The 10-year US Treasury yield dropped below 1 per cent for the first time on Tuesday, after the Federal Reserve delivered its first emergency rate cut since the financial crisis in order to stave off the long-term economic impact from the spread of the coronavirus.
The yield, which moves inversely to price, on the 10-year Treasury dropped to a fresh all-time low of 0.999 per cent in afternoon trading in New York.
The unscheduled cut indicates that investors believe a lot more action may be needed to stave off the worst financial effects of the spreading illness.
US equities fell after the US central bank cut its main policy rate by half a percentage point in response to “evolving risks” from the coronavirus outbreak. After initially surging in early New York trading, the S&P 500 stock index quickly fell more than 1 per cent alongside the Dow Jones Industrial Average and Nasdaq Composite.
Since the demise of Lehman Brothers in 2008, the Fed has repeatedly come to the rescue of stressed markets. Now, this pullback shows just how much force policymakers need to use to prop up asset markets and calm financial conditions after more than a decade of aggressive monetary policy support, with the focus now falling on whether the central bank takes further steps at its next scheduled meeting later this month.
“This raises the question of what the Fed does in March, especially if the jobs report on Friday shows no signs of the US economy slowing down,” said Ajay Rajadhyaksha, head of macro research at Barclays in New York. “Do they continue to react to market pricing or do they draw a line in the sand?”
In part, the drab market reaction reflects the fact that investors had anticipated the Fed’s move before it came; Fed chairman Jay Powell said at the end of last week that he was prepared to act as appropriate — a stance since echoed by other key central banks around the world. Stocks had already picked up this week after last week’s ugly declines.
In addition, investors are sceptical that interest rate cuts are sufficient to protect against a slowdown because of the coronavirus, especially after Mr Powell acknowledged during his press conference following the rate cut announcement that it was not clear how long the impact of the virus would persist.
Eric Stein, a portfolio manager at Eaton Vance, said he thinks another half-point rate cut is possible at the Fed meeting scheduled for March 18.
“They could have cut [0.75 percentage points] today, but they probably felt that another couple of weeks would make the impact of the virus clearer,” he said. “They were conservative with their response in case they need to step up easing if the situation gets worse.”
After initially surging in early New York trading, the S&P 500 stock index quickly fell nearly 3 per cent alongside the Dow Jones Industrial Average and Nasdaq Composite.
Other markets repeated the pattern set by stocks. Oil, which has been one of the hardest hit asset classes because of the direct impact on travel and fuel demand, also gave up most of its gains following the announcement of the Fed cut, after rebounding strongly in the past two days. Brent crude, the international oil benchmark, was up 0.5 per cent at $51.73 a barrel, but well off its earlier high of $53.90.
US government bonds rallied to new heights. Bonds stand to benefit from the Fed’s new stance as the haven assets are boosted both by rate cuts and by nerves over economic risks.
Some investors believe the Fed’s rapid response to the virus opens up moral hazard, with funds growing increasingly confident that the central bank will always come to their aid. Monetary policy may also offer poor solutions to a health crisis.
“I think the Fed cut has been a policy mistake,” said Davide Serra, founder of London-based investment firm Algebris, which manages about $13bn in assets. “Here, only the World Health Organisation, the Centers for Disease Control and Prevention and fiscal [policy] matter. Not central banks,” he said.
Mr Serra has been buying protection against falling prices in stocks and high-yield bonds ahead of and during last week’s market rout.
Still, Seth Carpenter, chief US economist at UBS and a former US Treasury official, said it may have been more dangerous for the Fed to wait for greater economic fallout. “There is no way that coronavirus will make the US economy stronger. It’ll either be a small negative or a big negative. If you cut and it’s not that bad then no problem. If it ends up being really bad and you didn’t cut, then it could take a lot longer to recover,” he said.
(Additional reporting by Eva Szalay, Laurence Fletcher, Joe Rennison, David Sheppard)