These are signs that the Fed will need to make deeper rate cuts, perhaps even plunging the United States back to 0% interest rates — emergency territory last experienced in the aftermath of the Great Recession.
“I would not be surprised if within the next few months the Fed went back down to zero,” said David Kelly, chief global strategist at JPMorgan Funds.
The bank’s US economics research team told clients Tuesday they now see a 50% chance of a return to zero this year.
Yet there is skepticism that easy money is an effective response to what is essentially a health crisis.
“Nobody checks interest rates before booking airline tickets or going out to the theater,” said Kelly.
The coronavirus is just the latest stress that the Fed is rushing to ease. Last year, seeking to blunt damage from the US-China trade war, the Fed cut interest rates three meetings in a row.
“We got a lot of pushback from that call,” said Philip Marey, Rabobank’s senior US strategist.
Markets imply 90% chance of recession
But the coronavirus outbreak, and subsequent market mayhem, has only increased Marey’s confidence that the warning was on target.
“They’re going to have to cut to zero even faster than we anticipated,” he said. “There were already cracks in the economy. The coronavirus only adds to that.”
Others say it’s premature to predict a return to zero rates. After all, if the coronavirus does less destruction to the US economy than feared, growth could rebound quickly.
Even if the economic pain proves significant, there is a risk that cutting rates from their already low levels won’t do much to fix the problem. In financial circles, that risk is known as “central bank impotence.”
“I don’t think the Fed will” cut rates back to zero, said Kristina Hooper, chief global market strategist at Invesco. “I think it realizes the diminishing effectiveness of rate cuts and it may not want to create more panic in markets, as it seems to have done with today’s decision.”
Still, bond markets are signaling that the Fed must take further drastic steps. The fact the 10-year Treasury yield plunged below 1% set off alarm bells across Wall Street.
Although JPMorgan expects the United States will avoid a recession in 2020, analysts there say the rates market are now implying a 90% chance of a run-of-the-mill US recession, (as opposed to a severe one like the 2008 Great Recession.)
“The market is pressuring the Fed; we don’t expect them to disappoint,” Bank of America strategists wrote in a note to clients Tuesday.
Will the Fed adopt negative rates?
All of this raises speculation that the Fed will follow in the footsteps of its peers in Europe and Japan by embracing negative interest rates.
Mester acknowledged that the Fed is studying the tools it could potentially use in a downturn and that its review will be “open minded” about the pros and cons of negative rates.
More likely, the Fed will turn to the kind of extraordinary steps it took during the Great Recession, such as promising to hold rates low for a period of time (aka “forward guidance” in Fedspeak).
But the central bank can’t solve the coronavirus crisis alone.
Joe Brusuelas, chief economist at RSM, said in the event of a “large economic downturn,” the federal government should create a special lending facility that would provide financing directly to small and medium-sized businesses. The goal would be to minimize layoffs and bankruptcies.
“We’re going to have to rely on the big guns: the fiscal bazooka,” Brusuelas said.