The Federal Reserve just made an emergency rate cut. Here’s why we believe this matters.
The US central bank has taken action to support investors. We look at why we believe this is significant and what it could mean.
The world agrees to act to fight the impact of Covid-19
Just an hour after the finance ministers of the world’s seven largest economies announced that they would take action to lessen the impact of the coronavirus, the US central bank the Federal Reserve announced an emergency cut in interest rates. The statement accompany the 0.5% cut was short and to the point: “The coronavirus poses evolving risks to economic activity” and that the Federal Reserve will “use its tools and act as appropriate to support the economy.”
Our coronavirus blog earlier this week talked about how this was a very likely possibility, that central banks around the world might act to help calm the fear that investors have about the coronavirus. With the Australian, Malaysian and now US central banks all taking action now, with more potentially to follow, we believe there are a number of key reasons why it matters for ISA investors.
1. An emergency cut is not just about supporting growth, it’s about confidence
Let’s look at what it is that interest rate cuts are actually trying to do. When a central bank like the Bank of England announces that it is lowering interest rates, this means that it now costs less for business to borrow money (because they don’t have to pay as much interest on their loans) and that you and I typically earn less interest in our savings accounts.
Both of these things are designed to encourage economic growth – businesses can now borrow more money to buy more equipment or hire more people, and we have more of an incentive to spend that money or otherwise invest it. They are typically used when the economy needs a boost, and given that company shares typically rise following a cut it’s no wonder that politicians like President Trump have called for larger cuts than have been delivered so far.
But an emergency interest rate cut is designed to do more than just provide a helping hand to the economy. When central banks step in to take action in the face of a major event it is to send a strong message to markets to essentially say ‘we got this’. By acting now and relatively quickly, we believe ISA investors can take reassurance that policymakers will genuinely take action when faced with a major challenge such as Covid-19.
2. Emergency cuts from the Federal Reserve are rare
There have only been eight emergency Federal Reserve interest rates cuts in the past 20 years. These were because of the three largest events to rock US markets – the burst of the technology bubble, 9/11 and the global financial crisis. With yesterday’s rate cut, it’s clear that the Federal Reserve sees the spread of the coronavirus as an issue that could pose a serious threat to investor’s capital unless they take action.
The positive scenario is if the rate of new infections begins to slow and is effectively contained. This would mean that the impact to the economy is less than previously thought and we would be more likely to see a bounce back in the short term.
3. The emergency cut might not be the only action the Federal Reserve takes
Interest rate cuts are just one tool in a central bank’s toolbox. In the announcement, the Federal Reserve did not rule out potentially taking other action besides if they see a need for it. This could include further cuts to the interest rate, potentially all the way down to 0% if need be which would be a truly significant move, as well as additional support for businesses if they suffer problems as a result of the coronavirus.
Prepare, don’t predict
We believe it’s times like this where investors can potentially achieve a lot more by being prepared in their investments rather than trying to predict what central banks or the spread of the coronavirus might do next. Spreading your investments across many different types and regions, known as diversification, can go a help reduce your exposure to events that might cause a drop in your investment value. We believe Focusing on your long-term savings goals is a great way to help tune out the noise of loud and scary headlines.