Financial markets on Monday ratcheted up bets the US Federal Reserve will be pressed to cut interest rates to cushion a feared hit to economic growth from the spread of the coronavirus, although one official cautioned against expecting the central bank to over-react to short-term market moves.
US interest rate futures surged to their highest levels since last fall as evidence the virus was spreading further outside its original epicenter of China spurred a global sell-off in stocks and panicked buying of government bonds.
Wall Street recorded its biggest sell-off in two years.
The federal funds futures contract tied to the Fed’s July policy meeting reflected a roughly 85 percent probability the central bank’s benchmark overnight lending rate would be at least a quarter percentage point lower after that meeting’s conclusion, according to the CME FedWatch tool. A month ago that was seen as a roughly 50-50 prospect.
Contracts expiring in early 2021 were priced for a Fed policy rate of around 1 percent or lower, compared with the current level of between 1.50 percent to 1.75 percent, where it sits after three rate cuts last year.
Top US central bank officials have signaled repeatedly that they see no need to cut rates further any time soon because they see the American economy performing well and it is too soon to judge the risk from coronavirus.
Cleveland Federal Reserve President Loretta Mester was the latest to take note of the risk.
In remarks to the National Association for Business Economics conference in Washington, she described the outbreak as a “big risk.”
“At this point, it is difficult to assess the magnitude of the economic effects, but this new source of uncertainty is something I will be carefully monitoring,” she said.
But Mester pushed back against the notion that the Fed would be driven to act in response to jittery financial markets.
“I just caution that you don’t want to over-react to volatility in the markets if you’re a monetary policymaker,” she said.
Still, as the virus spreads, the resolve of Mester and other policymakers is likely to be tested in the weeks ahead. Monday’s stocks swoon followed a sharp increase in the number of cases reported in Italy, South Korea and Iran.
“The immediate risk is now about financial conditions,” said Gregory Daco, chief US economist at Oxford Economics. “The real impact is small – but volatility, if the dollar rises, stocks fall, that is a direct hit.”
In the US Treasury market, the yield on the 30-year bond – often viewed as a proxy for growth expectations – tumbled to record low of around 1.81 percent. – Reuters
