Markets

Market pressure heats up on the Fed with at least three cuts now priced in for 2020

Key Points
  • Markets are putting pressure on the Federal Reserve to cut rates and have priced in at least three reductions this year.
  • For their part, central bank officials consistently have said it's too early to gauge the global economic impact from the coronavirus.
  • Some market participants say the Fed also could open up another round of quantitative easing.
Traders work on the floor at the New York Stock Exchange (NYSE) in New York, U.S., February 27, 2020.
Brendan McDermid | Reuters

The market clamor grew louder Friday for the Federal Reserve to step in with interest rate cuts to stem the damage from the coronavirus outbreak.

As Wall Street saw yet another aggressive stock selloff that took the market into correction territory, traders priced in an even greater chance for an interest rate cut, with expectations now for the Fed to act as soon as next month.

Futures pricing as of early Thursday afternoon was for a 68% chance for a quarter percent point cut in March, according to the CME FedWatch tracker. Traders indicated a near-50% chance of a second cut in April and a 74% chance that the move comes no later than June. Finally, the market sees about a 63.5% chance of a third reduction in December that would take the central bank's benchmark short-term lending rate to a target range of 0.75%-1%.

There's even a 42% probability of a fourth move in December.

The movement comes even though Fed officials continue to insist that it's too early to gauge the impact of coronavirus. The economic data particularly in the U.S. has continued to be strong, with reports Thursday showing a less-than-expected drop in durable goods orders and another strong showing for housing, with the 5.2% gain in pending home sales well above the 2% market expectation.

Still, the market is looking for the Fed to help stem what has been the worst week on Wall Street since the financial crisis.

Cuts, plus maybe some QE

While that response would likely come in the form of an interest rate cut or series of cuts, there's also some sentiment that the Fed could start up another round of quantitative easing to stimulate growth.

"We think a 10% S&P 500 equity index drawdown would prompt the Fed to act decisively, cutting rates and perhaps even stepping up its asset-buying program," Alain Bokobza, head of global asset allocation at Societe Generale, said in a note to clients.

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The market passed that 10% correction level in Friday trading, just months after wrapping up a powerful rally in 2019 that saw the S&P 500's total return eclipse 30%.

Fed officials have responded in cautious tones, saying they see U.S. growth as strong and policy as appropriate considering current conditions. But the central bank also is attuned to market conditions, seeing stocks as a key gauge driving consumer behavior and reflecting business conditions.

Should the correction swell into something more significant that could impact demand, that would be more likely to get officials to act than the current supply shock coming from China.

Former Fed Governor Kevin Warsh implored the central bank to act.

Warsh calls for 'global action'

"Today, the novel coronavirus is a material risk to the economy," Warsh wrote in a Wall Street Journal op-ed. "It represents an unexpected shock, and the Federal Reserve should lead the world's central banks in taking immediate action."

Warsh recommends the Fed approve a quarter percentage point rate cut done in conjunction with the People's Bank of China, the European Central Bank, Bank of England and Bank of Japan.

"Global action would help make the most of scarce policy ammunition," he added.

Though Fed officials have not committed to any policy changes, some recent statements have provided hints that they're taking the coronavirus threat seriously and are prepared to change their positions if the circumstances warrant.

In a speech last week, for instance, Fed Governor Lael Brainard didn't mention the virus but did make some strong statements regarding how committed the central bank should be to hitting its 2% inflation target, which it has undershot for most of the post-recession period.

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Brainard encouraged targeting an average inflation target that would include "supporting inflation a bit above 2 percent for some time to compensate for the inflation shortfall over previous years."

Vice Chairman Richard Clarida earlier this week said he also was prepared to change his stance if conditions worsen, and Dallas Fed President Robert Kaplan made comments to the Journal that indicated to some central bank watchers that he was looking ahead to the April meeting as a possible date for cutting.

JP Morgan Chase strategist Dubravko Lakos-Bujas told clients that Fed action now could help heat up the market after the coronavirus passes.

"Potential Fed insurance cuts at a time when the US employment base is close to full and prime-age participation rate is on a rise could result in an even hotter economy once the COVID-19 impact rolls off and stimulus remains," said Lakos-Bujas, who added that he was maintaining his 3,400 price target this year for the S&P 500.

The major averages recovered some of the steep losses they suffered in the morning and were heading into afternoon trading Thursday still negative as market experts deliberated what might stem the losses.

"The Fed may have to make more active use of its liquidity backstops to arrest a worsening of global financing conditions," economists at TS Lombard wrote. "Fiscal stimulus would also help. In general, time is of the essence — each risk can persist for a little before causing a tipping point."

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