Will the Fed Cut Rates in Reaction to the Coronavirus Outbreak?

The unexpected spread of the coronavirus beyond China has sent markets into a tizzy and increased the likelihood of a rate cut by the Fed in reaction to the potential economic fallout of the outbreak. The Federal funds futures now offer an 85% probability of a 0.25% rate cut before Fed’s July meeting this year, up from about 50% in the previous month.

There are also expectations for a further cut to as low as 1% from the present 1.50-1.75% levels before next year. The sudden sell-off in global equities and spurt in demand for government bonds hiked market expectations for intervention by the Fed for further easing to protect the US economy.

However, Fed officials have repeatedly played down the possible effect of the outbreak on the US economy, maintaining hope that the economic growth could remain moderate and that the virus will have only a short-lived impact on the US. The latest comments by Cleveland Fed President Loretta Mester indicate that the coronavirus offers a big risk to economic growth in the US, but it is too soon to assess the extent of its effect.

Analysts, however, remain concerned that the continued volatility in financial markets is something that can have an immediate impact on the economy, something the Fed will be forced to react to. Lately, US Treasury yields have also slid lower, a troubling sign that could put more pressure on the Fed to turn more dovish.