Traders expect Fed to cut rates to buffer US economy

SAN FRANCISCO • The United States Federal Reserve may need to move aggressively to cut borrowing costs to cushion the US economy from the effects of the rapid spread of the coronavirus outbreak, which sent global stocks tumbling this week.

Traders of futures contracts tied to the central bank’s policy rate are already betting on it.

On Thursday, they were pricing in about a 76 per cent chance of the Fed starting to cut rates as soon as next month and trimming an extraordinary three-fourths of a percentage point by September, according to CME Group’s FedWatch.

That would bring the short-term target rate to below 1 per cent for the first time since 2017.

Traders saw just a 33 per cent chance of a March rate cut on Wednesday.

But that was before a report showing new coronavirus cases in Iran, Italy and elsewhere were growing faster than in the outbreak’s epicentre of China, and leaders around the world began rallying their nations to prepare for a broader epidemic.

In the face of a potential economic slowdown as governments shut schools, cancel sporting events and restrict travel, global central bankers have for the most part taken a wait-and-see approach.

European Central Bank president Christine Lagarde said on Thursday that she would need to see a “long-lasting” shock to act, adding that it has “certainly” not got to that point yet.

In South Korea, home to one of the biggest outbreaks outside of China, the central bank unexpectedly held its fire on rate cuts.

Unlike many other central banks, the Fed still has some room to cut interest rates, although officials there have said they want to see a “material change” in the economic data before they take further action after cutting rates three times last year.

At the same time, though, they warned that with inflation already low, any response to an economic shock may need to be supercharged to have an effect.

On Thursday, Chicago Fed president Charles Evans told a central banking conference in Mexico City that with limited room to cut interest rates and a downward pull on inflation, “policymakers must commit to provide extraordinary accommodation in order to meet their mandate”.

Asked about the impact of the coronavirus directly, he said the Fed is paying “close attention”, although he reiterated what appeared to be the consensus view at the central bank: that the effect on the economy will be transitory.

Some major US corporations say the virus is already weakening their balance sheets and hitting earnings.

Wall Street’s three main indexes ended Thursday trading on track for their steepest weekly pullback since the global financial crisis, with the S&P 500 registering its biggest one-day loss in percentage terms since August 2011.

The yield on the benchmark US 10-year Treasury touched a record low of 1.2408 per cent.

“The Fed’s desire to be data-dependent may capitulate to market sentiment,” said Mr Jon Hill, an interest rate strategist at BMO Capital Markets.


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