Fed should not cut rates since the U.S. has ‘contained’ coronavirus, White House economic adviser says

America has “contained” the coronavirus, National Economic Council Director Larry Kudlow said Tuesday, adding that the U.S. economy is “fundamentally quite healthy” amid the rapid advance of the disease.

“We have contained this. I won’t say airtight, but it’s pretty close to airtight,” Kudlow told CNBC. The outbreak is a “human tragedy,” but it’s not likely to become an “economic tragedy,” he said.

Kudlow’s comments came after Dr. Nancy Messonnier, the head of the Centers for Disease Control and Prevention’s National Center for Immunization and Respiratory Diseases, said during a media briefing Tuesday that “it’s not so much a question of if this will happen anymore but rather more a question of exactly when this will happen and how many people in this country will have severe illness.”

Kudlow also said he does not expect the Federal Reserve to “make any panic move” to cut rates as a result of the epidemic — despite a 1,000-point plunge on the Dow Jones Industrial Average on Monday. The Dow closed down by almost 900 points Tuesday.

“I think they would prefer the option of staying the course with rates,” said Mark Luschini, chief investment strategist at Janney Montgomery Scott.

According to experts, however, policymakers might not have a choice. As recently as a month ago, CME Group’s FedWatch predictive tool showed only a 4 percent probability of a rate cut and a 13 percent chance of a hike when the central bank’s Board of Governors meets next month. As of Tuesday, the probability of an increase had dropped to zero, and the likelihood of a cut had risen to 19 percent.

The highest probability was for no change — above 80 percent in both cases — but the reversal at the margins shows how volatile the situation is likely to remain, experts said. And the specter of a bigger economic hit that affects the U.S. more directly means a June rate cut is seen as increasingly probable.

“The market is predicting — or basically asking — the Fed to cut, but not right away,” said David Bahnsen, chief investment officer of The Bahnsen Group.

There are still too many unknown variables regarding the novel coronavirus, which has spread from Hubei province of China throughout Asia into the Middle East and Europe, for investors to have much certainty about how or when the U.S. could be affected, but the centrality of China to global manufacturing supply chains means the ripple effects could be large.

Experts said the trajectory of the virus, its severity and duration of its spread will be key determinants for the Fed’s decision-making next month — particularly if one or more outbreaks strike the U.S.

“Given where the markets are now, if the meeting was today, they’d have to cut rates,” said Joseph LaVorgna, chief economist for the Americas at Natixis. “However, it’s possible between now and another month that the economy looks better than expected. … Right now, they’ve got the luxury of sitting and waiting.”

The Fed has good reason to wait, said Scott Ladner, chief investment officer at Horizon Investments.

Ladner expressed a common concern that lowering rates — especially because the benchmark rate is below 2 percent to begin with — would give the Fed little room to implement more stimulative policies in the event of a recession.

“The March meeting is probably too early for them to take any action. They’ve got more ammo than other global central banks, but it’s not unlimited ammo,” he said.

Bahnsen said, “I’m in the camp that I don’t want the Fed to have to continue with cutting when it’s purely sentiment- and market-driven.” He said a more potent policy tool might be to extend the short-term liquidity injections that the central bank has been providing to the “repo,” or interbank lending, market.

“When you have factory workers not going to their jobs, that’s not something you can fix with short-term interest rates.”

“A rate cut is far less significant as a monetary tool at this point compared with the quasi-QE4 bond buying,” he said. “Short-term T-bill buying to get the yield to un-invert has the effect of providing very significant liquidity priming into the marketplace.”

Making it less expensive to service debt can, in some cases, help businesses stay solvent and able to weather a downturn. “Lots of businesses will be pinched for cash. Making credit easier will smooth that,” said Bryan Routledge, an associate professor of finance at Carnegie Mellon University.

Luschini said, “What they’ll want to ensure is they’re doing what they can in an effort to not necessarily provide preventative medicine to the outbreak but to accelerate the recovery.”

But Routledge pointed out that the Fed’s policy toolbox can go only so far to mitigate the economic fallout the outbreak could cause.

“It’s hard to fix a real problem with monetary policy,” he said. “It’s hard to fix a lack of physical goods with monetary policy. When you have factory workers not going to their jobs, that’s not something you can fix with short-term interest rates.”

Source Article