Fed Emergency Cut Falls Flat; Yields Drop, Gold Rises; BoC Next

The U.S. Federal Reserve delivered its first inter-meeting rate cut since October 2008 yesterday, one week after stocks posted their biggest weekly decline since ... October 2008. Global central banks failed to deliver a coordinated cut after a bland G7 statement but the Federal Reserve did, with a 50 bps move. Yields on the U.S. 10-year government bond fell below 1.0% for the first time.

Oil and U.S. stocks initially spiked higher on the news, but the reaction lasted only minutes as a 'sell the fact' trade hit hard. A consistent reaction throughout the day was weakness in USD/JPY and jumps in bonds and gold. Also keep an eye on the U.S. Democratic presidential primaries in 14 U.S. states.

US 10 Yr Yield Daily Percentage Change US 10 Yr Yield Daily Percentage Change
The problem with the Fed surprise cut is that it was framed – unfairly or not – as an 'emergency' measure and to companies and Main Street all that does is underscore that coronavirus is an emergency. The S&P 500 jumped 80 points in seconds on the initial headlines but quickly gave it all back and closed down 86 points, or 2.8%.

As we warned yesterday:

“Even if cuts are delivered the effect could be fleeting as investors continue to grapple with an seemingly endless stream of headlines about the virus.”

This isn't a financial crisis and it won't be solved by financial measures. Undoubtedly, lower rates will help in a rebound but that won't come until there is some visibility towards an end to the pandemic. Once again on Tuesday there was an endless stream of bad news about infections and deaths. The WHO revised its estimate of fatality rates higher to 3.4%, which is certainly a scary number to ponder with little chance now that the virus can be contained.

The Bank of Canada is the next central bank on deck with a decision coming Wednesday. A 25 bps cut is fully priced in and 50 bps is a 65% probability in the OIS market. The BOC has said recently that it doesn't want to fall behind the Fed so 50 bps is far more likely and 75 bps is a real possibility because Poloz may want to get ahead of a further March 18 Fed cut.

In any case, the bond market is way ahead of both of them. U.S. 2-year yields hit 0.62% at the lows Tuesday and 10-year yields hit at record low of 0.90%. In a world where the Fed's mandate is to get inflation to 2% that looks like an overreaction, but it also seems reasonable in a world where the Fed will seemingly do whatever it can to keep equity valuations high.

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