Fed ready to cut rates despite doubts that it can offset coronavirus effect

The Federal Reserve is now prepared to reduce interest rates this month even though it recognizes that monetary policy cannot completely shelter a U.S. economy increasingly threatened by the coronavirus.

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

He was pushed into making that assurance by spectacular losses in U.S. 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 weeks. Goldman Sachs economists said on Sunday that the Fed may even act before its official gathering and perhaps in coordination with other central banks.

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.

Terrible week for stocks

Driving the rethink was the worst week for U.S. 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% lower on Friday, rallying back in the final 15 minutes of trading from losses that topped 3%. For the week, the index lost 11%. 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 predict a half-point cut this month.

Those at Goldman Sachs Group see reductions totaling 50 basis points by March 18 and a total of 100 basis through June.

They also see cuts coming, perhaps in tandem, from the euro area, Canada and the U.K. among others. Central banks last delivered coordinated rate cuts in 2008.

“Global central bankers are intensely focused on the downside risks from the virus,” the Goldman economists said in a report. “We suspect that they view the impact of a coordinated move on confidence as greater than the sum of the impacts of each individual move.”

The U.S.’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.

In trying to figure out what to do, policymakers 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 U.S. economy would be small and fleeting.

Worse than thought

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 U.S.”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 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 of credit

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-size 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 Friday in laying out his thinking on the potential for looser monetary policy.

With rates at a target range of 1.5% to 1.75%, 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 U.S.-China trade and ebbing risks of the U.K. 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 U.S. election year.