Federal Reserve Will 'Act as Appropriate to Support the Economy'--2nd Update

Date : 02/28/2020 @ 10:00PM
Source : Dow Jones News

Federal Reserve Will 'Act as Appropriate to Support the Economy'--2nd Update

By Nick Timiraos 

Federal Reserve Chairman Jerome Powell signaled the central bank was prepared to cut interest rates if needed to cushion the economy against the effects of a widening global slowdown due to the spreading coronavirus.

While the fundamentals of the U.S. economy remain strong, "the coronavirus poses evolving risks to economic activity," Mr. Powell said in a statement released Friday afternoon.

"The Federal Reserve is closely monitoring developments and their implications for the economic outlook. We will use our tools and act as appropriate to support the economy," he added.

Mr. Powell used similar language last June to indicate the Fed was prepared to cut interest rates if needed after the U.S.-China trade war threatened to aggravate a global slowdown. The central bank subsequently cut interest rates three times, most recently in October to a range between 1.5% and 1.75%.

Fed officials have been trying to avoid either waiting too long to respond to an unclear economic threat -- or acting too rashly, which could further undermine confidence. By Friday, however, the sharp market selloff prompted Mr. Powell to signal a stronger bias towards rate cuts. The Fed's next scheduled meeting is March 17-18.

Stocks pared their losses somewhat after Mr. Powell issued his statement at 2:30 p.m. The Dow Jones Industrial Average closed about 350 points lower, after shedding more than 1,000 points during the trading day.

Markets have painted the central bank into a corner. Just a few days ago, when the virus epidemic appeared limited mostly to China, investors in interest-rate future markets thought the Fed would cut rates by the summer.

Now, as the epidemic has spread on other continents, investors expect the Fed to cut interest rates by at least a quarter percentage point -- and possibly more -- at their March meeting, if not sooner.

Among the Fed's challenges: The coronavirus epidemic represents a shock to the economy's capacity to produce goods and services, or its supply side. Lower interest rates can't on their own address such supply-side shocks by, for example, allowing quarantined workers to return to idled factories.

But interest-rate policy can help prevent a supply shock from turning into a demand shock in which households and businesses hold off on purchases and investment.

The stock market selloff this week could change the Fed's equation because the rout could sap consumer confidence, amplifying any slowdown in demand caused by the supply shock, fear or uncertainty.

"If there's a recession coming because the supply side of the economy has been hurt badly, for example because people aren't able to go to work, the Fed isn't going to put people back to work by lowering rates," said former Fed Vice Chairman Donald Kohn. "But the question is whether there are spillovers to demand, and the extent of those. They may be able to address some of the spillovers."

Fed officials are facing two distinct economic problems. The first is the supply shock, for which the proper response depends entirely on the nature of the crisis. "If anything was out of the central bank's control, this kind of event is it," said Vincent Reinhart, a former senior Fed economist who is now chief economist at Mellon.

The second is the hit to demand associated with the market selloff and any associated rise in corporate borrowing costs. Mr. Powell's message Friday appeared to signal that to the extent the Fed could soften any pain from virus-related disruptions, it would do so.

Even though there is no playbook for dealing with a potential pandemic, "there are repeated case studies in U.S. history: If financial conditions tighten, you should offset them," said Mr. Reinhart.

While the Fed needed to reassure markets, "historically, the reassurance that works has been limited because you just don't know at that time what will be needed," said Mr. Reinhart.

Fed officials have their work cut out for them ahead of their policy meeting in mid-March as they confront potential problems their crisis playbook simply doesn't address. Typically, the Fed views natural disasters or other disruptions as temporary. Eventually, spending bounces back as the hit to growth fades.

The current situation is more challenging because of uncertainty, as reflected in this week's market selloff, over how long any disruptions might last and how broad and deep they could become, leading to declines in corporate profits, spending and hiring.

"The Fed has to be careful about defining what it needs to do or what it can do," said Mr. Kohn. If Fed officials "put a stake in the ground and say, 'This is not for monetary policy to address in any way, that's just going to make the situation worse in the markets.'"

Further complicating matters, interest rates are historically low, leaving much less room to counteract a downturn by reducing borrowing costs. Markets have been doing much of the Fed's work already, with market-determined interest rates falling to record lows in anticipation of rate cuts.

Moreover, while some commentators have called for coordinated global action, central banks in Europe and Japan, where interest rates are negative, have even less ability to use conventional policy tools to stimulate growth.

Fed officials over the past year grew reluctant to risk a selloff in stocks and rise in corporate borrowing costs by disappointing market expectations of easier monetary policy. They grew especially sensitive after they raised rates amid a declining market in December 2018 and watched the drop worsen.

Mr. Powell quickly pivoted last year by shelving plans to raise rates in 2019. The Fed cut rates beginning last summer, as worries about the U.S.-China trade war added to concerns about a global slowdown.

The Fed chairman called an end to a sequence of three reductions in October and has said since then officials would want to see a material change in the economic outlook to resume cuts.

A cumulative stock market decline of around 17% would exert a drag on growth equivalent to a nearly quarter-percentage-point increase in the Fed's benchmark rate, according to economists at Deutsche Bank.

The slide in the stock market this week prompted economists at IHS Markit to shave their forecast for consumer spending growth to a 2.0% annual rate for the first quarter, down from 2.5%. That would lower overall gross domestic product by more than 0.2 percentage points, to 1.8%.

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

 

(END) Dow Jones Newswires

February 28, 2020 16:45 ET (21:45 GMT)

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


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