US Fed ready to cut rates despite doubt they can fix coronavirus fallout

Powell issued a rare statement amid the coronavirus epidemic.PHOTO: AFP

Published

Feb 29, 2020, 3:47 am SGT

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WASHINGTON (BLOOMBERG) - The Federal Reserve is now prepared to reduce interest rates this month even though it recognises monetary policy cannot completely shelter a US economy increasingly threatened by the coronavirus.

Fed chairman Jerome Powell opened the door to a rate-cut at the Fed’s March 17-18 meeting by issuing a rare statement on Friday (Feb 28) pledging to “act as appropriate” to support the economy.

He was pushed into making that assurance by spectacular losses in US stocks as investors turned fearful that the spreading virus would significantly damage the American and global economies. Traders and a string of Wall Street banks now expect the Fed to lower rates in the coming months, with some seeing the possibility of an emergency cut before the central bank’s March meeting.

In doubt though is how much effect rate cuts will actually have amid a health emergency that threatens to reduce both supply and demand in the economy. No matter what the Fed does, factories can’t churn out goods if they can’t get needed materials from abroad. Consumers are also unlikely to spend if scared to leave their homes.

But cheaper credit can still help drive an economic rebound and restore confidence once the virus is controlled. And while it doesn’t like to be depicted as racing to the rescue of markets, the Fed can limit the damage from tighter financial conditions on the economy.

“Monetary policy certainly can’t meaningfully affect how the virus spreads,” former Fed Governor Laurence Meyer said. “But that doesn’t mean you do nothing. You still do what you can.”

Powell’s intervention 90 minutes before the stock market’s close on Friday marked a sharp pivot from the previous message of policy makers that it was way too soon to judge the economic impact of the China-borne epidemic. It also called into question the Fed’s hopes that it could hold policy steady in 2020 after cutting rates three times last year.

STOCK ROUT

Driving the rethink was the worst week for US stocks since the 2008 financial crisis.

“They didn’t want to have a continued free-fall,” said Peter Hooper, a former Fed official who is now global head of economic research for Deutsche Bank. “They know that the one thing that monetary policy can do is to give risk assets a bit of a lift.”

Stock prices bounced up in the wake of the Powell statement. The S&P 500 index ended 0.8 per cent lower on Friday, rallying back in the final 15 minutes of trading from losses that topped 3 per cent. For the week, the index lost 11 per cent. But in the wake of a series of worrying virus-related headlines on Saturday, investors are on edge again.

Hooper expects the Fed to cut rates by a quarter percentage point in March and April. His counterparts at Bank of America Corp predict a half-point cut this month. Those at Goldman Sachs Group see reductions totaling three quarters of a point through June.

The US’s first fatality from the coronavirus was a man in his 50s, Washington State health officials said on Saturday. President Donald Trump, briefing reporters at the White House after the news, renewed his public attacks on the central bank and said it was “about time” the Fed acted like a “leader” and lowered rates.

If the market rout continues, the Bank of America economists said an “emergency cut” outside of the Fed’s normal schedule of meetings is also possible. It’s not done that since October 2008.

In trying to figure out what to do, policy makers are pondering the same imponderables that investors are. Their initial thought was that the contagion would be contained mostly to China and that the impact on the US economy would be small and fleeting.

NOT IF BUT WHEN

That assumption was thrown into question as the virus spread from China to the rest of the world, with the Centers for Disease Control and Prevention saying it’s not a question of if but when it affects the US.“We’re going to get infections here and there for quite a while,” said former International Monetary Fund chief economist Olivier Blanchard, who is now with the Peterson Institute for International Economics in Washington. “The economic cost may be large.”

In a report released on Friday, Goldman Sachs economists led by Jan Hatzius said they anticipate the virus will inflict a “short-lived global contraction” on the world economy that stops short of an outright recession.

Such concern will have mounted over the weekend with news Saturday that Chinese manufacturing activity contracted sharply in February with an official gauge hitting a record low.

SUPPLY SHOCK

Blanchard questioned though how much good a Fed rate cut would do in the face of what he called “an unusual supply shock,” where factories are forced to curtail production because they can’t get parts from abroad.“Decreasing the policy rate by 25 basis points in that context doesn’t feel quite useful,” Blanchard said.

What’s more important, he said, is ensuring that credit keeps flowing to small and medium-sized companies that may face a liquidity squeeze due to supply chain disruptions from the virus.

Fed officials seem alert to the importance of maintaining the supply of credit.“The first way I’m going to think about this is whether or not lending behavior is adversely influenced,” Chicago Fed President Charles Evans said on Feb 27 in laying out his thinking on the potential for looser monetary policy.

POLICY SUPPORT

With rates at a target range of 1.5 per cent to 1.75 per cent, Fed officials reckon that monetary policy is already accommodative and providing support to the economy.

Some of the dangers the committee was worried about last year have also diminished with the signing of a phase one US-China trade and ebbing risks of the UK crashing out of the European Union.All things equal, Fed watchers says the central bank would probably prefer to stay on the sidelines during a US election year.