Fed’s Mester says rate cut unnecessary to offset virus risks

Business
Erica Fredrickson

Specialist Erica Fredrickson works with a colleague on the floor of the New York Stock Exchange, Monday, Feb. 24, 2020. Stocks are opening sharply lower on Wall Street, pushing the Dow Jones Industrial Average down more than 700 points, as virus cases spread beyond China, threatening to disrupt the global economy. (AP Photo/Richard Drew)

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WASHINGTON (AP) — A Federal Reserve official said Monday that she does not see a need to cut interest rates yet, even as worries about the viral outbreak that began in China caused global stock markets to plunge and some economists are penciling in a rate reduction by April.

“I see it as a risk to the (economy’s) outlook, but the fundamentals are still strong enough to support trend growth,” Loretta Mester, president of the Federal Reserve Bank of Cleveland, said. “I think our policy is well-calibrated to where we are … including the risks that are out there.”

She also said that, “we don’t want to overreact to the volatility in the markets” after just one day of sharp drops. The benchmark S&P 500 index fell 3.4% on Monday.

Mester’s comments at a business economics conference in Washington echoed remarks by two other Fed presidents on Friday. Both the St. Louis Fed’s James Bullard and the Atlanta Fed’s Raphael Bostic said a rate cut wasn’t yet necessary. Mester is the only one of the three with a vote on the Fed’s policy-making committee.

Yet Wall Street traders are increasingly pricing in the likelihood of a rate cut as soon as the Fed’s April meeting. Traders now see a 55% probability of at least one cut by then, according to the Chicago Mercantile Exchange’s Fedwatch tool. The central bank’s next meeting is March 17-18.

Gregory Daco, an economist at Oxford Economics, said the Fed should move quickly to avoid falling behind the curve. If markets continue to struggle, the U.S. central bank could be forced to cut as early as March, he said.

“Watching and waiting at this stage is a risky proposition,” Daco said. “Not reacting to financial market signals can worsen the economic impact of the virus.”

A key issue is how the coronavirus impacts the economy. If it mostly disrupts supply chains and factory output, a Fed rate cut may not be able to do much to restore that lost supply.

But if consumers cut back on spending out of concern about the economy’s health, or businesses pare investment in the wake of slower growth overseas, then Fed rate cuts could offset some of that drop in demand, Mester said.

Catherine Mann, chief global economist at Citi, said that the financial markets were previously complacent about coronavirus because investors expected it to mainly impact factory output and supply chains in China. They thought that would be a temporary hit and the global economy would quickly recover.

But with the virus spreading, it threatens to have a broader impact, Mann said. Travel and tourism around the world will likely be severely crimped and consumers in countries that have been hit by the virus, such as South Korea and Italy, will likely cut back their spending as quarantines are imposed. That won’t be so easily made up.

Mann said that Citi has cut its forecast for global economic growth this year to 2.5%, the lowest since the Great Recession more than a decade ago.

Fed rate cuts may only have a limited impact, Mann added. Interest rate cuts by the Fed are typically less effective amid widespread uncertainty. Lower rates won’t necessarily get businesses to invest more in their plants or buy equipment if they aren’t sure how the economy will fare in the coming months.

And consumers won’t necessarily spend more, even with lower rates, if they are waiting to see how the viral outbreak progresses, or if they are staying home out of fear.

“The Fed cannot offset those two sentiment and uncertainty effects,” Mann said.

Roger Ferguson, CEO of retirement services firm TIAA and former vice chair of the Federal Reserve Board of Governors, also raised doubts about the effectiveness of a cut.

“It’s not 100% clear that having interest rates (one-quarter of a percent) lower will have a direct impact on manufacturing goods or getting people back to work,” he said.

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