Emergency Move At The Fed: Cuts Rates By Half Point As Coronavirus Spreads

FOMC Chair Powell answers reporters questions at the March 3, 2020 press conference

Ranko Berich (Monex Europe) | Jay Powell and the Fed have taken the warning financial markets have given about coronavirus over the past weeks to heart and brought out the big guns with a 50bp intra-meeting rate cut. This is a tool that has not been used since 2008, and comes after a serious worsening in the global macroeconomic outlook due to the Covid-19 outbreak shattering previous optimistic assumptions that it would be mostly contained within Q1.

On the surface, the rate cut does look like markets have bludgeoned the Fed into cutting rates. OIS markets were pricing in 50 basis points of cuts as early as the end of last week, and interbank lending rates have been plummeting at rates not seen since 2008 over the last week. The weight of these expectations means that if the FOMC did not cut rates, they would risk tightening financial conditions dramatically from market levels. With the world facing a macroeconomic shock of historic proportions, the FOMC has decided that the market is right, and the US economy needs significant monetary support to buffer the incoming shock.

The cut shows the extent to which the coronavirus outbreak has proven to be far worse than the previous base case assumption shared by central banks, which anticipated the outbreak would be contained and a relatively rapid recovery would occur in Q2. This base case is now in absolute tatters after the global spread of the virus over the past two weeks, hence the seismic volatility seen in financial markets – and now central bank policy.

After the Fed’s bold action, the onus is now on other central banks to ease aggressively. For example, the Bank of Canada will struggle to avoid easing aggressively tomorrow while the RBA and RBNZ may soon find themselves uncomfortably close to the effective lower bound of their policy rates. With central banks using their primary policy tools so early in the overall timeline of a global outbreak, there is now a risk that if the virus is not contained in the first half of the year, monetary policy will be out of ammunition.