The Fed Implements Emergency Rate Drop

Yesterday the Federal Reserve cut interest rates by 0.5%. As real estate investors who are about to refinance a project, we can raise a glass and make a toast to Jerome Powell.The Fed has been saying for some time that they intend to address a downturn with aggressive monetary policy. Today’s announcement was not at their regularly scheduled meeting that happens every 6 weeks. The last time the Fed took extraordinary action like this was during the financial crisis in 2008.

Today’s move will lower the cost of some borrowing, but not all. Long term rates are linked to the yield on the 10 year treasury which is determined by market forces, more than the actual short term lending rate set by the Fed. Still it’s a positive step for real estate investors. Some home owners and investors will choose to accelerate their planned refinance to take advantage of the lower interest rates. That lower rate will create more free cash flow in the economy that could eventually make its way back into the economy. Some will choose to maintain their payments constant and increase the principal portion of the payment to accelerate the amortization of the loan.

In terms of the broader economy, and the economic slowdown, like we talked about last week, this tool is completely useless as a counter-measure to the corona virus induced slowdown in the global economy.

I cancelled two trips in the past week because of concerns flying in a Covid-19 environment. I caught the H1N1 Swine flu when traveling in Japan back in 2009 and I know exactly what that’s like. I have no desire to be laid up in bed for a few weeks or worse. I also have no desire to be in a mandatory quarantine situation for two to three weeks. I have no desire to accelerate the spread of the disease.

It’s not like the lower interest rates would stimulate me to travel again. The interest rates have no influence on my decision to travel or not.

Economists don’t really have a vocabulary to describe this situation. They tend to think in terms of price elasticity of demand. The concept of price elasticity describes how sensitive demand is to changes in price. For example, if my flight to Italy last week was to increase in price to, say, $2,000, I probably would choose not to travel based on price and of course the risk of corona virus infection. But if the price were to drop to, say $300, I would definitely travel under normal circumstances. But we’re not in normal circumstances and I would still choose not travel because of the risk of corona virus infection. So while the demand might be elastic with price, it’s highly inelastic due to corona virus. The two are not connected in any way.

So that’s the demand side of the equation.

Let’s look at the supply side of the equation.

A recent report published in the Harvard Business review last week speaks directly to the question of supply chain disruptions. If you wanted to go buy a new Fiat automobile, they’ve shut down their factory in Serbia due to parts shortages. Perhaps you are looking for a new Hyundai or Kia SUV. Here too, manufacturing plants in Korea have been shut down due to parts shortages.

So perhaps lower interest rates might stimulate some to go buy a new car. For the time being, there’s ample supply. But in a few weeks, we can expect that some models will be more difficult to source. Some buyers may substitute for another product.

Then again, some may choose to wait until conditions normalize before making any major financial decisions.

Suffice to say, that the attempt to stimulate the economy where the supply chains have been disrupted won’t help if the manufacturers can’t get their product to market. A half point drop in the interest rate won’t create more surgical masks, manufacture more Tylenol or bring more container ships from China.