"He ain't seen my heat."

Nuke: I want to bring the heater. Announce my presence with authority.

Crash: To announce what?

Nuke: My presence with authority.

Crash: To announce your presence with authority?! This guy's a first ball fastball hitter, looking for the heat.

Nuke: So what? He ain't seen my heat.

Crash: All right, Meat. Give him your heat.

Bull Durham

In a surprise move, on March 3, 2020, the US Federal Reserve cut its benchmark rate by 50 basis points to a targeted upper bound of 1.25%. The markets were calling for a cut by the Fed — or at least inclination of support at its next meeting. The markets got what they wanted, and more — which is the problem that led to the recent sell-off. In our view, the Fed cutting interest rates does nothing to address the economic impact of the coronavirus. This is not a financial or credit problem. This is a supply and demand problem brought on by containment efforts to control the spread of the coronavirus. Rate cuts would help alleviate a financial problem and are likely to support during the recovery, but again, in our view, will do nothing to offset the slowdown in the near-term.

So, where does this leave us?

First, while the current conditions are vastly different from other economic slowdowns, in the past, Fed rate cuts have coincided with tighter credit conditions. At this time, it is difficult to suggest that credit conditions have tightened up. In fact, since the three rate cuts by the Fed late last year credit conditions have actually eased. Therefore, the Fed’s efforts, with best intentions, is unlikely to improve the situation.

This chart shows the US Federal Reserve’s Federal Funds Rate compared to the Chicago Fed National Financial Conditions Credit sub-index. When the Financial Conditions Index is below zero, it indicates that credit is easy and the Fed does not need to cut rates to increase liquidity or make it easier to access credit. When it increases to and then surpasses zero, it indicates that credit is tight and lower interest rates will help to ease credit conditions. Currently, credit is easy (below zero) yet the Fed still cut rates, which is unusual and not due to a tight credit market.

Secondly, as we have said in the past, when evaluating the Fed’s actions, “the medium is the message.” While Chairman Powell commented in the press conference that the US economy was solid, his actions said otherwise. You can’t have it both ways. Just as a tightening implied economic strength, an easing implies weakness. By cutting rates the Fed is signaling that the US economy faces headwinds. And by cutting rates outside of a set meeting, the signal was loud. This is why, in our view, the markets sold off following the announcement. And until the economic situation clears, we believe the volatility will remain.

As we have been saying, at this point in time, while the risks have increased, we are not of the belief that the current environment will evolve into a recession. The earnings impact, however, hasn’t been fully realized. As such, until we have greater clarity about the earnings growth impact of the containment efforts of the coronavirus in the US and other countries, we will remain defensive and underweight equities with our model asset allocation at 50% equities and 50% fixed income.

A rise in interest rates typically causes bond prices to fall. The longer the average maturity of the bonds held by a fund, the more sensitive a fund is likely to be to interest-rate changes. The yield earned by a fund will vary with changes in interest rates.

Currency risk is the risk that fluctuations in exchange rates may adversely affect the value of a fund’s investments.

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Kevin Headland, CIM

Kevin Headland, CIM, 

Co-Chief Investment Strategist

Manulife Investment Management

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Macan Nia, CFA

Macan Nia, CFA, 

Co-Chief Investment Strategist

Manulife Investment Management

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