The Federal Reserve’s surprise rate cut reflects the increasing uncertainty the U.S. economy and investors currently face. Jim Cielinski, Global Head of Fixed Income, provides his views on what the highly unusual move means for markets and why he believes investors should remain cautious.

Key Takeaways

  • The Federal Reserve (Fed) surprised markets on Tuesday by announcing a 50-bps cut to their benchmark policy rate in response to heightened concerns around the COVID-19 outbreak.
  • As the rate cut will not cure market volatility or the economic slowdown any more than it will cure the coronavirus outbreak it aims to address, we recommend investors remain cautious, recognizing that bonds have provided, and we expect they will continue to provide, diversification against precipitous equity market declines.
  • Although we cannot predict what the ultimate impact of the outbreak will be on the global economy, we recognize that times of severe market stress always offer opportunities and believe the trick is being able to take advantage of them.

The Federal Reserve (Fed) surprised the market this morning by announcing a 50-basis point (bps) cut to their benchmark policy rate, dropping the federal funds target range to 1.0% to 1.25%. The move was highly unusual as it took place between their regularly scheduled policy meetings, reflecting both the seriousness of their decision and the rapidly changing environment that the U.S. economy – and investors – currently face.

The COVID-19 coronavirus epidemic is a unique challenge for all of us insofar as it creates genuine uncertainty. Whether we are citizens, company leaders, policy makers or investors, most of us prefer to approach problems analytically, by looking at data and facts and making informed judgments based on careful research. But facts and data are currently in short supply. While the Fed was a little circumspect on why they decided to cut interest rates today, we believe they did so because the one thing they knew for sure was they had to be early, not late, in their response to the quickly escalating situation. Better to be safe than sorry, they thought.

We take a similar, forward-looking approach to managing our fixed income funds. The plunge in benchmark government bond yields in recent days has been extraordinary. Bond yields across the globe are at or near record lows, with the U.S. Treasury 10-year note paying just roughly 1%. Government bonds provide little value on the surface. But they have provided, and we expect they will continue to provide, diversification against precipitous equity market declines. In the past week, most risky assets – from stock markets to corporate bond markets – have sold off materially while government bonds have generated strongly positive returns. As of Monday’s close, the S&P 500 Index was down 4.05% year to date while the Bloomberg Barclays U.S. Intermediary Government Index was up 3.3%.

We continue to feel that caution is warranted and that investors will be better served by not looking to time the markets. Today’s rate cut is not a cure for market volatility because it is not a cure for the virus. Nor will it cure an economic slowdown. While current spread levels in corporate bond markets are not suggesting an outright economic recession is around the corner, a view we concur with, we – like the Fed – can only continue to analyze the facts as they emerge.

We expect the economy to struggle as supply chain bottlenecks worsen and uncertainty delays both capital and consumer spending. As such, we welcome the Fed’s action as we believe it builds a stronger foundation for the economy regardless of how quickly we emerge from the current uncertainty. However many new cases of infection emerge, when the rate begins to slow, citizens and investors will find a world with lower rates and much greater financial liquidity. As a lot of corporate spending and consumer demand may well be postponed, we could as a result see a rebound in the U.S. economy in the second half of the year.

That said, in the coming weeks, we do not think Tuesday’s Fed action will eliminate the extreme volatility present in markets today. Stocks and bonds will continue to rise and fall on signals from the world’s central banks, economic data and, most importantly, the growth rate of the coronavirus. Those gyrations may create opportunities for active managers as some markets or securities may become severely oversold or overbought.

While neither we nor the Fed have an edge in predicting how the virus will spread, we are well equipped to quantify value in securities and can make informed judgments about whether they offer enough return potential to compensate for the risks. Times of severe market stress always offer opportunities. The trick is being able to take advantage of them.