What was shaping up as one of the most boring policy rate decisions in some time has suddenly gained a measure of uncertainty because of investor concern about the coronavirus. Over the past several days the U.S. 10-year Treasury yield has declined by 21 basis points, from 1.82% to roughly 1.61%.
While we do not expect the Fed to acknowledge the Chinese-based outbreak in its policy statement due out on Wednesday — the news conference will be another matter — the Fed will surely note the pricing in of a Fed rate cut by 25 basis points by the end of October.
The central bank will most likely address the shift in expectations and investor sentiment in talks by the regional presidents and Federal Open Market Committee governors in the days after the two-day meeting.
Even with the markets’ reaction to the outbreak of the virus, the Fed will almost certainly hold the policy rate in a range between 1.50% and 1.75% and the increase in interest paid on excess reserves rate to 1.6% from 1.55%. The technical adjustment in that rate is to facilitate the trading of the funds rate well within the policy target range of 1.5% to 1.75%.
The Federal Reserve has done an excellent job of shaping public and investor expectations around such moves, and there is no reason to expect that such a technical adjustment will be interpreted as a change in monetary policy. We anticipate no significant increase in the policy statement and the Fed to describe its current policy stance as appropriate.
The news conference by Fed Chairman Jerome Powell will surely address the Fed’s estimation of potential global economic damage linked to the coronavirus. Powell’s communications, which have improved noticeably over the past several months, will most likely use the discourse of supply shocks, and first- and second-order effects, to engage in a clinical and sterile discussion of the potential economic impact.
