The Federal Reserve Board (Fed) just took an unusual step in response to coronavirus fears: It announced it would cut interest rates by 50 basis points (0.5%). This is the largest rate cut since the 2008 financial crisis. Notably, the Fed changed the policy two weeks ahead of its regularly scheduled Fed meeting, implying that policymakers felt an urgent response was necessary.
Rate cuts of this magnitude are fairly rare, and the Fed typically reserves measures like these for significant economic weakness.
The U.S. economy still looks solid, but the impact of the coronavirus is unclear, and this move is a response to that uncertainty. Fed Chair Jerome Powell pointed to concerns regarding coronavirus’s impact on demand and business conditions from the travel industry and globally exposed companies in a press conference on Tuesday. Companies have already started to reduce earnings guidance for 2020, and economists have cut gross domestic product (GDP) growth expectations. Most economic data is backward-looking, so few datasets are current enough to take the recent coronavirus spread into account here in the U.S., and the extent of the outbreak’s impact has yet to be seen.
It was a surprising move, but the decision showed policymakers are monitoring the situation closely and are ready to act if the economy does show signs of weakening. In our view, it’s better for the Fed to be proactive than reactive.
There is a price to pay for today’s cut, though. The Fed has less ammunition to fight a recession if the economy does weaken significantly. Historically, policymakers have had to administer a 5% rate cut to combat slowing economic growth and recessionary conditions.
What about stocks?
In the near-term, lower rates could help boost risk assets, and buoy consumer and business confidence going forward. Historically, stocks have reacted well to deep rate cuts. Since 1970, the S&P 500 Index has risen 2.8% in the three months after at least a 50-basis point rate cut, and 10.5% in the 12 months following.
What should you do?
Times like these remind us why it is prudent to check-in regularly on your investing plan to ensure you remain on track. We believe the impact of coronavirus on the economy and earnings will be transitory in nature, with the second quarter likely being hit the hardest. Stock market volatility could persist, given the level of uncertainty surrounding the outbreak’s impact on corporations and the economy. If that type of environment is unsettling for you, you may want to revisit your plan, because becoming more neutral on your equity exposure may be a better position for you. However, if you have a longer time horizon to reach your financial goals, you may want to use the volatility to your advantage by considering opening a managed portfolio or buying some of the securities on your watch list that have become more attractively priced.
The opinions expressed here are not meant to be used as investing advice. For more information, visit our website.
Lindsey Bell is Ally’s Chief Investment Strategist, responsible for shaping the company’s point of view on investing and the global markets. She is also President of Ally Invest Advisors, responsible for its robo advisory offerings. Lindsey has a broad background in finance, with experience on the buy-side and sell-side, in research and in investment banking and has held roles at JPMorgan, Deutsche Bank, Jefferies, and CFRA Research.
Lindsey holds a passion for teaching individuals how to become successful long-term investors. She frequently shares her knowledge as a guest on national news outlets such as CNBC, CNN, Fox Business News, and Bloomberg News. She also serves on the board of Better Investing, a non-profit organization focused on investment education.