Heisenberg Report

The Coronavirus Infects Fed Communications

Those waiting on a sign from the Fed that monetary policy stands ready to offset any deleterious economic impact from the coronavirus may take some solace in the monetary policy report released Friday.

A word search turns up only two hits for “virus”, but the relevant passages are worth quoting briefly, ahead of Jerome Powell’s testimony next week.

After noting that “downside risks to the US outlook seem to have receded in the latter part of [2019]”, the Fed notes that “more recently, possible spillovers from the effects of the coronavirus in China have presented a new risk to the outlook”.


This language is, of course, somewhat perfunctory, but if you want to be consistent when it comes to rationalizing your trading and investment decisions based on central bank forward guidance, you should be cognizant of the extent to which possibly material macro risk factors start to creep into official communications.

More colloquially: If you want to argue that the only “macro” catalyst that matters is accommodative monetary policy and central bank liquidity provision, then it’s incumbent upon you to keep yourself apprised of the evolution of the language around incoming risk factors, because that could tip future policy leans.

In the “international developments” section of the report, you find this:

Recent indicators provide tentative signs of stabilization. The global slowdown in manufacturing and trade appears to be nearing an end, and consumer spending and services activity around the world continue to hold up. Moreover, in some economically important regions, such as China and the euro area, data through early this year suggested that growth was steadying. The recent emergence of the coronavirus, however, could lead to disruptions in China that spill over to the rest of the global economy. 

That latter sentence speaks for itself, but the preceding sentence is already dated. That is, the most recent data out of the euro-area (GDP and industrial production) paints a worrying picture. And there is no question that the nascent bounce in China will be snuffed out by the virus – it’s just a matter of how big the hit will be, and how long it takes for the assumed V-shaped recovery to pan out.

The rest of the report generally echoes recent Fedspeak and reiterates the January statement.

I’d note (again) that there are multiple channels through which the economic implications of the virus can affect US monetary policy, with the main transmission mechanism being a scenario wherein the euro-area and China come under pressure, leading to persistent economic underperformance versus the US. In that scenario, the dollar would likely remain stubbornly strong, raising the risk of imported disinflation, imperiling the Fed’s policy rethink before it’s even announced and creating an absurd scenario wherein rate cuts aimed at helping mitigate unwanted currency strength end up turbocharging an already outperforming economy, thereby accidentally strengthening the greenback in the face of waylaid economies overseas.

The following chart rolls up pretty much every point made above in one way or another.

Food for thought – and if you want to chew on it some more, you’re encouraged to read the linked post below.

Read more:

How The Coronavirus Could Force The Fed Back To Zero (A Nuanced Take)