Fed cut expected in March; Will it be 25bp or 50bp?

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Although the Federal Open Market Committee will meet March 17 to 18, speculation about a coordinated cut by central banks across the globe before then continues, and experts are debating whether the Fed will cut 25 basis points or 50 basis points.

“This will be another wild week for financial markets, but optimism is growing that central bank intervention will prop up risky assets and that scientists and drug companies are getting closer to developing test treatments and vaccines,” said Edward Moya, senior market analyst at OANDA.

“Investors salivated that the bottom could be near as hopes were growing central banks would deliver a global policy response to contain the economic impact of the coronavirus,” he said.

Scott Colbert, executive vice president and chief economist at Commerce Trust Co., expects “the Fed will reduce rates by 50 bps on or before their meeting this month.”

“It is unreasonable to suggest that the Federal Reserve should not react to a change in the U.S. economic outlook," said Scott Colbert, executive vice president and chief economist at Commerce Trust Co.

“It’s become increasing clear the outlook for global growth, given the coronavirus outbreak, has fallen materially both in the short- and medium-term and the slowdown will be deeper than initially envisioned,” Colbert added. While the impact on the U.S. economy likely “will be less severe, the tightening of financial market conditions here (rapidly falling stock prices, rapid increase in corporate credit spreads and a dramatic reduction in the liquidity of secondary market trades) and the reduction in a very benign inflationary pressure suggest the Federal Reserve should aggressively accommodate, perhaps in a coordinated fashion with other Central Banks.”

And while the move would not be a cure for COVID-19, “it is unreasonable to suggest that the Federal Reserve should not react to a change in the U.S. economic outlook and, as such, help reduce the strain this rapid falloff in demand, even if perhaps temporary, is likely to induce,” he said.

Goldman Sachs economists expect a 50 basis point cut at or before its March meeting, possibly in conjunction with moves by other central banks.

Others see a smaller, 25 basis point cut, including Morgan Stanley Chief U.S. Economist Ellen Zentner. She also sees the Fed offering “an explicit promise to continue if growth damage extends.”

Berenberg Capital Markets Chief Economist for the U.S. Americas and Asia Mickey Levy, and U.S. Economist Roiana Reid agree the Fed will trim 25 basis points off its funds rate target (to a range of 1.25%-1.5%), when it announces its monetary policy decision on March 18, “in response to the coronavirus-related sharp correction in the stock market and to brace against the potential negative economic impact.”

While the virus has caused “a negative real supply shock to China and some other regions that is rippling through the global economy,” Levy and Reid note it “cannot be fixed by monetary policy easing. Moreover, monetary policy is already easy, with ample excess reserves in the banking system and very loose financial conditions, including the lowest bond yields in history.”

But the stock market’s losing streak could impact “consumer confidence, a strong point that has been supporting solid gains in consumption and housing while industrial production, business investment and exports have been weak.” And with oil prices declining, headline inflation will fall further below the Fed’s 2% target “which gives the Fed more flexibility to provide an emergency ease under the circumstances,” they said.

“We believe the anticipated Fed rate cut will have at most a limited and temporary impact and is not sufficient to lift market confidence without other positive news,” Levy and Reid added. They expect the virus’ impact to be “temporary” and “the stock market will recover when market participants gain confidence that the spread of the coronavirus is under control, reducing uncertainty, and allowing participants to make economically rational assessments about how long disruptions to global supply chains and distribution channels will last and what will be the shape of the rebound.”

“The Fed has an unhealthy relationship with financial markets,” they said, and the markets expect the Fed to ease “whenever anything goes wrong,” whether monetary policy “can fix any problem.”

Fed action “only satisfies those cravings,” and “will have little impact on economic decisions by consumers or nonfinancial businesses. Nevertheless, the Fed has a clear tilt towards easing and will respond by reducing rates once again.” This action takes the Fed “even closer to the zero lower bond,” Levy and Reid note, “raising serious questions about its future conduct of monetary policy.”

Elsewhere, construction spending soared 1.8% in January, to a record $1.369 trillion, the Commerce Department reported Monday. The December figure was revised to a 0.2% gain from a 0.2% dip initially reported.

Economists polled by IFR Markets expected a 0.7% increase.

The Institute for Supply Management’s PMI slid to 50.1 in February from 50.9 in January.

Economists expected a 50.5 reading.

Although respondents’ comments “were generally positive,” according to Timothy R. Fiore, chair of the ISM’s Manufacturing Business Survey Committee, many noted the coronavirus’ effect on them:

  • “Coronavirus is wreaking havoc on the electronics industry.”
  • “January started out strong, but the effects of the virus in China [and] the continued grounding of the 737 Max have suppressed new orders.”
  • “Coronavirus and its impact on the supply chain: We will see some softness in demand, but also [experience] havoc on items sourced from China that may cause significant delays to production.”
  • “Coronavirus continues to be front and center as a major supply chain risk to our company. Access to information in China — from our supply base and customers — is slow to come by.”
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