The Market Today
Emergency Fed Cut Amid Escalation of Coronavirus Fears
by Craig Dismuke, Dudley Carter
March 2020 Forecast Revision – Escalating COVID-19 Outbreak Further Alters Growth and Rate Projections
- COVID-19 has spread considerably faster than SARs and has not been contained to China
- COVID-19 has now spread to Europe and the U.S. where it is having meaningful, negative economic ramifications
- Fed has responded with a 50-basis-point cut in an emergency, intra-meeting policy decision (March 3, 2020)
- Eventual U.S. economic impact will be determined by the degree and duration of the uncertainty domestically
- We now expect U.S. growth to slow to 1.0% in 1Q20 and 0.9% in 2Q20 followed by a modest rebound in 2H20
- Any rebound in activity is likely to be delayed by the magnitude and persistence of the outbreak
- Based on the currently expected economic ramifications, we expect to see fiscal stimulus and further monetary easing
- We have very little certainty in how COVID-19 will progress going forward, clouding growth and rate projections
- Current projections continue to presume panic from outbreak is contained; if not, recession is increasingly probable with rates quickly falling to near-zero
- For link to Forecast Revision, please click here
- For link to full Coronavirus Chartbook, please click here
Vining Sparks appeared on Fox Business this morning to discuss the merits of the Fed’s emergency rate cut and need for more stimulus measures. To view the interview, click here.
ADP Shows No Symptoms of Coronavirus: February’s ADP Employment report showed that the economic damage from the coronavirus has not yet affected private payrolls. ADP projected 183k private payrolls added, beating expectations for 170k new payrolls. According to the report, the service sector accounted for 94% of new jobs with particular strength in the trade/transportation/utilities, and the leisure/hospitality sectors. Both are expected to be negatively affected by the disruption to the global supply chain and the slowdown in travel and tourism.
Housing Activity Continues to Show Strength: Mortgage applications rose 15.1% for the week ending February 28 on a 26.0% increase in refi apps and a 2.7% drop in purchase apps. The 4-week average for refis is now almost triple its level from the end of 2018. Thirty-year mortgage rates have now dropped from 4.94% in December 208 to 3.45%, according to the Freddie Mac U.S. Mortgage Market Survey. Despite the small pullback in the current report, purchase applications are up 19% from the end of 2018. Housing activity has now rebounded strongly following a sharp drop in 2018. New home sales are up 19%, existing home sales are up 10%, and new housing starts are up 21%.
ISM Non-Manufacturing Index and Fed Beige Book to Give More Color on Coronavirus Impact: The February ISM Non-manufacturing index is expected to inch lower at 9:00 a.m. CT. Also released today, the Markit Services and Composite PMIs are scheduled for release at 8:45 a.m. The Fed will release its Beige Book report on business activity around the country in preparation for its official policy meeting on March 18.
Fed Surprised with First Emergency Cut Since 2008 Financial Crisis: Just two hours after the G-7’s joint statement on the coronavirus response appeared to delay any policy action from officials in the world’s largest economies, the U.S. Federal Reserve surprised markets with a 50-bp emergency rate cut at 9 a.m. CT (more below). As the headlines hit, stocks surged back into positive territory, short Treasury yields plunged to new lows back to late 2016, longer yields dropped to new historic lows, the Dollar extended its recent tumble, and gold prices soared. Fed Chair Powell said in a press conference that followed that officials made the decision to keep the U.S. economy strong amid the risks posed by COVID-19. “The virus and the measures that are being taken to contain it will surely weigh on economic activity, both here and abroad, for some time,” Powell noted, adding the recent spread outside of China and “a bit here in the United States” had led the Fed to conclude the outlook had changed “materially.”
