- The Federal Reserve made a surprise emergency cut of 50 basis points to the federal funds rate on Tuesday in a desperate attempt to reduce the impact of coronavirus.
- Cutting rates won’t solve all problems; we don’t know how much the coronavirus will hurt the global economy.
- Stocks are overpriced. The Fed rate cut could inflate the bubble even more.
On Tuesday morning, the Federal Reserve cut the federal funds rate by half a percentage point to help protect the economy from the coronavirus impact.
When the economy is slowing, reducing the federal funds rate is a tool the central bank uses to stimulate financial activity. Consumers and businesses will spend and invest more, which in turn will boost stock prices.
The benchmark interest rate is now 1% to 1.25%. This is the first emergency rate cute since the financial crisis of 2008 and the biggest cut since then.
The rate cut follows a G7 meeting where the group committed to using policy tools at their disposal but took no specific measures to combat COVID-19.
Investors were surprised when the Fed lowered rates on Tuesday. U. S. stocks jumped following the announcement but started to plunge again about an hour later. Markets would rally again on Wednesday, with the Dow gaining almost 1,200 points.
Why Rate Cuts Can Be A Bad Thing
While this rate cut might seem like a positive thing at first, it’s not clear whether conventional policy tools can combat a disease like coronavirus. At the same time, the rate cut will likely inflate the stock market bubble as it encourages investors to buy more stocks, possibly leading it to pop.
Last week, markets plunged sharply, bringing them to more reasonable levels. But the surge in stocks we saw on Monday and Wednesday pumped up the bubble again, which will pop one day – the question is when.