The probability of the U.S. Federal Reserve issuing another rate interest rate cut is increasing, economists say, and the spread of the coronavirus may speed up that decision.
According to the CME Group’s Fedwatch Tool, which uses futures to calculate the Fed’s next move, the probability of a rate cut occurring in June now sits at 37 per cent and is up nearly 15 per cent since the beginning of the year. In July, that number shoots up over 50 per cent.
The coronavirus, which has infected more than 24,000 people, has certainly played a role in that. Fed chair Jerome Powell said in a press conference following the central bank’s January meeting that he was “very carefully monitoring the situation” and that it was likely to have an economic impact.
Scotiabank chief economist J.F. Perrault already has a Fed interest rate cut priced in for the third-quarter of 2020. The coronavirus’ impact, he said, could mean that it comes sooner than expected.
“What the virus does is two things: it gives us more confidence the Fed will cut and if you’re responding to the negative impacts of an event happening now… you’ve got to do that sooner rather than later,” Perrault said.
Central banks are notoriously slow to react, however, and Perrault said that the challenge for the Fed is that much of the economic data for February that they would need to make a decision on policy isn’t available until April or May.
Although the Fed will also be tracking the number of patients infected with the virus in the U.S., those won’t need to balloon to merit another cut, Perrault said. Fear alone could lead to a drop in the tourism, food and retail sectors, he said, which would likely have a negative effect on consumer spending figures.
Philip Marey, the senior U.S. strategist for the Netherlands-based Rabobank, has expected the Fed to cut interest rates to zero since the beginning of the year, either to stop the U.S. from entering a recession or as a response to one. The impact of the coronavirus has also convinced him that the Fed is about to do away with its neutrality and move again towards hawkish policy.
The U.S. economy is already in the late stages of its business cycle and at the end of the December, the Institute for Supply Management’s manufacturing index, which tracks factory activity, declined to its lowest levels since the financial crisis. The coronavirus is now another challenge that the economy must leapfrog.
“Apart from the imports, the manufacturing is more vulnerable than in other periods in the U.S. and is already showing a lot of weakness so this comes at a bad moment that could make things worse than it would in other circumstances,” Marey said.
The virus has already caused its share of economic pain in China, where government economist Zhang Ming said he expected first-quarter GDP to fall to five per cent or even lower. RBC Global Asset Management chief economist Eric Lascelles has docked China 0.3 percentage points in 2020 GDP and 0.2 percentage points off of the rest of the world. It’s clear there’s already been a spillback effect on the U.S. as companies such as Nike Inc., Walt Disney Co. and Starbucks Corp. have been forced to shutter some of their locations.
Lascelles also had a Fed cut priced in for 2020 and while he admits the coronavirus could bring the initial timeline forward, he doesn’t expect it to be the main cause of any monetary policy action.
As for the Bank of Canada, Capital Economics economist Stephen Brown wrote in a note that it may have issued a rate cut when SARS broke out in 2003, but he doesn’t see the same scenario repeating itself.
The Bank of Canada might think twice this time, Brown said, because it may not want to heat up the housing market at a time that governor Stephen Poloz is describing it as “frothy.” There may be a hit to growth, but Canada should be able to overcome it, he said.
“Even if there is a hit to growth, it should prove short lived and there would be scope for a rebound afterwards,” Brown wrote.
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