The Federal Reserve took over the global response to the coronavirus on Tuesday, cutting its key policy rate by half a percentage point as the group of top seven countries pointed to the “downside risks” of the spread of the disease.
In a unanimous statement by the Fed’s Open Market Committee, members said “the fundamentals of the US economy remain solid”, but added that the fast-spreading virus “poses evolutionary risks to activity economic”.
The Fed decision – its first emergency rate cut since the height of the global financial crisis – came after G7 finance ministers and central bank governors pledged to take “all the right political tools” To maintain the economic health of the advanced world.
While Australian and Malaysian central banks also cut their key policy rates on Tuesday to ward off the recession, others were slower to act. The European Central Bank has taken a more cautious approach, while Mark Carney, the Governor of the Bank of England, has suggested that different countries would adopt an approach tailored to national needs rather than in-depth coordination of the 2008 financial crisis.
“In all jurisdictions, there will be differences in the exact form and timing of these measures,” said Carney.
In the United States, the Fed’s rate setting committee has reiterated that it “is closely watching” developments and will continue to “do the right thing to support the economy.”
At a press conference Tuesday after the announcement, Fed Chairman Jay Powell stressed the underlying strength of the U.S. economy, but said the Fed had already seen the effects of the virus on sentiment forecasts for the travel and hospitality industry, and for manufacturers who depend on foreign supply chains.
“The effects are at a very early stage,” he warned. “I don’t think anyone knows how long it will take.”
The stocks veered just after the Fed’s move, which will set its key rate at 1% at 1.25%. Following Mr. Powell’s press conference, the S&P 500 was down 1.3% and the Nasdaq was down 1.1%.
T-bills have recovered, with the yield on the two-year note sensitive to policy falling by 16 basis points to 0.74% and the 10-year yield by 13 basis points at 1.03%. Yields fall when prices rise.
Bank of America, considered the most sensitive to the rates of the major American banks, fell 5% after the drop. Smaller banks and less diversified lenders did worse: lender for tech company Silicon Valley Bank fell 7.2%
“Since the Fed has little firepower left, they intervened early,” said Alicia Levine, chief market strategist for BNY Mellon Investment Management. “The cuts will stabilize the feeling.”
Donald Trump, who made the economy and the financial markets a cornerstone of his presidential re-election campaign, had put increasing pressure on the Fed to lower interest rates in recent days, stocks being collapsed in response to the spread of the virus.
After the Fed announcement, he tweeted: “The Federal Reserve is shrinking but has yet to relax and, above all, align with other countries / competitors. We are not playing on level ground. Not just for the USA. It is finally time for the Federal Reserve to lead. More flexibility and cut! “
Tuesday morning, before markets opened in the United States, G7 finance ministers and central bank governors released a statement following Monday’s OECD forecast suggesting that the global economy is headed for recession .
The statement contained few specific commitments, unlike his decisive response to the 2008 financial crisis. But he pledged budget support to ensure that health systems can respond to the disease and to topple economies while the policymakers currently estimate that they will be in serious decline for at least a few months.
Financial market observers, however, predicted that other central banks and finance ministries would now be under serious pressure to follow the Fed with more decisive action.
With lower interest rates in Japan, the Eurozone and the United Kingdom than in the United States, David Page, senior economist at Axa Investment Managers, said that the Fed’s decision “presents a challenge for other international central banks, “but they were more likely to meet scheduled meetings.
Andrew Kenningham of Capital Economics said the ECB should react and predicted that it would cut its deposit rate by 0.1 percentage points next week, placing it further in negative territory at -0.6%.
Powell said on Tuesday that the Fed was in “active discussions with central banks around the world on an ongoing basis”.
A central bank to take action early in the day was the Reserve Bank of Australia. He said the epidemic had a “significant effect” on the country’s economy, as it reduced rates by a quarter of a percentage point to 0.5%.
The Australian government also confirmed on Tuesday that it was preparing a “targeted and measured” fiscal stimulus package, as policymakers increasingly feared that Australia would face its first recession in nearly three decades.
“The overseas coronavirus epidemic is currently having a significant effect on the Australian economy, particularly in the education and travel sectors,” said Philip Lowe, Governor of the RBA, in a statement.
The Fed’s decision on Tuesday “raises the question of whether they know something the market doesn’t know,” said Torsten Slok, chief economist at Deutsche Bank Securities. “We literally have no economic data to hang our hat on. They certainly don’t want to be blamed for being late. “
Slok added that the time between signaling a rate cut and actually reducing it was “extremely short”.
On Friday, the Fed announced a possible cut, in a rare press release outside of a scheduled meeting. In its statement, the Fed included the phrase “do the right thing”, a phrase it used in the past to signal its intention to cut.
As recently as last week, investors saw no chance of a decline at the next Fed meeting on March 18, according to an analysis of short-term interest rate futures by the CME group. By Monday, that probability had risen to 100% as short-term interest rates plummeted.
“Given the wording on the economy that accompanied the emergency action, there is unfortunately real concern that the 50bp drop will be seen not only as markets forcing the hand of the Fed again, but also as a further slippage in communication from the Federal Reserve, “said Mohamed El-Erian, chief economic adviser at Allianz.
“It is all the more important that this action be framed in the context of a coordinated global political effort and not only correlated,” he added.
Steven Mnuchin, US Secretary of the Treasury, told parliamentarians at a hearing on Tuesday that he “very” supported the Fed’s decision.
“I think they did the right thing to move forward,” said Mnuchin. “All central banks and finance ministers are very focused on what we can do together and independently on what we can do to resist the economic impact of this situation. This is going to have an impact on many people in the short term. “
As the evidence for the spread of the coronavirus increased in the United States, some analysts have questioned whether the brutal instrument of monetary policy is the best response to the economic fallout from a potential pandemic.
“The Fed obviously sees this as a potentially substantial demand shock to the economy and wants to anticipate the damage if possible,” said Tim Duy, monetary economist at the University of Oregon. “The risks of early and large movements are minimal in an environment of low inflation. The Fed remains focused like a laser on preventing a recession. “
Additional reporting by Richard Henderson and Jennifer Ablan in New York
