COVID-19 and the Fed

New, much cleaner look for my old newsletter(Cold Brew). Trying out a new newsletter service so things might not work as expected.


So the Fed cut 50 basis points partly because of the Coronavirus but what does the rate cut really mean?

Fed is the Federal Reserve Bank. Each country has one. RBI is the Indian Fed. They are like the Chief Financial Officer of the country.

The world works on debt. Everyone borrows money. Businesses take out loans to build products, and customers take out personal/housing/(worse credit card) loans.

The most critical component in debt is the interest rate. It affects how much you will end up paying in total. It is even more essential for longer-term debt (10-30 years); in such cases, you might pay more interest than the principle itself.

These interest rates are set by the respective market. So housing loan interest will be set by the housing market, credit card APR by the credit market, etc. But all of these pay very close attention to the Fed interest rate. All of these interest rates go up or down based on what the Fed does. They are directly proportional.

Why are they directly proportional to Fed's rates? That is a complex system, and out of scope for now.

But how does this affect the stock market?

When Fed cuts rates, money becomes cheap. Businesses and consumers can borrow cheaply and easily. So the assumption is that companies can produce more goods and services that will lead to more profit. More profit means higher valuation for companies, which means a higher stock price.

So, the stock market is inversely proportional to the Fed's rate action.

An increase in the Fed rate results in lower stock prices, and a decrease in fed rate cut(like today) results in higher stock prices.

Now, when the US coughs, the world catches a cold. Anything that the Fed does has rippling effects across the globe. Expect RBI and other reserve bank authority around the world to cut their rates too.

Few actionable items:

  • Hold off on the housing loan. Interest rates may go down.

  • Consider refinancing student loans.

  • Expect interest in a high yield savings account to go down.

  • Lock in the CDs and FDs. Interest rates on those may go down.

  • Stock valuations have gone up, but revenues might take a more substantial hit because of the halted supply chain. So it does not guarantee if this rate cut will stimulate the market or the economy.

Invest for the long term. Focus on signals and not noise.