ETFMG Market Segment Expert in Bond Buyer

Will coronavirus make the Fed sick?

Just when everyone thought there would be little drama at this week’s Federal Open Market Committee meeting, the coronavirus has infected the broader markets. Experts still say monetary policy will be immune for now.

“Although the coronavirus news rightly has everyone worried, I doubt the FOMC will make it a big part of their deliberations on Wednesday,” said Peter Ireland, an economics professor at Boston College and a member of the Shadow Open Market Committee.

While it is likely to come up at Chairman Jerome Powell’s press conference, Ireland said Powell’s answer will likely be: “while the Fed is watching the developments on the spread of the disease just like it watches all other news that can potentially impact the U.S. and global economies, for now the movements in stock prices have been relatively small in percentage-point terms and seem to reflect fears of the worst possible outcomes instead of the most likely outcomes.”

Financial asset prices can be volatile, he added, and “if better news comes out tomorrow suggesting the spread of the virus has been more contained, then stock and bond prices are going to snap back to where they were before.”

Fed officials “have made it clear that it’s going to take a lot to knock them in either direction away from being on hold until after the November elections,” Ireland said. “I just don’t see the news as being nearly enough to force the Fed to change its policies.”

“Continued uncertainty regarding the life cycle of the new coronavirus contagion is flattening the yield curve as a flight to quality is driving down treasury yields,” said Bryce Doty, senior portfolio manager at Sit Fixed Income Advisors. “With the Fed expected to stay on hold this week, shorter-maturity bond yields have declined less than long-term maturities.”

He added, “the Fed will likely give a nod to the hit to global growth from the coronavirus outbreak which could re-steepen the curve as investors could take it as opening the door to a possible rate cut in the future.”

And with the yield curve flattening Monday and the threat of it “inverting once again,” Doty said, “some investors think the Fed may actually increase the rate being paid on excess reserves from 1.55% to 1.60% all because the actual fed funds rate has gone 0.01% below the rate being paid.”

But such a move “would just make the repo problem worse by increasing the incentive for banks to hoard cash at the Fed and cement the Fed as the lender of first, not last, resort for daily liquidity. With the yield curve already inverted from T-Bills to the five year, we just don’t see a rate increase to the interest on excess reserves making sense.”

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