Powell Said Nature of the Disruption Requires “Multi-Faceted Response”: Several times, however, Powell hinted that the “virus outbreak is something that will require a multi-faceted response,” including actions from healthcare officials, fiscal authorities, and state and local leaders. Powell himself pointed out the problem that some analysts had used to criticize the idea of a Fed cut, saying “We do recognize that a rate cut will not reduce the rate of infection, it won’t fix a broken supply chain.” However, he went on, “we do believe that our action will provide a meaningful boost to the economy” through avoiding “tightening of financial conditions which can weigh on activity and will help boost household and business confidence.” Reflecting the delicate balance the Fed was faced with – sounding confident in its tools to keep a solid economy stable without fueling fears the virus’s economic effects will be immune to lower rates and could be worse than feared – stocks quickly reversed lower during Powell’s press conference and yields tumbled to new lows.
Markets Sold the News: After falling as much as 3.7% after Powell’s remarks, the S&P 500 closed down 2.8%. Treasury yields made headlines with the entire curve between the 2- and 10-year yields falling more than 20 bps at one point in the afternoon, and the 10-year yield falling below 1.00% for the first time ever. By the end of trading, the 2-year yield had lost 20.4 bps to close at 0.70% while the 10-year yield fell 16.4 bps at 0.999%. Despite the Fed’s surprise 50-bp cut, the spread between the 3-month and 10-year yields rose just under 14 bps from its pre-cut level while the spread between the 2-year and 10-year yields rose just over 5 bps to 29.4 bps. At Tuesday’s close, fed funds futures had repriced sharply to imply nearly three rate cuts by the end of the year, in addition to the surprise cut on Tuesday; an effective year-end rate around 0.43%.
Markets Respond to Fed Decision as More Data Reflects Virus-Driven Standstill: Global markets were mixed a day after the Fed’s surprise rate cuts as equities generally rose but bond yields pointed in different directions. The Fed said it cut rates in an attempt to protect the U.S. economic expansion from catching COVID-19, a sickness it expects could remain a headwind to growth “for some time,” both directly and through actions taken by countries to control its spread. More evidence of the virus’s economic effects in Asia were released overnight, with another services PMI in China (from 51.8 to 26.5) and one in Hong Kong (from 46.8 to 33.1) both tumbling to record low levels. China has been providing stimulus for weeks and Hong Kong’s central bank cut its target policy rate by 50 bps shortly after the Fed’s announcement. South Korea also announced on Wednesday additional fiscal stimulus to fight the virus’s effects.
U.S. Equities Get a Boost from Biden: South Korean stocks surged to lead a mixed day across Asia while Europe’s Stoxx 600 was just under 2% higher around 7 a.m. CT near its highest levels of the overnight session. U.S. futures had recovered nicely after yesterday’s post-Fed fall, with some analysts pointing to Vice President Biden’s solid performance in Super Tuesday primaries as providing support. Based on current projections from the WSJ, Mr. Biden accumulated more than 340 delegates on Tuesday compared with Senator Sanders grabbing just under 300 and Senator Warren and Mr. Bloomberg adding roughly 40 each. Just before the ADP payroll tally was released, contracts on the S&P 500 were 2.3% stronger, the 2-year yield was down 2.6 bps, and the 10-year yield had edged 0.8 bps lower. The yield decline moderated after the stronger-than-expected ADP report.
Fed Cuts Rates as Economic Impact of Coronavirus Grows: The FOMC voted unanimously to cut its overnight target range 50 basis points to 1.00% – 1.25% in an intra-meeting decision. In their brief statement accompanying the emergency policy action, the Fed noted that “the coronavirus poses evolving risks to economic activity.” The statement also noted that “the fundamentals of the U.S. economy remain strong.” However, the expected economic impact of the coronavirus is growing. The transmission to the U.S. economy will occur via disruptions to the supply chain, weakness in global demand as Asian and European growth falter, disruptions in travel and tourism, and deterioration in financial conditions. Going forward, if containment efforts persist in disrupting economic activity, the U.S. economy would likely face recessionary conditions resulting in the Fed cutting even more aggressively.