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Last week’s equity rout brought central bankers to act before the economic data which would be infected by the coronavirus outbreak, start kicking in.
The Federal Reserve (Fed) slashed the interest rates by 50 basis points on Tuesday in a surprise action. While Goldman Sachs called for a 50-bp action before the scheduled March 15-16 FOMC meeting, even they wouldn’t expect the cut to come as soon.
The UAE central bank and the Bank of Canada (BoC) proceeded with a 50-basis-point cut following the Fed action.
Elsewhere, the Reserve Bank of Australia (RBA) lowered its cash rate to the historical low of 0.50% couple of hours before the Fed.
The Bank of Japan (BoJ) and the European Central Bank (ECB) announced that they stand ready to act if necessary, even though these banks have significantly less maneuver margin to cut their interest rates compared to their peers.
The Bank of England’s (BoE) next governor Andrew Bailey swam against the tide however, saying that they need to see more data evidence to judge how the coronavirus outbreak would ‘feed through’. But Goldman Sachs, who successfully predicted the Fed’s unscheduled intervention, is now expecting a 50-basis-point cut at the BoE’s March meeting as the virus outbreak would ‘push the UK economy to the edge of recession’ and that ‘the MPC has sufficient policy space to join other major central banks in easing policy’. Bailey will take the helm of the BoE on March 16 and could announce his first rate cut by March 26 MPC meeting.
In addition to central bank actions, G7 officials made a joint statement that they would put fiscal stimulus measures in place to support economies.
Then, the US Congress announced on Wednesday a $7.8 billion emergency spending bill to combat the virus-led economic slowdown. This was three times the amount suggested by President Donald Trump.
Unfortunately, though, the mix of combined monetary and fiscal interventions across major economies failed to trigger a sustainable rebound in equity markets. Investors seem more concerned than relieved following the deluge of central bank cuts and fiscal support.
It is hard to tell why the market gave such a negative kneejerk reaction to synchronized interest rate cuts, but one plausible explanation is that lower borrowing rates wouldn’t fix the supply chain disruptions which have meaningfully dented the activity since January and should heavily weigh on the company earnings in the first quarter. On the other hand, interest rates are so low, that the lack of envy for borrowing is clearly not a problem of cost.
Second, the Fed’s unexpectedly brisk reaction may have been somewhat clumsy. Because the Fed could have some information about the economy that the market doesn’t, investors may have interpreted the Fed’s move as a panic response to a bigger problem that they don’t see yet. As such, the Fed’s anxiety may have provoked unease among investors, who may have thought that if the Fed cuts twice the standard 25 bp so hurriedly, then the economy might be in real trouble.
But more importantly, investors now believe that the monetary stimulus alone is no longer enough to boost the economic activity. It is time for governments to step in and act in tandem with the central banks to improve the economic conditions. Hence, promises should be followed by concrete policy action. And we are unsure about the European governments’ ability to move forward with impactfully expansive fiscal policies.
What will happen next?
The Fed is expected to lower the interest rates again on March 15-16 monetary policy meeting.
Activity on US sovereign markets suggest that the probability of another 25-basis-point cut from the Fed stands at 66% and the chances of another 50-basis-point cut are 34% at the time we are writing these lines.
We are not sure whether the European Central Bank (ECB) and European governments would loosen their purses’ strings as did the US, but ECB’s Vice Chair Luis De Guindos repeated on Monday that the fiscal policy is the correct answer. ‘When you have a problem, you can’t always look at central banks’, he said.
Still, the expectation is a 10-basis-point cut at the ECB’s next week meeting, and a total of 20-basis-point cut by the end of this year, according to data compiled by Bloomberg.
What’s the risk?
It is good that central banks and governments act to reverse the coronavirus’ negative impacts on the economy. While the virus-led disruptions will certainly have a significant blow on global growth, we haven’t seen related data just yet.
The risk is, when the data starts kicking in, the central banks and governments may have already played their joker and be left with a reduced maneuver margin to deal with renewed market headwinds.