By Nick Timiraos
WASHINGTON -- Markets and global events are giving central
bankers a case of déjà vu.
Last year, the threat of a growth downturn exacerbated by trade
uncertainty prompted the Federal Reserve to cut interest rates.
Now, the potential for a global coronavirus outbreak is again
putting the Fed in a delicate spot.
A top Fed official said Tuesday it is too early to tell whether
any virus fallout that roils supply chains, output and travel will
force the central bank to resume rate cuts in the coming
months.
The disruption from the outbreak in China "could spill over to
the rest of the global economy," Fed Vice Chairman Richard Clarida
said in a speech Tuesday. "But it is still too soon to even
speculate about either the size or the persistence of these
effects, or whether they will lead to a material change in the
outlook."
The coronavirus has led to significant quarantines in China
since January, initially focusing attention on how much a hit the
global economy might take from idled production in the world's
second-largest economy.
Signs that the virus is spreading -- other countries across
Europe and Asia reported more cases in recent days -- led to a
sharp pullback in risk-taking by investors this week. A rout in
global financial markets deepened Tuesday, with stocks falling
after hitting all-time highs over the past two months and the yield
on the benchmark 10-year U.S. Treasury note trading at a new record
low.
Investors have been placing growing bets on rate cuts later this
year in interest-rate futures markets, according to CME Group, with
markets expecting the Fed to have cut at least once by June and
again by December.
A substantial decline this year in long-term yields means
borrowing costs have already grown more favorable. Markets for now
don't expect the Fed to cut rates at its March 17-18 meeting, which
could give the central bank time to see how developments unfold
without risking a negative market reaction if it doesn't
immediately lower rates.
Fed Chairman Jerome Powell has said the central bank will want
to see evidence that disruptions are persistent and material for
the U.S. economy before cutting interest rates.
"There's just great uncertainty around where this virus is going
to go and when the full effects are going to be realized, so I'm
open minded," Minneapolis Fed President Neel Kashkari said in an
interview Monday. "I don't see any urgent need to move until we
have more information."
Mr. Clarida described the U.S. economy and interest-rate policy
as being in a "good place" on Tuesday. "That said, monetary policy
is not on a preset course," he added. The central bank "will
proceed on a meeting-by-meeting basis."
The Fed doesn't set policy based on day-to-day market movements.
But if price changes are sustained, that can influence the economy
through changes in household wealth and business and consumer
confidence.
Separately, the head of the International Monetary Fund
cautioned countries against overreacting to the coronavirus threat
and urged governments to take "well-targeted and proportionate
measures" to avoid hurting their economies.
"We have to be vigilant and calibrate the measures
appropriately," said IMF Managing Director Kristalina Georgieva in
an interview.
Beijing has sealed off entire regions and put tens of millions
of people in a lockdown, disrupting global supply chains and
raising the prospect of setbacks for growth there and elsewhere in
the world.
Among the challenges facing the Fed: With its benchmark rate
between 1.5% and 1.75%, the central bank has less room to stimulate
growth by cutting rates, which are already historically low.
Fed officials have demonstrated a willingness over the past year
to ease policy to defuse looming economic threats. An escalation of
the U.S. trade war with China beginning last May prompted the Fed
to cut rates beginning in July.
"The interconnectedness of our economies means that literally,
no man is an island. If one economy starts to struggle, the
spillover effects onto others can take hold rapidly," New York Fed
President John Williams said in a speech last November, shortly
after the Fed called an end to its series of cuts.
Last year, the Fed cited the need to move quickly at the first
sign of economic contraction because with its short-term benchmark
rate at a historically low range, it didn't have as much room to
cut as in previous downturns. It also justified the move by
pointing to mild inflation readings, which are expected to continue
this year.
A separate issue is that monetary stimulus may not be a neat
tool for addressing near-term virus disruptions. "Monetary easing
works best when interest rates are relatively high and the economy
faces a demand shock. Neither is the case here," said Roberto
Perli, an analyst at Cornerstone Macro.
Investors are concerned about the global economy due to the
potential for supply-chain disruptions, especially in Asia, and
confidence shocks that can't be easily repaired with lower interest
rates. Rate cuts are designed to encourage more households and
businesses to spend and invest today, rather than wait until
tomorrow.
If factories are closed and supply chains are disrupted, lower
interest rates may have less immediate effect. "At best,
monetary-policy easing should be thought of as something that can
facilitate the rebound when the virus is contained, not as
something that can prevent growth deterioration now," Mr. Perli
said.
Negative rates in Europe and Japan have left central bankers in
those countries with less room to counteract a downturn if growth
sputters amid virus-related disruptions. "Japan doesn't have the
ability to smooth out a coronavirus shock" with monetary policy,
said Jason Cummins, an economist at hedge fund Brevan Howard.
The lack of a robust policy response to slowdowns abroad is "the
exact kind of potential mechanisms through which the U.S. economy
can be affected," said Cleveland Fed President Loretta Mester on
Monday. Along those lines, the prospect for slower global growth
last year "affected our monetary policy and our assessment of the
outlook."
--
Bojan Pancevski
contributed to this article.
Write to Nick Timiraos at nick.timiraos@wsj.com
(END) Dow Jones Newswires
February 25, 2020 15:54 ET (20:54 GMT)
Copyright (c) 2020 Dow Jones & Company, Inc.