By Shrutee Sarkar
(Reuters) – The Federal Reserve will cut U.S. interest rates by 25 basis points later this month but it is a close call, according to a Reuters poll of economists who have substantially raised their forecasts for the chances of a recession following the coronavirus outbreak.
Those conclusions come after the Fed chopped interest rates by 50 basis points on Tuesday – its first such emergency move since the financial crisis – to offset economic risks from the virus which have rocked financial markets for weeks.
But a large majority of respondents – just over 85% – challenged the move, saying that cutting interest rates was not the most effective policy to fight disruptions from the spreading coronavirus epidemic.
The Fed’s rate cut failed to calm global financial markets, with safe-haven Treasury yields hitting lifetime lows repeatedly. The S&P 500 index of Wall Street shares dropped over 10% from its Feb. 19 closing high, after logging its biggest weekly percentage decline since October 2008.
“A rate cut by the Fed, especially now, so early in the coronavirus episode, is terribly ill-considered. If we get a bunch of new cases or deaths…does the Fed easing have persistent benefits to the stock market – because it certainly is going to do next to nothing to directly boost the economy,” noted Stephen Stanley, chief economist at Amherst Pierpoint.
“They just fired off their bazooka, and if it does no good, then what? The argument that the Fed should be early and aggressive and get ahead of events is persuasive, but in this case, when there is little to nothing the Fed can do to prevent the more adverse scenarios, I just don’t buy it.”
In the poll taken March 4-6, 44 of 75 economists forecast at least a 25 basis point cut at the March 17-18 policy meeting, including nine who predicted a half a percentage point cut at the meeting. The remaining 31 expected no change.
Median forecasts from the poll predicted one more cut by the end of the second quarter, taking the federal funds rate to 0.50-0.75%.
“The bar for Fed officials to tell market participants that they are wrong to look for another near-term cut is high given the fragility of markets. So while the March meeting is a close call, we think the Fed will deliver another 25 basis points of easing,” said Michelle Meyer, U.S. economist at BofA global research.
When asked if the Fed should ease further in March, respondents were evenly split, suggesting a lack of confidence that monetary policy is the right tool to use to fight a near-term economic slowdown driven by the virus.
The interest rate futures market is pricing in a 100% chance of a cut in March. Futures pricing reflected a roughly 63-37% chance of a quarter percentage point cut versus a half point reduction.
“Uncertainty is high across several dimensions – the Fed’s reaction function, the number of U.S. cases to be reported in coming weeks, the extent of the weakness in upcoming U.S. and global data, and financial conditions,” wrote Jan Hatzius, chief economist at Goldman Sachs in a report to clients.
“But all things considered, our baseline expectations are an additional 25 basis point cut at the March 17-18 meeting followed by a 25 basis point cut in April.”
The coronavirus has induced supply-chain disruptions, travel bans, a shutdown of factories and in China, lockdowns of cities.
There was a clear jump in the median probability of a U.S. recession over the next two years.
The risk of a recession rose to 30% in the next year from 23% predicted last month and to 40% in the next two years from 30% penciled in previously.
Three economists went so far as to predict the fed funds rate would fall to zero by the middle of this year and three said it would reach that level by the end of next year.
Other central banks, including the Bank of Canada, the Reserve Bank of Australia and the Malaysian central bank, have eased this week, with others expected to follow soon, including the Bank of Japan. [ECILT/JP]
China’s economic hit was now expected to be more severe in the current quarter than thought three weeks ago, triggering expectations for rate cuts to be front-loaded.
(Graphics by Mumal Rathore, Polling by Sarmista Sen; Editing by Chizu Nomiyama)