Fed: Into the Breach Again

Published on March 2, 2020

The markets this morning have been doing some of the heavy lift for the Federal Reserve, with equities attempting a bounce back from last week’s debris, almost certainly on the high likelihood of a rate cut by the Fed and reports of a G7 call tomorrow to discuss the potential economic and financial fallout and a response to the coronavirus crisis.

** The Federal Open Market Committee is indeed near certain to cut the policy rate, by 50 basis points, in the wake of the rapidly deteriorating market and near term demand outlook and especially in the wake of Chairman Jerome Powell’s intervention Friday afternoon with his terse, carefully worded statement that dialed back to the “act as appropriate” language that preceded the three rate cuts last year.

** The question, then, is when rather than if, and all else being equal, we believe the FOMC’s strong preference is to wait until its regularly scheduled March 17-18 meeting to lower the policy rate to a 1%-1.25% fed funds target range. They will also frame the cuts with an aggressively dovish guidance on both rates and the other “tools” that Chairman Powell made a point in referring to in his carefully worded statement on Friday.

** Those tools will be aimed at ensuring there is no market dysfunction and include everything from unlimited overnight repurchase agreements, extending the maturities of the term repo offerings, or a delayed tapering of the current balance sheet expansion. If needed, the FOMC could also reaffirm the availability or expansion of the existing dollar swap lines with foreign central banks.

** That said, the fear of a severe market dislocation looms large in the Fed’s tactical calculations on the timing to a policy response. On that, the Fed will be willing if necessary, to make an inter-meeting rate cut before the March meeting if credit markets are threatening to freeze up or the stock market reverses into a freefall so steep and rapid it threatens systemic instability. Otherwise, short of credit market dislocation, the FOMC would strongly prefer to stand aside and let the markets function in its price discovery process.

** G7 officials have promised a conference call tomorrow to “weigh their response to the corona virus impact” on their economies, and we expect a commitment to stimulus “as needed” that will include central bank vows to take whatever actions deemed necessary and, if truth be told, within reach when there is little rate space for many central banks other than the Fed. It is likely to be a volatile trading day tomorrow amid the elevated expectations, and if the Fed’s hand is forced into an inter-meeting move before the March meeting, we would not be surprised to see a coordinated statement of support by all the main central banks.

** We think it highly likely Chairman Powell’s Friday afternoon intervention – issued under his own name rather than as an FOMC document — was followed this weekend by a conference call meeting of the full FOMC. That, in turn, is likely to mean a highly coordinated communications campaign by the half dozen or more Fed officials speaking this week and culminating with Friday’s Shadow Open Market Committee conference in New York that will see a handful of Fed officials attending.

** That suggests there will be plenty of dovish messaging this week, all with the intention to keep the market pricing in rate cuts and, hopefully, to help stem a market panic on the coronavirus effects on the economy. The takeaway from the Fed speak this week is likely to be a clear willingness to ease rates, and a willingness to “go big” as needed; the FOMC’s gathering consensus is that timidity at this point would be counterproductive.

** Tactically, the Fed would like to refrain from an inter-meeting move before the March meeting, if for any other reason, as a signal of stability and to provide some time for the US testing process to get underway more fully for a better sense of the estimated impact on aggregate demand and supply disruptions. To step in too early with a rate response would be tantamount to a premature currency intervention that proves ineffective.

** While it is true there is little a rate cut can do to make people go to work or to go out to spend on restaurants and the like, the point of a rate cut would be twofold: in general, to help break the fear feedback loop, and more specifically, to help cushion an inevitable need to refinance or take out bridge loans along the strained global supply chains (that are very finance intensive) or smaller businesses needing bridge funding to bridge the loss of customers.

** The Fed will also be monitoring very closely for evidence of a more sustained change in spending and consumer confidence that would suggest a structural shift in aggregate demand that would in turn lead to another downward revision in the assumed short run r* and thus a lower policy rate just to stay accommodative.

** In addition to the Fed’s repositioning of its rate stance to counter the sudden rush of downside risk, the dramatic turn of events in the last week or more is also very likely to accelerate the FOMC’s decisions on refining its recession fighting tools and credibility. We understand that the strategy and tactics when up against the Zero Lower Bound was in fact already on the March agenda after financial stability issues were debated at the January meeting.

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