Fed's Wait-and-See Posture Tested by Virus -- 2nd Update

Date : 02/25/2020 @ 11:03PM
Source : Dow Jones News

Fed's Wait-and-See Posture Tested by Virus -- 2nd Update

By Nick Timiraos 

WASHINGTON -- A top Fed official said Tuesday it is too early to tell whether the coronavirus outbreak will force the central bank to resume rate cuts in the coming months.

Disruptions 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."

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 virus-related disruptions that roil supply chains, output and travel is again putting the Fed in a delicate spot.

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 deepening rout in global financial markets Tuesday. Stocks fell after hitting highs over the past two months and the yield on the benchmark 10-year U.S. Treasury note closed at a new low.

Mr. Clarida said the Fed doesn't set policy based on day-to-day market movements. Instead the Fed looks at whether broad and sustained changes in stocks, bonds and currencies influence household wealth and business and consumer confidence.

"You have to look at credit availability. You have to look at confidence, " he said.

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. Probabilities for a rate cut at the Fed's next scheduled meeting, on March 17-18, rose to around one in three on Tuesday, up from one in 10 last week, according to futures markets contracts calculated by CME Group.

Mr. Clarida said monetary policy isn't on a preset course and decisions "will proceed on a meeting-by-meeting basis."

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."

Dallas Fed President Robert Kaplan echoed those sentiments in an interview Tuesday. "We are a number of weeks away from being able to make the judgment" about whether a rate change is needed, he said.

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.

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."

--Michael S. Derby contributed to this article.

Write to Nick Timiraos at nick.timiraos@wsj.com


(END) Dow Jones Newswires

February 25, 2020 17:48 ET (22:48 GMT)

Copyright (c) 2020 Dow Jones & Company, Inc.

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