Fed surprises with prompt 50bps cut

David Page, Senior Economist at AXA Investment Managers, comments on the latest US Federal Reserve rate cut:

• Fed cuts Fed Funds and IoER rate by 50bps in surprise intermeeting cut – the first of its kind since 2008.
• Fed Chair Powell explained that the cut was a reaction to “evolving risks” of the coronavirus.
• He stated that the Fed believed that the policy was currently “appropriate”, but that the Fed was “monitoring closely” and would “use out tools appropriately”.
• Powell described a “fluid” situation, we consider the likelihood of a further 0.25% easing at the scheduled meeting on 18 March and in late April, taking the FFR to 0.5-0.75%.
• Powell also referred to the G7 statement showing a high level commitment to use appropriate tools. This throws down the gauntlet to other central banks, but we see other central banks as more likely to stick to scheduled meetings.

The US Federal Reserve announced an intermeeting 50bps rate cut to the Fed Funds Rate, taking it to 1.0-1.25%, and to the interest on excess reserves (IOER) rate, taking it to 1.1%. The rate cut was described as unanimous and in reaction to the “evolving risks” surrounding the coronavirus. This was the first inter-meeting rate cut since 8 October 2008, when the Fed reacted to the Lehman’s Brothers collapse. We had only just shifted our outlook to suggest that the Fed would cut by 0.50% this month (at its scheduled meeting on 18 March) and a further 0.25% in April. We were surprised by the Fed’s swifter move.

Fed Chair Powell held a press conference after the cut and explained that the Fed was reacting to “new risks” posed by the coronavirus to the US economy. The Fed Chair stated that he saw the Fed as part of a multifaceted approach, including health institutions, where appropriate fiscal policy, but that monetary policy could also play a role by offsetting tighter financial conditions and supporting consumer sentiment. Powell stated that he was happy with monetary policy and thought the current stance was appropriate. However, he also said that the Fed continued to “closely monitor” the situation and would “use our tools to act appropriately”, language that continued to echo the Fed’s statement on Friday that preceded this easing.

The outlook is necessarily uncertain for the next meeting in a fortnight’s time. Much will depend on the unknown developments in coronavirus. The US currently reports 106 cases. South Korea saw the number of cases rise from 100 to 4000 within the space of around 10 days illustrating how “fluid” this situation could prove. If the virus continues to spread globally and in the US this could present additional downside risk to the US economic outlook and create an incentive to ease policy further. We would suggest risks are skewed to the downside. Much will also depend on market reaction. The S&P 500 index rallied by 7% on Monday after the Fed’s statement on Friday. It is so far down 1% on the day, with stocks rising and unwinding 2% after the move. If financial conditions tighten further, the Fed may also be encouraged to ease further. The Fed’s decision to move intermeeting likely reflected a desire by the Fed to get ‘ahead of the curve’, with markets pricing at least a 50bps easing at the March meeting and two subsequent cuts thereafter. Markets now consider the possibility – a little shy of 50% - for an additional cut in two weeks’ time, if not this is fully priced for the April meeting. This suggests a view that the Fed has ‘cleared the decks’. However, there seems little point for the Fed moving aggressively now to then sit on its hands for nearly two months until the end of April. Moreover, the experience of the intermeeting cut in 2008 was that it was a complement, not a substitute to easing at scheduled meetings. For now, we pencil in a 0.25% rate reduction at the Fed’s scheduled meeting on 18 March and 29 April taking the Fed funds rate to 0.5-0.75%.

Powell also referred to today’s G7 statement. He stated that this was a strong and high level commitment of what needed to be done, but stated that individual authorities will need to do what is required in their own institutional contexts. Nevertheless, this presents something of a challenge for other international central banks. ECB President Lagarde only suggested providing support yesterday, somewhat behind other central bank’s. With little monetary policy space, the ECB appears keen to move more cautiously. However, the Fed’s move throws this into sharp relief, not least as the euro reached $1.12 after the Fed’s cut and is up nearly 4% over the last couple of weeks. Nevertheless, we see the ECB continue with a cautious approach to easier policy that could include targeted liquidity provisioning next week and a refocus towards corporate bond purchases as we move into Q2. The Bank of England will also have to consider its policy in the context of a meeting not scheduled until 26 March. For the BoE it makes sense to wait until after the 11 March Budget and with global financial markets not hanging on the BoE’s outlook it may have the luxury of more time. Nevertheless, we forecast a 0.25% rate cut at that meeting on 26 March.