Another emergency interest rate cut by the US Fed

Marius Paun | London, UK | Senior dealer | 17th March 2020

In an aggressive move to save the US economy from the effects of the coronavirus pandemic, the US Federal Reserve slashed interest rates by 100 basis points on Sunday evening from 1.25% to 0.25%. The central bank also announced a $700 billion asset purchasing program, known as quantitative easing, and cut reserve requirements to zero for the banking sector. The Fed explained the decision by saying ‘the outbreak harmed communities and disrupted economic activity in the United States and many other countries’.

On top of that, the Fed said that other central banks around the world, the Bank of England, the Bank of Japan, the European Central Bank, the Swiss Central Bank and the Bank of Canada also took action to increase liquidity through existing dollar swaps arrangements. These massive multiple programs seem to be the largest move ever recorded in a single day, a reminder of the efforts made during the 2008 financial crisis.

The Fed added that the quantitative easing will be split between $500 billion of Treasuries and $200 billion of agency-backed mortgage securities. In its function as ‘lender of last resort,’ it appears the US central bank considers that the priority is to support liquidity and the stability of the banking system. The purchases began on Monday. As a reminder, the Fed had already cut interest rate by 50 basis points over the past few weeks and supplied $1.5 trillion to the repo market. It’s not clear if that second emergency meeting would replace the regular Federal Open Market Committee meeting.

Despite the announcement the S&P 500 (together with the rest of US stocks) nosedived 8% after the opening on Monday, triggering what’s called ‘a circuit breaker’ – a system meant to prevent the collapse of the stock market. The rules applying to regular trading hours are:

  • Level 1 – if S&P 500 drops 7%, trading will pause for 15 minutes
  • Level 2 – if S&P 500 declines 13% trading will pause again for 15 minutes if the drops take place before 3:25 p.m.
  • Level 3 – if S&P 500 drops 20%, trading would halt for the rest of the session.

The current breakers were put in place following the violent sell-offs during the 2008 financial crisis. During the last week, the circuit breaker has already kicked in three times, the testimony of the widespread panic which engulfed the markets. The US stocks are already well into a bear market territory, down more than 20% from their recent highs. Even President Donald Trump, notorious for tweeting repeatedly of US shares reaching all times highs not long before coronavirus outbreak, has admitted the US ‘may be headed into a recession and that the worst could last until August’?!!!

This week, the S&P 500 has posted the biggest one-day loss since 1987 yesterday, tanking 12%. The volatility index – VIX, the so-called Wall Street fear gauge, closed at an all-time high record of 82.69. It was higher than the peak of the financial crisis of 80.74. Because the current event is not the result of a financial crisis, so little in the way of past performance to refer to, and even the health scientists don’t understand it fully, or better said its future effects to our way of life, very few feel confident to predict where the bottom will be. Tuesday’s choppy trading is yet another indication of panicky markets looking desperately for direction.

For the past few years, the S&P 500 enjoyed a decentrally with the chart showing a string of higher highs and higher lows. But for the last five weeks what a drop? From a high of 3396 seen on 20th February to the current level of 2426, that’s a 40% loss.

It’s worth noting the ranges of the weekly/daily candles have gone through the roof. Pretty obviously, the momentum is now with the sellers, price is below the moving averages, the short term one is below the long term one and both pointing downwards.

Bullish scenario

Is there one? As an attempt for a pullback quickly runs out of steam if today’s session is any indication so far. Bulls will want to test the next resistance at 2530. If that proves successful it can generate momentum leading to the 23.6% Fibonacci retracement at 2580 followed by another handle just above 2600 mark. Bulls could also find some encouragement that the current price levels are so far below the moving averages that a relief rally back could be in the cards at some point.

Bearish scenario

The current pullback seems to have been a false alarm as the early gains were given back rather quickly. If that proves to be the case it would signal that the bears remained in control and we’re looking at 2315, the low of late December 2018 as the next support.