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Under Pressure, Fed Apt to Continue Easing


Whatever one may think of the wisdom of the Federal Reserve’s March 3 interest rate cut, it has embarked on a preemptive easing of credit in response to economic threats posed by the corona virus and seems likely to remain on that course.

Not only did the Fed’s policymaking Federal Open Market Committee cut the federal funds rate to a new target range of 1% to 1.25%, it adopted an implicit easing bias, setting up market expectations for further rate cuts.

The FOMC announcement, which came little more than an hour after Group of Seven finance ministers and central bankers pledged to jointly support economic growth, declared that “the Committee is closely monitoring developments and their implications for the economic outlook and will use its tools and act as appropriate to support the economy”.

Having moved decisively from a stand-pat posture to renewed easing (aggressive easing at that) there is every reason to expect the Fed to continue the process. Markets will expect the FOMC to move the federal funds rate lower again at its regularly scheduled meeting March 17-18, and they seem likely to get what they want.

Even though Tuesday’s inter-meeting, 50 basis-point slashing of the funds rate did not have the effect the Fed would have liked, it has committed itself to following a “risk management” doctrine prevalent in central banking circles since before the financial crisis – that the best way to avoid the zero lower bound is to ease aggressively at the first sign of trouble.

That same strategy militates in favour of further rate action and, possibly, an extension of the more expansive balance sheet policy the Fed has been pursuing since the fall.

Although the FOMC decision was unanimous, it can’t have set well with everyone in the Fed system. Truth be told, there were those who thought the FOMC should have seized an opportunity to take back at least one of last year’s rate cuts in recognition that trade and other risks had receded. An upward adjustment of the funds rate would have given the FOMC more of a buffer above the zero lower bound.


As it is, the Fed has left itself even less room to move.

Arguably, Tuesday’s rate cut was a big mistake. For one thing, it came a day after the Dow Jones Industrial Average had roared back by 1,293.96 points. That gain, which built on a late Friday rally sparked by Fed Chairman Jerome Powell’s pledge to “support the economy”, erased a big part of last week’s 12.5% drop.

After the rate cut announcement, the Dow and other stock gauges leaped initially, but then swung sharply in the other direction, ending Tuesday off nearly 3%. At this writing, stocks have rallied, but largely because of relief that Socialist Bernie Sanders performed poorly in the Super Tuesday primaries.

So one could argue that the Fed’s action backfired and that it wasted precious monetary ammunition.

Belying its own assertion that “the fundamentals of the US economy remain strong”, the Fed stirred fear among investors by signaling a deteriorating outlook. To some, Powell and his colleagues look panicky, incompetent and both market and politically driven.

Nevertheless, it would not be surprising if the FOMC were to take the bottom end of the funds rate target range below 1% on March 18 – unless the virus and its economic fallout somehow diminishes substantially over the next two weeks.

The recent evolution of US monetary policy has been a remarkable thing to behold – just as remarkable as the swing from tightening to easing at the start of last year.

The Fed has moved a long way in the past few weeks from being in what many proclaimed to be a year-long funds rate pause to aggressively preemptive easing. Despite enormous pressure from Wall Street and the White House to cut rates, the Fed stayed on the sidelines, not wanting to appear panicky, market-driven or politically influenced.

Powell & Co were proceeding cautiously, “carefully monitoring” the virus and its potential impact on consumption, production and trade. They were no doubt weighing the potential benefits and potential negative consequences of cutting rates.

Before last week’s mass hysteria in global markets, Fed officials seemed almost aloof, prompting president Trump into strident criticism. “I totally disagree with the Fed,” he said on Feb. 26. “I think our Fed made a terrible mistake.”

Fed officials weren’t totally detached. They acknowledged the economic damage that could be coming to US shores from the viral outbreak in Wuhan, China. But the mood was largely wait-and-see.

Thus, when I sat down with Richmond Federal Reserve Bank president Tom Barkin on Feb 19, he sounded very reluctant to presume that the disease had caused the economic outlook to deteriorate enough to warrant any kind of monetary response.

Hoping for a ramping up of Chinese output, Barkin told me and a colleague, “My read is that if everything gets up to speed in the next few weeks, it will be a minor bump. It won’t be an issue. If you’re out for months, then you’ve got a more significant impact – on 10-15% of the economy.”

