Skip to Content

What to Know About Emergency Interest-Rate Cuts

How this move to promote economic stability may affect your portfolio.

Editor’s note: Read the latest on how the coronavirus is rattling the markets and what investors can do to navigate it.

Are zero interest rates warranted as an emergency measure?
Central banks’ mandate is to ensure that the market operates with financial and economic stability--that is, that inflation is kept in check and unemployment is minimized.

So, during moments of market panic when this stability appears to be jeopardized, we should expect the central bank to act. Interest-rate cuts are a key way for central banks to alleviate the pressures on households, companies, and even the government. This can have knock-on consequences on other areas of the market though, including for the banks.

Are there other tactics the Fed can use to promote economic stability?
There are other methods for the central banks to inject stimulus into the financial system and promote financial and economic stability, such as:

  • Quantitative easing. This is when the government purchases long-term bonds and mortgage-backed securities to spur the economy.
  • "Helicopter money." This is a sheer increase in an economy’s money supply.

As the market stands, the Federal Reserve recently announced that it will purchase another $700 billion of Treasury bonds and mortgage-backed securities. It also struck a deal with five other central banks in Canada, the United Kingdom, Japan, Switzerland, and the eurozone to lower their rates on currency swaps to keep the financial markets functioning normally.

Are these emergency measures good for investors?
They’re likely a positive for long-term investors, although that can be hard to see from the eye of the storm. It’s natural to get a bit anxious when authorities like the Federal Reserve recognize the challenges in the environment, but in general it's a good thing that central banks are taking proactive steps to address the situation and help the speed and magnitude of the economy.

What is the most effective way to stimulate the economy?
A few ways central banks might try to limit contagion or secondary effects include:

  • keeping credit available to households and businesses;
  • providing liquidity to all market participants;
  • maintaining low borrowing costs; and
  • trying to limit market financial stress.

But beyond these measures, we actually think the entity that might have the most direct economic impact falls outside the scope of the central banks: fiscal policy.

So, when you consider that the banks don’t directly control the strongest lever of the economy, combined with their mandate, it makes sense that they are going to such lengths to stimulate against a great unknown.

Should I worry about interest rates during this downturn?
We at Morningstar Investment Management are broadly looking at two things during this time: risk and opportunity. Here’s what that looks like:

  • From a risk perspective, we are dealing with the same unknowables that central banks are. We can all hope that the coronavirus will be a historical memory 10 years from now, but we have little idea of what might happen tomorrow or even in three months. That uncertainty is why investors should considering diversifying, keeping costs low, and seeking underpriced assets.
  • We also seek opportunity. Right now, market participants are skeptical. Most stocks have fallen; many bonds have risen. This environment means we have an opportunity to do what others can’t or won’t: to see opportunity amid the madness.

What does that mean exactly? Well, at a minimum, this means calmly seeking to rebalance (an approach that phases the selling of what we believe to be “safer” bonds in favor of buying beaten-down stocks), and if the market panic worsens, search for areas the market might have mispriced on the downside.

A couple of important disclaimers here:

  • We can’t and won’t need to know where the “bottom of the market” is. We believe we can seek long-term profits by simply buying assets for less than they’re worth and not panicking when everyone else does.
  • “The market” is the culmination of several underlying markets. We take a bottom-up, granular approach to investing, so we will continue to analyze more than 200 asset classes in our search for what we believe to be attractively priced investments.

In times like these, we look to this Warren Buffett quote for perspective and motivation: “Every decade or so, dark clouds will fill the economic skies, and they will briefly rain gold. When downpours of that sort occur, it’s imperative that we rush outdoors carrying washtubs, not teaspoons. And that we will do.”

Opinions expressed are as of the current date; such opinions are subject to change without notice. Morningstar Investment Management shall not be responsible for any trading decisions, damages, or other losses resulting from, or related to, the information, data, analyses or opinions or their use. This commentary is for informational purposes only. The information, data, analyses, and opinions presented herein do not constitute investment advice, are provided solely for informational purposes and therefore are not an offer to buy or sell a security. Please note that references to specific securities or other investment options within this piece should not be considered an offer (as defined by the Securities and Exchange Act) to purchase or sell that specific investment. Performance data shown represents past performance. Past performance does not guarantee future results.

All investments involve risk, including the loss of principal. There can be no assurance that any financial strategy will be successful. Morningstar Investment Management does not guarantee that the results of their advice, recommendations or objectives of a strategy will be achieved.

Asset allocation and diversification are investment methods used to help manage risk. They do not ensure a profit or protect against a loss.

This commentary contains certain forward-looking statements. We use words such as “expects”, “anticipates”, “believes”, “estimates”, “forecasts”, and similar expressions to identify forward-looking statements. Such forward-looking statements involve known and unknown risks, uncertainties and other factors which may cause the actual results to differ materially and/or substantially from any future results, performance or achievements expressed or implied by those projected in the forward-looking statements for any reason. Past performance does not guarantee future results.

Morningstar® Managed PortfoliosSM are offered by the entities within Morningstar’s Investment Management group, which includes subsidiaries of Morningstar, Inc. that are authorized in the appropriate jurisdiction to provide consulting or advisory services in North America, Europe, Asia, Australia, and Africa. In the United States, Morningstar Managed Portfolios are offered by Morningstar Investment Services LLC or Morningstar Investment Management LLC, both Registered Investment Advisors, as part of various advisory services offered on a discretionary or non-discretionary basis. Portfolio construction and on-going monitoring and maintenance of the portfolios within the program is provided on Morningstar Investment Services behalf by Morningstar Investment Management LLC. Morningstar Managed Portfolios offered by Morningstar Investment Services LLC or Morningstar Investment Management LLC are intended for citizens or legal residents of the United States or its territories and can only be offered by a Registered Investment Advisor or investment adviser representative.

Investing in international securities involve additional risks. These risks include, but are not limited to, currency risk, political risk, and risk associated with varying accounting standards. Investing in emerging markets may increase these risks. Emerging markets are countries with relatively young stock and bond markets. Typically, emerging-markets investments have the potential for losses and gains larger than those of developed-market investments.

A debt security refers to money borrowed that must be repaid that has a fixed amount, a maturity date(s), and usually a specific rate of interest. Some debt securities are discounted in the original purchase price. Examples of debt securities are Treasury bills, bonds and commercial paper. The borrower pays interest for the use of the money and pays the principal amount on a specified date.

The indexes noted are unmanaged and cannot be directly invested in. Individual index performance is provided as a reference only. Since indexes and/or composition levels may change over time, actual return and risk characteristics may be higher or lower than those presented. Although index performance data is gathered from reliable sources, Morningstar Investment Management cannot guarantee its accuracy, completeness or reliability.