【Economic Perspectives】Central Bank Watch – Fed is now ready to cut more quickly and aggressively

After US and global stock markets suffered the worst week since 2008, Fed Chair Powell issued a surprise official statement reaffirming that the central bank would “act as appropriate” to respond to the risks posed by coronavirus. This rare inter-meeting statement hinted that Fed is ready to act preemptively soon to provide additional accommodation. We view that a 50bp cut in March and a total of 50-75bp cut during 1H20 are now possible. At present, the market is overestimating Fed rate cut odds. The current non-financial public health concern is fast-moving so we need to closely monitor events right up until the meeting.

  

• Fast-spreading virus is a game-changer for US Fed actions. Fed was intending to keep rates steady at least for several months after cutting the benchmark lending rates three times last year to the range of 1.5-1.75%, until CODIV-19  unexpectedly changed its policy pace. In the mounting concerns that the virus crisis would derail global economy (we have slashed growth forecast on 25 Feb), more than US$7tr wiped off the value of stocks worldwide from the level of 19 Feb. Powell’s surprising formal brief statement on 28 Feb, as we interpret, made a clear stance that Fed is ready to take action very soon to counter the risks poses by virus spread and to soothe market fears.

 

• We expect Fed to cut soon to soothe market. The timing and magnitude are the focus now.  We expect Fed to act soon this month, with an aggressive 50bp insurance cut, more likely on its 17-18 March meeting than an emergency gathering to authorize an inter-meeting rate cut, unless virus spread turns much worse rapidly. The yield curve has been inverting even steeper recently and a 25bp cut seems not enough to help normalize the shape of the yield curve. In addition to a March cut, we now see a sum of 50-75bp cut during 1H20 possible. The ultimate amount of easing depends on the economic fallout and outlook.

 

• More signs of wider virus outbreak in US underway: new cases have been increasing faster since 23 Feb in multiple US states. As of 3 Mar (8:00 GMT+8), 99 cases have confirmed in US. With testing ramping up this week, US may brace for more confirmed cases.  

 

• US economy remains solid and COVID-19 impact on it is expected to be fairly limited in 1Q20. Powell said in his 27 Feb statement that “the fundamentals of the US economy remain strong, but COVID-19 poses evolving risks to economic activity”. Trump is counting on strong economy to win reelection this year, who said on 27 Feb that he hoped the Fed would step in soon and cut rates. Rate cuts, by making it cheaper to borrow money, would provide only a bit of supporting to the domestic demand, especially consumer spending; while virus risk hurts both supply and demand sides. If the infection numbers in US accelerate, stock prices would continue to feel pressure despite whatever Fed does.