

President Donald Trump had been ramping up the pressure on Federal Reserve to slash the interest rates to 0% or lower to match weaker economies in Europe and Asia for almost a month amid rising fears of coronavirus plunging the US economy. The emergency rate cut of 50 bps by the Fed was widely criticised by Trump as insufficient, citing the need for more easing.

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Federal Reserve seems to have listened to Trump’s desires. Trump praised the Fed’s move to slash the rates to near zero and welcomed it as a positive move for the economy.

However, the Fed has urged Trump and the Congress to unleash their own stimulus plans. Trump declared a national emergency to free up US$50 billion in federal resources to combat coronavirus on 13 March 2020, pushing back the criticism that his administration was not prepared to confront the pandemic. The House had also passed funding of billions of dollars for healthcare and stay at home workers on 14 March 2020.

The Fed expects to hold the rates near zero until it is confident that the US economy has been pulled out economically from the coronavirus outbreak.

Stimulus plans by the Fed and global central banks

The central banks are going for rate cuts and stimulus packages to pump up their respective economies.

People’s Bank of China pumped 100 billion yuan (~US$ 14.28 billion) on 16 March 2020 through open market operations via medium-term lending facility into the financial markets. It also announced a cut in the reserve requirement ratio (RRR) for eligible banks last week, which will release 550 billion yuan of long-term funds.

The Reserve Bank of New Zealand has cut its official cash rate to a record low of 0.25%, from 1% to support the economy from the COVID-19 impact. The bank also delayed the start of new capital requirements by 12 months freeing up money for lending as the economy grapples from coronavirus outbreak.

ALSO READ: COVID-19 Epidemic: Global Rate Cuts; OECD Downgrades Economic Growth Forecasts

The European Central Bank announced a US$135 billion fiscal stimulus with no interest rate cut on 12 March 2020 to fight coronavirus impact.

The Reserve Bank of Australia (RBA) slashed its cash rate by 25 bps in its 03 March 2020 meeting with rates reaching 0.5%. Further, PM Scott Morrison announced US$17.6 billion stimulus package with major thrust on jobs, cash flow and investment.

The RBA Governor, in RBA’s statement released on 16 March 2020, also announced that the bank is prepared to purchase Australian government bonds in the secondary market for the smooth functioning of the financial markets.

There is an emerging need for coordinated action to combat the downfall in the global economy. The Federal Reserve has struck a deal with five other foreign central banks - The Bank of Canada, the Bank of England, the Bank of Japan, the European Central Bank and the Swiss National Bank, to enhance the provision of liquidity via the standing US dollar liquidity swap line arrangements.

Hence, a combined effort by all central banks is expected to improve liquidity globally and will ease the burden of existing debt for the borrowers to an extent.

Will the rate cut fix the US economy?

All the schools and businesses have come to a freeze with people pulling back from travelling to dining out at public places. This indicates a major hit to the incomes of several people.

There has also been a substantial disruption in trade linkages, technology, manufacturing, pharma, retail, education and tourism industries.

The Fed’s interest rate cut decision will have a minimal impact on the contraction in economic activity. At most, the current move can prevent disruptions in the Treasury and can tackle the credit crunch situation to an extent.

While the cost of borrowing may be low now, workers and businesses can still suffer from a steep decline in consumer spending, supply disruption, decline in demand and disappearance from public events.

Market experts anticipate a negative growth in the second quarter for the US economy. Layoffs have already begun as small and medium businesses have started to suffer a significant decrease in their sales figures.

The outlook for the economy is uncertain, depending on the spread of the virus.

The actions of the Fed have not revived market confidence as evident by fall in the stock-index futures. Monetary policy can take care of the financial domino effect but cannot fully counteract the economic impact of massive close-downs of public places. A favourable fiscal policy is the prerequisite for that.

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