The Fed delivers an emergency interest rate cut

Marius Paun | London, UK | Senior dealer | Wednesday, 04th March 2020

So the big news yesterday is that the US Federal Reserve decided to step in and slash the interest rates by 50 basis points from 1.75% to 1.25%. It was an emergency move meant to combat the negative economic impact of the coronavirus outbreak after last week, causing the Dow Jones to fall more than 12% (more than 10% signifies correction territory). Shortly before that, the ‘Group of Seven’ finance ministers pledged to take action to contain and mitigate the damage to their economies. However, they did not give any specifics, so any cheering in the world markets was rather short-lived.

Although the timing might have been a surprise for some analysts, the move was widely expected. CNN reported that CME’s FedWatch tool predicted a 100% chance the Fed will cut rates in March. In addition, on Friday the probability for 3 rate cuts for the whole year was around 80%. It’s an understatement to say the reaction was mixed.

Many commentators blamed the way it was done, with no hype, no prewarning and ‘at a time when few were watching’. The US President demanded the Fed cut rates, even more, saying ‘they must further ease and most importantly, come into line with other countries’’. Indeed, the effect was probably less than what the US central bank would have hoped for, as the Dow Jones closed over 600 points down (although it recouped most of it the next day).

Investors and or economists also pointed out that easing the monetary policy is hardly an antidote for saving the world economy from a virus outbreak. On the demand side, the central bank can’t force people to go out to shop or travel abroad. Despite the incentives, fear or, better said, the self-preservation instinct, would take over.

Same goes for the supply, certain companies will suffer regardless of how cheap the credit is. No government or central bank can force people back to work (if self-quarantine becomes the norm) or keep factories open. Going forward, the questions now are how many cuts will follow and how far will they go.

The rumours the cuts will be coordinated (as it happened in 2008) are making headlines too. Early Tuesday the Reserve Bank of Australia cuts interest rates to a record low of 0.5% from 0.75% and on Wednesday the Royal Bank of Canada slashed from 1.75% to 1.25%; both moves largely expected.

But many other central banks could find it rather hard to implement: Bank of Japan’s key rate is already -0.1%. The European Central Bank is also limited by a deposit rate of -0.5%. Especially in the countries with base rates below zero, policymakers are reluctant to reduce them even further on concerns that banks, already seeing their profit margins squeezed, might pull back on lending.

Let’s look at the weekly chart for Dow Jones to see what possible scenarios it can suggest.

First, for the past few years the Dow Jones enjoyed a decent rally. It dropped below the trendline at the end of 2018 only to rebound above it quickly after. It appears to be the case this time as well. After last week’s violent selloff taking the price well below the moving averages, it now moved back above the trendline and is on course to test the 61.8% Fibonacci retracement at 26500.

Bullish scenario:

A sustained move above 26500 would indicate additional buying power. If bulls can generate solid momentum then look for a test of resistance around 27000 handles. Overtaking that could trigger another surge with next resistance seen at 27320-27340 range. However, this week’s rebound needs to be confirmed first by a close above the trendline.

Bearish scenario:

If the current rally-back is not confirmed and the price drops below the trendline again it would signal the increased presence of sellers. The next support is around 26330 followed by even stronger support at 26050-26100 range. A cross below that would mean the selloff has resumed and a further drop towards the 50% Fib Retracement at 25500 is on the cards.