- Federal Reserve Chairman Jerome Powell on Tuesday announced that the central bank cut its key interest rate by 0.5 percentage points.
- The move is designed to blunt the impact of the novel coronavirus on the US economy.
- But the move won’t stop the spread of the virus and it’s no surprise that the stock market is still selling off.
- But the interest rate cuts could provide a boost to the market and economy after the virus is contained and activity gets back to normal.
- Neil Dutta is head of economics at Renaissance Macro Research.
- This is an opinion column. The thoughts expressed are those of the author.
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Markets are said to stop panicking when policymakers begin to panic. The Federal Reserve’s decision to deliver a 0.5 percentage point emergency rate cut as the spread of coronavirus worsens qualifies as a panic move.
The Federal Reserve cannot permanently inflate the level of asset prices in the face of an economic disruption like the coronavirus, but they can provide a short-term floor under sentiment.
As many investors began to suspect that the Fed would cut rates in response to the potential disruption, there was not much room for Chairman Powell to surprise to the upside and there was plenty of room for the Fed to fall short of market’s expectations for easing. By announcing a large rate cut outside of the normal meeting schedule, the Fed was able to provide a modest element of surprise.
However, the Fed’s tools, by its own admission, are not adequate to deal with a public health crisis.
The market wants to know how far the virus will spread and the Fed cannot answer that question. The panic needs to be seen from the other end of Washington DC, with a strong response from the Trump administration and Congress. This is one reason why we suspect the market’s positive reaction to today’s news was short-lived. Stocks, as of this writing, have given up a bit less than half of yesterday’s gains.
Treating a natural disaster like an economic event
The Fed is treating what is a natural disaster as an economic emergency. Let us explain. Believe it or not, first quarter US GDP growth is tracking 2.7%, according to the latest data from the Atlanta Fed. Despite this solid showing, the consensus among Wall Street economists expects growth slowing sharply in the current quarter, to 1.0% to 1.5%. Let’s assume growth slows to the mid-point of this range, that would imply growth in March actually declines by nearly 2.0% at an annual rate.
When has growth been so weak outside of recessions? Usually during times of significant weather events: the winter of 2014, Hurricanes Katrina and Andrew come to mind. When have we seen emergency rate cuts? In October 2008, following the Lehman bankruptcy, when credit markets seized up in August 2007, when the Nasdaq bubble popped in March 2001. Usually the Fed makes an emergency cut in times of economic and credit market stress.
So, the Fed has provided a temporary floor on sentiment, and stopping the bleeding is good. But, the market is going to have to take some potential lumps through the spring as we see potentially weak numbers come out in March.
Potential upside later in the year
However, let’s not lose sight of the upside: the Fed may well be treating a temporary natural disaster like a financial market or economic event.
There is some chance that we’re not talking about COVID-19 in six months and the economy begins to come back. It’s highly likely by that time the Fed won’t have reversed course and hiked rates back to the pre-virus level. So our guess is that the economy will come back much more quickly than these rate cuts will be reversed (and more global central banks likely to join in).
Given the likelihood of lower rates and an economic bounce back, we’re likely to see short-term pain through the spring, but some reasons for optimism as the summer heats up.
Neil Dutta is head of economics at Renaissance Macro Research. He analyzes global economic and cross-asset market themes, providing leading-edge forecasts for institutional clients.