Fed expected to lower rates at March Meeting

We now project that the Fed will lower its Fed funds rate target by 25 basis points to 1.25%-1.5% at its scheduled March 17-18 FOMC meeting, in response to the coronavirus-related sharp correction in the stock market and to brace against the potential negative economic impact. We emphasize that the coronavirus is a negative real supply shock to China and some other regions that is rippling through the global economy and cannot be fixed by monetary policy easing. Moreover, monetary policy is already easy, with ample excess reserves in the banking system and very loose financial conditions, including the lowest bond yields in history.

However, the Fed is very concerned about how the sharp decline in the stock market may hit U.S. consumer confidence, a strong point that has been supporting solid gains in consumption and housing while industrial production, business investment and exports have been weak. The sizable fall in oil prices related to global economic weakness is expected to lower energy prices and push headline inflation further below the Fed’s 2% inflation target, which gives the Fed more flexibility to provide an emergency ease under the circumstances.

We believe the anticipated Fed rate cut will have at most a limited and temporary impact and is not sufficient to lift market confidence without other positive news. The coronavirus is a temporary phenomenon that is harming global economies and has generated widespread uncertainty about its many unknowns. The stock market will recover when market participants gain confidence that the spread of the coronavirus is under control, reducing uncertainty, and allowing participants to make economically rational assessments about how long disruptions to global supply chains and distribution channels will last and what will be the shape of the rebound.

The Fed has an unhealthy relationship with financial markets; whenever anything goes wrong, markets look to the Fed to ease, somehow presuming that monetary easing can fix any problem. Markets crave central bank easing under any circumstances and a Fed ease at this point only satisfies those cravings. Currently, with the U.S. Presidency and Congress lacking credibility, the Fed perceives that it must fulfill the role of a credible policymaker to address an emerging crisis in any way possible. A rate cut will have little impact on economic decisions by consumers or nonfinancial businesses. Nevertheless, the Fed has a clear tilt towards easing and will respond by reducing rates once again. From an already very low Fed funds rate, this Fed move would put it even closer to the zero lower bond, raising serious questions about its future conduct of monetary policy.

Mickey Levy, mickey.levy@berenberg-us.com

Roiana Reid, roiana.reid@berenberg-us.com

Member FINRA & SIPC
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