As the spread of coronavirus spooks financial markets, investors are betting that central banks will come to their aid.
Traders have this week raised expectations for rate cuts from the Federal Reserve and other big central banks, wagering that they will repeat the response to market turbulence that has become familiar since the financial crisis.
Markets are now pricing in more than two cuts by the Federal Reserve over the coming 12 months, implying a reduction of at least half a percentage point from the current level of 1.5-1.75 per cent. The consensus at the start of the year was that even a single cut was not a done deal. That shift, along with a flight into safe assets, helped push the 10-year US Treasury bond yield to an all-time low on Tuesday.
“The whole global growth picture has changed for the worse,” said Chris Iggo, chief investment officer for core investments at AXA Investment Managers. “I’m not sure what [the Fed] had in mind two months ago is still as relevant today. The Dow down 900 points is something that makes them sit up and take notice.”
Fed policymakers have so far given no indication of a shift in policy. Vice-chairman Richard Clarida said on Tuesday that coronavirus would have a “noticeable’’ impact on Chinese growth, which could spill over into the rest of the world. “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 said.
For now, it is still unclear how companies’ supply chains could be affected or how large a drag the outbreak could be on growth globally. “It’s a difficult situation for [the Fed], because they’d like to see more clarity on the economic front, and right now, there isn’t a whole lot of economic data to confirm how bad the coronavirus could be,” said Kathy Bostjancic, chief US financial economist at Oxford Economics.
Moreover, the Fed may be more hesitant to ease policy further, she said, given that it had indicated at the end of last year that it sought to remain on hold and see the impact of the cumulative 0.75 percentage points it cut between July and October in 2019.
Investors have focused their attention on the Fed in part because it is rare among developed world central banks in having significant space to lower interest rates. But even the European Central Bank, which cut its deposit rate to minus 0.5 per cent last September, is now priced for a further tenth of a percentage point cut this year. At the start of the year, investors had begun tentatively pricing in rate rises in 2021. Germany’s government bonds, which serve as a benchmark for all eurozone debt, now trade at sub-zero yields up to maturities of 30 years.
The resurgent expectations for monetary easing contrast with a widespread belief following 2019’s massive bond rally that central banks were largely out of ammunition and were likely to pass the baton to government spending when it came to stimulating economies.
“The reaction we have seen demonstrates that central banks are still the only game in town,” said Antoine Bouvet, senior rates strategist at ING. “A shift towards fiscal policy was also going to be a gradual one that occurred over many years.”
Mr Bouvet added that rate cuts were unlikely to do much to address the fallout from the spread of coronavirus. “The markets are tending towards this response because they are used to it and it’s probably the fastest policy response to put into practice. But it’s not the most useful tool for addressing a crisis like this,” he said.
In the UK, a borrowing and spending boost is expected in next month’s Budget and investors are betting this will happen in tandem with lower interest rates. Markets are pricing slightly more than one Bank of England cut this year. UK gilt yields are close to all-time lows, with the 10-year bond trading at a yield of 0.52 per cent on Wednesday.