Patience confronts panic

| February 28, 2020

This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors. This material does not constitute research.

The Fed has consistently professed patience in considering the implications of the coronavirus. Financial markets, however, have rendered a different verdict: panic. The S&P 500 has dropped more than 10% from its February 19 record high, 10-year and 30-year Treasury yields have set record lows, risk spreads have widened and fed funds futures have priced a better-than-even chance of a 25 bp cut at the March FOMC and three more through 2020. While financial markets could force the Fed’s hand, the Fed still looks more likely to ride out the coronavirus and not cut rates at all this year.

What are Fed officials saying?

At the last FOMC meeting in January, Chairman Powell noted that the Fed would be “closely monitoring” the situation but that it was too soon to tell what the economic impact of the virus would be.  Vice Chairman Clarida echoed that sentiment a few days later.  More recently, as the virus has spread well beyond China, Fed officials have fleshed out their sentiments.

Dallas Fed President Kaplan on February 18: “There’s a scenario that this would turn out to be a first and second quarter event and much of the effect will reverse later in the year.  We’re going to have to continue to assess how this unfolds and make a judgment about whether this is a transitory event. If it’s a transitory event, I personally would be much more reluctant to think about changing the stance of monetary policy.”

Atlanta Fed President Bostic on February 21: “We know it’s going to be disruptive to China, to production, to a lot of the supply chain.  When I talk to businesses here, what they tell me is that it’s going to be a short-run disruption.  They’re not expecting an extended negative impact.  So I think this is going to be a short-term hit.  We’ll get the economy back to its usual level” (after that).  While we have that as our baseline, we’re always open and monitoring to make sure that there aren’t new things that are coming up that have some deeper implications for the economy.”

Fed Vice Chairman Clarida on February 25: The virus is likely to have a “noticeable impact” on Chinese growth in Q1.  “The disruption there could spill over to the rest of the global economy.  But it is still too soon to even speculate about either the size or the persistence of these effects, or whether they will lead to a material change in the outlook.”  He noted that Q1 GDP data for China will not be available until April.

Chicago Fed President Evans on February 27: “I think it would be premature, until we have more data and have an idea of what the forecast is, to think about monetary policy action….If circumstances required some additional accommodation, we have that capacity. The first way I’m going to think about this is whether or not lending behavior is adversely influenced.  After several months, and having a better idea of how this is going to transpire through this year, I think we will be better positioned to think about what the implications might be for monetary policy.”  He went on to say “I think that our monetary policy is pretty well positioned for the risks that we have seen coming.  I would say that this was not on my radar screen when we made three rate cuts last year, but I certainly feel better about the positioning of policy with any type of additional risk that we might be facing.”

Translating the Fedspeak

The overriding theme in these comments is that Fed officials would prefer to wait for hard data on the U.S. economy before making a determination.  If the FOMC sticks to that strategy, it will probably need to wait at least until April. The February data for the U.S., to be released in March, are unlikely to show any effects given the limited concerns here until a few days ago.  Moreover, the bar for an ease is probably at least marginally higher given that the U.S. economic data in early 2020 have been predominantly robust.

As the quote from Evans notes, it is important to keep in mind the context before the coronavirus became such a threat.  The Fed already moved monetary policy to what officials consider an accommodative stance last year, as it adopted insurance cuts to insulate against tail risks related to the uncertainty surrounding U.S.-China trade tensions.  While trade tensions and the coronavirus are clearly very different, the broad notion is similar: a potentially game-changing phenomenon of unknown duration that would most likely prove transitory.

The fact that the Fed is already accommodative has clearly been of little or no comfort to panicky market participants over the past week, but the Fed’s behavior last year is relevant.  In particular, the “insurance” cuts quickly morphed into a “we’re happy to be here and are going to stand pat for a while” stance in early 2020.  Many pundits argue that there is little downside to a pre-emptive cut now that could be quickly reversed if the threat dissipates in the spring.  However, Fed officials have historically proven too slow to reverse these sorts of pre-emptive moves

Given the proximity to the zero bound, Fed officials also need to make sure that any rate cuts are timed for maximum impact.  A quick, pre-emptive move ahead of any hard evidence of economic deterioration would likely prove unnecessary if the virus dissipates relatively quickly. And it would be irrelevant if the tail risk scenarios that a cut would be designed to combat come to fruition.  A modest decline in borrowing rates could theoretically provide a modest short-term boost to consumer and business confidence, but if there is a coronavirus outbreak in the U.S., curtailing people’s movements, shutting businesses, halting travel and so on, then there is not much the Fed can do to address that.  A pre-emptive move in that case will be soon forgotten.

In addition, the Fed runs the risk of exacerbating the panic if it were to respond in the absence of hard evidence to support such a step.  Panicky market participants could well raise their fears in response to a Fed move, thinking that Fed officials may know something that the general public does not.  It seems to me that a global, coordinated rate cut along the lines advocated by Keven Warsh in the Wall Street Journal on February 27 would be even more likely to heighten fears rather than to soothe them.  In essence, the Fed or global central banks collectively would be yelling “Fire!” in a crowded theater.  Chairman Powell and company can serve the U.S. better in this instance by offering a voice of reason amidst panicky financial markets and perhaps an apprehensive public.


It is still far too early to ascertain how the coronavirus will impact the U.S. and global economies.  The range of possible outcomes is immense, spanning from a modest short-term disruption followed by a quick bounceback to large-scale quarantines and business interruption on a global basis.  In the latter case, easier monetary policy will certainly be called for, though it is unclear how helpful it would be.  Market participants and a number of Fed watchers are calling for quick action, but the Fed appears inclined, for the moment, to let the situation play out.

A patient approach by monetary policymakers looks like the proper course until we know more.  While this time could be different, every other pandemic in modern times has blown over fairly quickly without having more than a transitory economic impact.  With monetary policy already easy, the Fed can operate under the assumption that a similar pattern will hold for the COVID-19 virus until there is sufficient hard data to make a rigorous assessment.

john.killian@santander.us 1 (646) 776-7714

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