Federal Reserve Chairman Jerome Powell has signaled the central bank’s readiness to slash interest rates to cushion the economy against the effects of a widening global slowdown and potential health emergency due to the spreading coronavirus.
“The fundamentals of the U.S. economy remain strong,” Powell said. “However, the coronavirus poses evolving risks to economic activity. The Federal Reserve is closely monitoring developments and their implications for the economic outlook. We will use our tools and act as appropriate to support the economy.”
Powell’s statement came as Wall Street was gripped by a massive selloff, with market volatility spiking intraday to levels reminiscent of the 2008 financial meltdown. The so-called investor “fear gauge,” or the VIX volatility index, tested resistance at around 49 multiple times during trading on Feb. 28 before settling at 40.11 at the closing bell.
Volatility levels above 31 are challenging for investors, who widely view this as a red-line plateau above which extraordinarily high levels of market uncertainty and fear prevail.
“When you look at volatility regimes, once you get above 31 on the VIX you have an uninvestable environment. … There’s no valuation as a catalyst,” explained Hedgeye CEO Keith McCullough, on the Feb. 28 episode of “The Macro Show.” “It’s the prevailing conditions of growth, inflation and the market signal. If my market signal doesn’t give up greater than 31 on the VIX I’m not buying a damn thing on this ‘dip’ because it’s not a ‘dip.'”
Top White House economic adviser Larry Kudlow tried to calm markets Feb. 28 about the continuing selloff, telling reporters at a White House briefing that global markets “have gone too far,” amid fears the epidemic could spiral into a pandemic.
“My reading of the numbers that we have at hand—and I acknowledge this could change, I acknowledge the situation could deteriorate, I acknowledge the risks—but given what we know factually, it looks to me like the market has gone too far,” the National Economic Council director said, adding, “I’ve seen this before and it could come back very rapidly.”
Allen Sukholitsky, chief macro strategist at Xallarap Advisory, told The Epoch Times in an emailed statement that market sentiment reacted so violently at last week’s sharp correction of key Wall Street stock indexes because investors have come to expect unusually low volatility in what is fundamentally a risky class of assets.
“The long-term average for the VIX has been 20. We do not consider a move above 30—which has taken place 8 percent of the time—as evidence of what future equity performance will look like,” Sukholitsky said. “Instead, our concern is that since the global financial crisis, investors have come to expect low volatility out of equities, when they are actually among the riskiest of asset classes.”
Mounting Rate-Cut Expectations
Powell’s statement of the Fed’s willingness to deploy monetary policy tools to counteract significant coronavirus-driven spillover into the economy came amid soaring expectations the Fed would cut interest rates at its next meeting.
During last week’s equities meltdown, the Fed Funds futures market assigned a 100 percent chance of a rate cut at the Fed’s March policy meeting, according to the CME FedWatch Tool.
The Fed chairman used similar language last June to flag the central bank’s readiness to slash rates amid mounting concerns of a deteriorating economic outlook exacerbated by the U.S.-China trade war. Afterward, the Fed cut its benchmark rate three times, most recently in October to a target range between 1.5 percent and 1.75 percent.
Federal Reserve Bank of St. Louis President James Bullard said Feb. 28 the coronavirus situation has increased the likelihood of a rate cut, but added he thinks the Fed won’t need to take action if the health scare is contained.
“Further policy rate cuts are a possibility if a global pandemic actually develops with health effects approaching the scale of ordinary influenza, but this is not the baseline case at this time,” Bullard said in prepared remarks ahead of a presentation in Arkansas.
He told reporters after his speech at the Fort Smith Regional Chamber of Commerce, as cited by The Wall Street Journal: “I wouldn’t want to prejudge the March meeting. Obviously, the situation is very fluid, and we are going to want to monitor events right up until the meeting.
“Focusing on central banks is probably not the best idea here. The best idea is to focus on public health.”
Sukholitsky told The Epoch Times that “global central banks are faced with a daunting task: solving a problem, whose root cause is neither economic nor financial, by using tools that are designed to solve economic and financial problems.”
“Nevertheless, the Fed may be forced to act if U.S. inflation expectations continue to fall from their current levels, which were last seen in 2016 and have been falling since 2018. The Fed likely needs a few more months to evaluate the trajectory of both the economy and the outbreak,” he said.
“For now, we are sticking with our forecast of two cuts in the second half of this year.”