Federal Reserve cuts rates a half-percentage point in face of coronavirus

Federal Reserve chairman Jay Powell has been under pressure by Donald Trump to cut interest rates as markets fell in response to coronavirus fears. Photo / AP

The Federal Reserve took charge of the global response to coronavirus on Tuesday, cutting its main policy rate by half a percentage point as the group of seven leading nations pointed to the "downside risks" from the spread of the disease.

And the 10-year US Treasury yield dropped below 1 per cent for the first time on Tuesday
In a unanimous statement from the Fed's Open Market Committee, the members declared "the fundamentals of the US economy remain strong", but added that the fast-spreading virus "poses evolving risks to economic activity".

The Fed's move — its first emergency rate cut since the peak of the global financial crisis — came after G7 finance ministers and central bank governors pledged to take "all appropriate policy tools" to maintain the economic health of the advanced world.

While the Australian and Malaysian central banks also cut their main policy rates on Tuesday to stave off recession, others have been slower to act. The European Central Bank adopted a more cautious approach, while Mark Carney, the Bank of England's governor, suggested different countries would take a domestically tailored approach rather than the big bang co-ordination of the 2008 financial crisis.

"Across jurisdictions there'll be some differences in the exact form and timing of those measures," Mr Carney said.

In the US, the Fed's rate-setting committee reiterated that it was "closely monitoring" developments and would continue to "act as appropriate to support the economy".

At a press conference on Tuesday after the announcement, Fed chair Jay Powell stressed the underlying strength of the US economy, but said the Fed had already seen effects from the virus on sentiment forecasts for the travel and hotel industry, and on manufacturers that depend on foreign supply chains.

"The effects are at a very early stage," he cautioned. "I don't think anybody knows how long it will be."

All the central banks and finance ministers are very focused on what we can do together and independently on what we can do to weather the economic impact of this

Steven Mnuchin, US Treasury secretary

Stocks gyrated immediately after the Fed's move, which will set its policy rate at 1 per cent to 1.25 per cent. Following Mr Powell's press conference, the S&P 500 was 1.3 per cent lower, and Nasdaq was down 1.1 per cent.

Treasuries rallied, with the yield on the policy-sensitive two-year note falling 16 basis points to 0.74 per cent, and the 10-year yield fell to 0.99 per cent in afternoon trading. Yields fall when prices rise. The 10-year Treasury is one of the most important interest rates in global finance, underpinning borrowing and savings rates across the globe.

Bank of America, considered the most rate-sensitive of the big US banks, fell 5 per cent after the cut. Smaller banks and less diversified lenders fared worse: technology company lender Silicon Valley Bank fell 7.2 per cent

"Given the Fed has little firepower left they went early," said Alicia Levine, chief market strategist for BNY Mellon Investment Management. "The cuts will stabilise sentiment."

Donald Trump, who has made a strong economy and financial markets a cornerstone of his presidential re-election campaign, had been increasing pressure on the Fed to cut interest rates in recent days as stocks have slumped in response to the virus's spread.

After the Fed's announcement, he tweeted: "The Federal Reserve is cutting but must further ease and, most importantly, come into line with other countries/competitors. We are not playing on a level field. Not fair to USA. It is finally time for the Federal Reserve to LEAD. More easing and cutting!"

Trader Gregory Rowe works on the floor of the New York Stock Exchange. Photo / AP

On Tuesday morning before markets opened in the US, the finance ministers and central bank governors of the G7 had released a statement following the OECD's forecasts from Monday that suggested the global economy was heading for recession.

The statement contained few specific commitments, unlike its decisive response to the 2008 financial crisis. But it pledged fiscal support to ensure health systems could respond to the disease and to tide economies over during what policymakers now believe is likely to be a serious slowdown for at least a few months.

Financial market observers, however, predicted that other central banks and finance ministries would now come under serious pressure to follow the Fed with more decisive action.

With interest rates lower in Japan, the eurozone and the UK than in the US, David Page, senior economist at Axa Investment Managers, said the Fed's move "presents something of a challenge for other international central banks", but they were more likely to stick to scheduled meetings.

Andrew Kenningham of Capital Economics, said the ECB would have to respond and predicted it would cut its deposit rate by 0.1 percentage points next week, putting it further into negative territory at -0.6 per cent.

Mr Powell said on Tuesday that the Fed was in "active discussions with central banks around the world on an ongoing basis".

One central bank to take action early in the day was the Reserve Bank of Australia. It said the outbreak is having a "significant effect" on the country's economy as it cut rates by a quarter of a percentage point to 0.5 per cent.

The Australian government also confirmed on Tuesday that it was preparing a "targeted and measured" fiscal stimulus package amid growing concerns among policymakers that Australia could face its first recession in almost three decades.

"The coronavirus outbreak overseas is having a significant effect on the Australian economy at present, particularly in the education and travel sectors," said Philip Lowe, RBA governor, in a statement.

The Fed's move on Tuesday "raises the question whether they know something the market doesn't know", said Torsten Slok, chief economist at Deutsche Bank Securities. "We literally have no economic data to hang our hat on yet. They certainly don't want to be blamed for being behind the curve."

Mr Slok added that the time between signalling a rate cut and actually cutting had been "extremely short".

The Fed foreshadowed a possible cut on Friday, in a rare statement outside a scheduled meeting. In its statement, the Fed had included the phrase "act as appropriate", one it has used in the past to signal an intention to cut.

As recently as last week, investors were seeing no chance at all of any cuts at the Fed's next meeting on March 18, according to an analysis of short-term interest rate futures by the CME Group. By Monday, that likelihood had risen to 100 per cent as short-term interest rates went into freefall.

"Given the wording on the economy that accompanied the emergency action, there is a real worry unfortunately that the 50bp cut will be viewed not only as the markets again forcing the hand of the Fed but also as yet another communication slippage on the part of the Federal Reserve," said Mohamed El-Erian, chief economic adviser at Allianz.

"It makes it even more important that this action be framed in the context of a co-ordinated global policy effort and not just a correlated one," he added.

Steven Mnuchin, US Treasury secretary, told House lawmakers during a hearing on Tuesday that he "very much" supported the Fed's move.

"I think they did the right thing getting ahead of this," Mr Mnuchin said. "All the central banks and finance ministers are very focused on what we can do together and independently on what we can do to weather the economic impact of this. This is going to impact a lot of people in the short term."

As evidence of the spread of the coronavirus grew in the US, some analysts wondered whether the blunt instrument of monetary policy was the best response to the economic fallout of a potential pandemic.

"The Fed obviously views this as a potentially substantial demand shock to the economy and wants to get ahead of the damage if possible," said Tim Duy, a monetary economist at the University of Oregon. "The risks to early and large movement are minimal in a low-inflation environment. The Fed remains focused like a laser on preventing a recession."

Written by: Brendan Greeley in Washington, Colby Smith in New York and Chris Giles in London

© Financial Times