The Federal Reserve on Tuesday reduced its policy rate to a range between 1.0% and 1.25% as the central bank implemented a preemptive cut to bolster financial conditions as the coronavirus continues to spread. The use of monetary firepower is a clear signal to policymakers and investors that there will be a major slowdown in economic growth in the United States that will last until late this year.
While the Fed is not well positioned to address supply shocks, the relief provided by the cut will support rate-sensitive sectors like autos and the housing industry that will most likely experience a large shock as households pull back on large capital purchases. Federal Reserve Chairman Jerome Powell in his news conference did not say that he expects a fiscal response by the advanced economies. We interpret this as a not-so-thinly veiled shot across the bow of the fiscal authority in Washington D.C.
A major question was not addressed: If the virus fades, will the Fed take back the cut?
Powell said that the Fed is talking with global central banks, and investors should anticipate a variety of liquidity commitments, increased asset purchases and rate cuts to support targeted funding by G-7 fiscal authorities. We expect further rate cuts by the United States, the U.K. and the European Union. We anticipate that the Bank of Japan will make commitments to increase asset purchases. All will most likely provide enhanced forward guidance around their respective central bank meetings.
Still, a major question needs to be addressed: Assuming this is a transitory event, will the Fed take back the rate cut in early 2021 once the worst of the crisis has passed? Powell chose to talk around answering that question.
We now expect another 50 basis points of cuts by the end of the year and do not rule out a return to the zero boundary in the event of an exigent and unusual circumstance of a significant breakout of the virus that results in a large economic downturn.
There is a strong case to be made that the government’s fiscal authority, and not the monetary authority of the Fed, needs to take the lead on addressing the economic risks around the Covid-19 virus. There will be an interagency meeting in Washington D.C. this afternoon that will start the process by which the federal government will use its powers to provide trade and bridge financing to small and medium enterprises that may face a period of reduced revenues.
That should also include a period of regulatory forbearance and, in the case of a significant economic downturn, the construction of a special lending facility to offset what would be an increase in unemployment and bankruptcies. It will be soon be time for the federal government to bring out its biggest gun: fiscal firepower.
