As market practitioners, too often we obsess with financial indicators when it comes to forecasting Federal Reserve policy. I have heard plenty of tongue-firmly-planted-in-cheek comments about how the Fed needs to cut rates because we are a whopping 8% from all-time highs. These pundits joke that the Fed needs to come to the rescue of the stock market bulls as they are not used to this many downticks.
Yeah, I get it. It seems ridiculous that less than a 10% decline would prompt calls for a Fed cut. But those who dismiss a Fed rate cut are missing the big picture.
The Federal Reserve is tasked with managing the economy, not the markets. Of course the markets are an important part of this responsibility. And no doubt, the Federal Reserve would be foolish to not take the signals it sends into account, but at the end of the day, their ultimate goal is to ensure the best functioning of the economy for the citizens of the United States.
One of my main beefs with Fed forecasters is that too often they make their analysis too complicated. Sure, the Central Bank has all these fancy econometric models that influence their decisions, but the FOMC board members are people, and their motivation is too plainly simple. They don’t want to make a mistake. They don’t want to be embarrassed. They weigh the consequences of being right and wrong, and then vote accordingly.
Usually this results in them being behind the curve. Why risk your career with a bold call? The risk reward does not favour doing anything except reluctantly going along with what the market prices in.
However, I contend this flu situation is different. Let’s face it – the Federal Reserve is the only Central Bank that matters. With world trade grinding to a halt, what the world needs is US dollars. Sure, the ECB can do an emergency cut to an even-more-negative rate, but is that going to help their economy? Not a bloody chance. I would argue it would actually hurt more than help. Could Australia or another smaller Central Bank cut? No doubt. But what is that really going to do?
The Federal Reserve needs to supply the US dollars the world so desperately needs.
Some might argue it’s not the Federal Reserve’s duty to tune their monetary policy to global needs. Don’t disagree.
But with today’s warning from the CDC, the game has changed. From an articled titled “CDC Says Americans should brace for ‘significant disruptions‘”:
“We are asking the American public to prepare for the expectation that this might be bad.”
Public health experts on Tuesday began publicly discussing the coronavirus as a disease which is expected to spread across much of the world population, including throughout the United States.
The CDC issued a warning Tuesday that it expects the illness to spread in the U.S. and that Americans should prepare themselves for “significant disruption in their daily lives.”
“Ultimately we expect we will see community spread in the United States,” Nancy Messonnier, director of the National Center for Immunization and Respiratory Diseases at the CDC told reporters. “It’s not a question of if this will happen but when this will happen and how many people in this country will have severe illnesses. We are asking the American public to prepare for the expectation that this might be bad.”
The reality is that the coronavirus has not been contained, and is now spreading to the rest of the world. You can’t put the toothpaste back in the tube. The CDC warning for Americans is sober and realistic.
Now, let’s imagine you are an FOMC board member. You can wait until this problem gets worse. You can wait for the bond market to rally another 10 handles and the stock market collapses another 8%. And then, when the fear is truly palpable, you can cut rates.
But, why not cut preemptively? It is plainly obvious that you are the only game in town. This problem is so large and encompassing, as the leader of the financial world, the task falls to you.
As a Fed board member, ask yourself what are the consequences of being late? The world remembers you as the mopes who helped plunge the world into a recession during a generational unique pandemic. And what are the consequences of being early? Not much. You might fuel this stock market bubble. But on the other hand, most everyone (Wall Street, Donald Trump, homeowners) wants lower rates, so the pushback will be mostly from a bunch of hard-money old men yelling at kids to get off their lawn.
It is clear to me that for the first time in a long time, there is a decent chance for an emergency rate cut. I am not predicting it. I am not sure if the Fed has the bravery to do something this out of the ordinary.
But if I was a FOMC board member, I would be pushing hard for it. Yeah, maybe it would be overkill, but if I was wrong, I would just take it back next quarter. Being too easy would be a welcome development as it would mean the virus didn’t spread as badly as feared.
I am sure to get all sorts of flak for this attitude, but if you have moral qualms with my view, then ignore it and simply ask yourself, what will the Fed do? That’s all that matters. My conclusion is that the chance of a inter-meeting rate cut is higher than the market believes. Not because the stock market is falling, rather because this is a serious economic situation and the Fed’s liquidity is desperately needed. Let’s hope they realize this before it is too late.
Thanks for reading,
PS: I know the Fed can provide liquidity with tools others than just interest rates. I anticipate that swap lines and other measures will also be incorporated into their announcement.