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The Federal Reserve in Crisis: What's Next?

| MoneyRates.com Senior Financial Analyst, CFA
min read

covid-19-chained-to-piggy-bankWith much of the economy in lockdown due to the coronavirus pandemic, the Federal Reserve faces a tough question as it meets next week: How do you stimulate the economy when much of the population is forced to stay home?

The simple answer is that they can't stimulate the economy right now. The job of the Fed has now shifted to stabilizing the economy.

The message coming out of next week's Federal Open Market Committee (FOMC) meeting is likely to focus less on interest rate policy than on steps to provide stability to lenders and investors. That leaves it to consumers to take their own actions on interest rates.

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Will The Fed Cut Interest Rates Again at the Next Meeting?

The federal funds rate is currently in a range of 0% to 0.25%. This matches the lowest range that fed rates reached during the 2008 financial crisis.

With the fed rate already at this historical low point and near zero, a further rate cut seems unlikely but not impossible. Theoretically, fed rates could actually move into negative territory, as rates from some other central banks around the world have already done.

However, lowering interest rates is traditionally a move to stimulate economic activity, but that activity is thwarted by concerns about the spread of COVID-19 currently. Thus, the Fed's focus seems to have moved from stimulating the economy to stabilizing the financial system.

Stabilizing financial institutions with liquidity

The risk to the financial system can be seen as a chain reaction. If many borrowers can't repay their debt due to the current economic distress, the lenders who were expecting repayments may be caught short.

This in turn limits the ability of lenders to provide further loans, so more borrowers fail and the cycle of financial distress grows wider and wider.

The Fed has addressed this by providing liquidity to the system. This includes financing loans, providing short-term loans to financial institutions to help them manage cash flow, and buying securities backed by loans to help provide funding for further loans.

The common goal of these various steps is to give financial institutions the funding they need to keep making loans - or at least to be able to hold off on collecting on all their current loans.

The availability of credit is seen as essential to tiding the economy over during the current crisis. So, a major focus of next week's Fed meeting is likely to be an update on this effort.

Will the Fed provide quarterly projections?

It will also be interesting to see if the Fed issues new economic projections. These might provide insight as to the path the Fed sees the economy taking through the economic shutdown.

Normally, the Fed provides these projections once a quarter. It did not do so as planned in March because the regular meeting was cancelled in favor of a series of emergency meetings.

It remains to be seen whether the Fed will release new economic projections in next week's meeting. Instead, it may deem that there are too many unknowns about the current situation to allow for reasonable forecasts.

If the Fed is able to update its projections, though, they would provide a valuable window into how it sees the economic crisis playing out after the coronavirus outbreak.

The Stock Market Has Stabilized - Somewhat

For all the bad news it is dealing with, one thing the Fed has in its favor is that the stock market has stabilized over the past month - relatively speaking, that is.

After reaching a peak on February 12, 2020, the Dow Jones Industrial Average fell by 37% to its low point on March 23, a period of less than six weeks.

It has since recovered some of that loss and, as of late April, stood 22% below its high point.

Since a plummeting stock market can destabilize the financial system, the fact that the free fall has stopped helps the Fed. However, with the Dow now routinely rising or falling by several hundred points per day, the market is still not exactly stable.

Investors are trained to take a long-term view, which may be why some have started to look beyond the crisis in recent weeks.

However, investors also hate uncertainty. The continued erratic behavior of the stock market reflects just how uncertain the future remains.

Plummeting Oil Prices, the New Concern

While stock prices may have pulled out of their recent dive, a fresher concern for the Fed as it meets next week is the collapse of oil prices.

Oil plunged so far so fast that the prices on futures contracts actually turned negative. This sounds strange, but it reflects the fact that at some point it costs more to store oil than the oil is worth. Thus, when oil prices fall far enough, owning it is a liability rather than an asset.

The value of oil has fallen below the cost of storage because there is a massive oversupply, and that highlights the unique problem with the collapse in oil prices given the current health crisis.

The delicate balance of oil prices

Normally, there are winners and losers when oil prices fall. While it is bad for oil producers, it is good for consumers.

In fact, low oil prices can play a role similar to low interest rates. They can help stimulate the economy by allowing consumers to spend more on other things.

Now, though, since consumers are largely restricted from traveling, there is little opportunity for consumers to benefit from lower oil prices.

Instead, the collapse in oil prices merely adds to the economic distress.

Since oil is traded globally, prices in one part of the world have an effect on prices in other places. However, the cost of production is very different depending on the location from where the oil comes.

For example, it is much more expensive to produce oil by fracking in the U.S. than by drawing it out of an oil well in Saudi Arabia. Thus, a collapse in oil prices hurts U.S. producers - and those employed by them - more than it hurts oil producers in many other countries.

The added employment concerns, along with the fact that falling energy prices have already caused the Consumer Price Index to drop, may prompt the Fed to consider negative interest rates.

The question remains, though: How much would lower interest rates stimulate the economy when opportunities to spend money are severely restricted due to the coronavirus outbreak?

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What to Do About Your Interest Rates

Regardless of what the Fed does next week, consumers don't have to watch helplessly as their savings accounts earn less and less interest.

The latest MoneyRates.com America's Best Rates study found that a huge difference exists between the top rates on savings accounts and the industry average.

That means there are still opportunities for many to fight back against lower interest rates. In fact, MoneyRates.com found that over two-thirds of U.S. deposits are with banks offering savings account rates of 0.10% or less.

With some banks still offering savings account rates over 1%, this means many consumers have an opportunity to raise their rates even in a falling rate environment.

That's something consumers can do for themselves that the Fed can't right now.


FOMC Date2020 FOMC Meeting Update Articles
03/12/2020Next Fed Meeting Won't Solve Global Economic Crisis, But Here's What Consumers Can Do
01/22/2020January 2020 Fed Meeting - More Than Meets the Eye?

 

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