And when I asked Barkin how aggressive the Fed should be if there were to be a “more significant impact”, Barkin replied, “We’re still in an economy that I predict to be growing somewhere around trend. We’re still in an economy where I predict unemployment to be at or below where we see it right now, and we’re in an economy where I’m seeing inflation starting to firm and head toward 2%, and in that economy, especially having taken out insurance last year in the form of three cuts, I’d like to see the economy run for a while. I’d like to see the cuts take full effect.”

Of course, those remarks preceded the following week’s bloodbath on Wall Street that sent stocks into correction territory.

But even on Feb 25, when the sell-off was well underway, Fed vice chairman Richard Clarida was taking it slow. The US economy was “in a good place”, and while the coronavirus was “likely to have a noticeable impact on Chinese growth” that “could spill over to the rest of the global economy”, he said it was “still too soon to even speculate about either the size or the persistence of these effects, or whether they will lead to a material change in the outlook”.

By the end of that week, the cascade of stock selling, accompanied by a flight into safe havens that drove bond yields to record lows, had clearly unnerved the Fed.

The sell-off prompted Powell’s terse Friday, Feb 28 afternoon statement: “The fundamentals of the US economy remain strong. However, the coronavirus poses evolving risks to economic activity. The Federal Reserve is closely monitoring developments and their implications for the economic outlook. We will use our tools and act as appropriate to support the economy.”

Powell’s statement greatly moderated market losses last Friday afternoon, and the rally carried over into Monday. Stocks soared Monday, despite a drop in the Institute for Supply Management’s manufacturing index that reflected spillover effects from the virus.

The G7 Ride Again

The following morning, the world’s monetary authorities waded in, despite Monday’s big rally.

First came a joint statement by G7 finance ministers and central bankers, including Powell and US Treasury secretary Steve Mnuchin:

“Given the potential impacts of COVID-19 on global growth, we reaffirm our commitment to use all appropriate policy tools to achieve strong, sustainable growth and safeguard against downside risks. Alongside strengthening efforts to expand health services, G7 finance ministers are ready to take actions, including fiscal measures where appropriate, to aid in the response to the virus and support the economy during this phase. G7 central banks will continue to fulfill their mandates, thus supporting price stability and economic growth while maintaining the resilience of the financial system.”

The G7 pledge of coordinated action by G7 policymakers, partly at the instigation of ever ready interventionist International Monetary Fund chief Christine Lagarde, was viewed as vague. But soon thereafter came the FOMC rate cut announcement.

Europe and Japan are far more in need of some kind of stimulus than the US. But Mnuchin is the senior partner on the US team in the G7 process, and Powell no doubt felt bound to follow through with a sizable rate cut the same day, instead of waiting for March 18.

It is perhaps significant that the G7 talked about possible fiscal measures because for a year or more, Powell and other Fed officials have made precisely the point that governments cannot rely solely on monetary policy. Alas, in the US, $1 trillion annual budget deficits limit room for further fiscal stimulus.

Trump nevertheless was talking even before the virus outbreak about another tax cut. But that is not something he is likely to get unless the Republicans regain control of the House of Representatives in the November election.

Moving forward, the Fed can and should stand ready to furnish ample liquidity to ensure that the system’s financial synapses keep firing.

But it has already acted aggressively to do that in wake of the September short-term funding pressures, supplementing large and regular repo operations with $60 billion per month of outright Treasury bill purchases. Those now seem sure to be extended longer than originally intended.

Of course, it has now made 125 basis points of cumulative rate reductions since last July, reversing all of the four 2018 rate hikes and then some.

Beyond that, the Fed must ask itself whether either lower rates or reinvigorated quantitative easing would accomplish anything constructive or whether it would expose the impotence of monetary policy.

Arguably the supply and price of money is not the problem. The world is awash with it at record low rates. More won’t reopen plants and ports, rebuild supply lines, end travel restrictions or calm contagion fears.

Nevertheless, if this now thoroughly politicised bug continues to destabilise the global economy, the Fed may well feel it has no choice but to act further. If it does so, however, it will likely do so with a renewed determination to retrace its easing steps once the crisis has passed – whether it says so publicly or not. The more diplomatic course would be to reiterate that policy is “not on a pre-set course” and that it will “act as appropriate”.

Steven Beckner

Julie Ros

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