Can Fed Rate Cuts Save the Economy?
The Fed made a rare, but not unprecedented intra-meeting rate cut of 0.50 percent (to a range of 1 - 1.25 percent) on March 3. In a unanimous decision, officials said despite an economy that remains strong “the coronavirus poses evolving risks to economic activity.” In his press conference after the decision, Fed Chair Powell acknowledged that the action would not shield the economy from the potential negative impact from the spread of the virus; rather it was an attempt to ensure that there was ample liquidity in the market and also to boost confidence.
Regarding the hope for confidence building, economists and investors were not convinced. Mohamed El-Erian explained to me that the problem that the Fed faces is that it can’t address the supply shock (not enough stuff available to sell) that occurred because China (the world’s manufacturer) was shut down for at least a month. However, the central bank is focusing on how consumers may react to the virus, which could create a demand shock (spooked people may pull back on spending).
Economist Joel Naroff was blunt in his assessment of the central bank action: “you cannot fight a virus with rate cuts It is hard to believe the Fed members actually think rate cuts will induce greater business or consumer spending Even worse, the Fed may have botched the messaging. If you cannot wait two weeks to cut rates, then why shouldn’t consumers, businesspeople and investors believe that the economy is on the verge of a recession? An emergency cut means this is an emergency!”
The sharp tip of the economic impact from coronavirus has already been seen in the travel, tourism and hospitality industries, as companies enact travel bans and organizers all over the world are canceling conferences and trade shows; the energy sector, which is coping with crude oil prices that have plunged by more than 20 percent; and tech and chip companies that are unable to fulfill orders without precious Chinese components.
As a result, economists are slashing growth estimates. The Organization for Economic Cooperation and Development said global growth could plummet to just 1.5 percent in 2020, down from the 2.9 percent predicted before the outbreak took hold. Diane Swonk, Chief Economist Grant Thornton, said “growth is likely to be flat to negative in seven of the ten largest economies in the first quarter,” including China, Japan, Germany, the UK, France, Italy and Canada.” As a result, she believes global growth will slow to 1.8 percent in 2020, “well below the 2% threshold that indicates a global recession.”
In the U.S., Swonk forecasts a growth recession, which “occurs when growth is too weak to keep unemployment from rising. U.S. growth is poised to slow to a near standstill in the first half as the global economy tanks, and growth for the year is [likely to be] 1.5 percent, one half percent weaker than it was just a month ago. A recession cannot be ruled out.” El-Erian agrees as he increased the odds of a 2020 recession in the U.S. to as high as 50 percent, up from his prior assessment of 25 percent.
While the U.S. may be in better shape than the rest of the world, because manufacturing accounts for only 11 percent of GDP and tourism accounts for 2.9 percent (the corresponding shares for Italy are 15 and 13 percent, respectively), Paul Ashworth, Chief U.S. Economist at Capital Economics notes that “U.S. air transportation (0.7 percent of GDP), retail (5.5 percent of GDP) and arts, entertainment, recreation, accommodation and foods services (4.2 percent of GDP) could all be hit hard.”
As a result, Ashworth lowered his full year growth prediction to 1.8 percent, from 2 percent, but he did so with a caveat: “those forecasts still assume a relatively benign domestic outbreak, with the number of cases peaking in the tens of thousands over the next few months and then tapering off during the warmer summer months.”
Markets/Investor perspective: The Dow, S&P 500, NASDAQ, and Russell 2000 are all back in correction territory (down by more than 10 percent from recent highs) and the day-to-day gyrations continued to persist. As fears of an economic slowdown spread, short-term investors are selling stocks and pouring into the bond market. The yield on the 10-year Treasury sank to all-time lows (below 0.7 percent), which in turn pushed mortgage rates to all-time lows, according to Freddie Mac. The average 30-year fixed-rate conventional loan was at 3.29 percent and the 15-year was 2.79 percent, the lowest levels in nearly 50-years. So while there is a lot of uncertainty, now may be a great time to refi a home loan to see if you can reduce your monthly nut, of course, you have to run the numbers.