Fed officials downplay virus even as markets see rate cuts
WASHINGTON (AP) — When Wall Street expects the Federal Reserve to cut interest rates, should that influence the Fed’s decisions?
Two Fed officials diverged on that issue in remarks Friday at a monetary policy conference in New York. The disagreement occurred just as the scenario is playing out in real life: Investors increasingly expect the Fed to cut its key short-term rate this year to help cushion whatever economic damage China’s viral outbreak ends up causing.
Still, other Fed officials have said in recent days that they see no need for rate cuts anytime soon.
Concerns about the consequences of the coronavirus rattled stock and bond markets Friday, particularly after a survey of purchasing managers by IHS Markit found that U.S. business output declined in February for the first time in more than six years. The Dow Jones Industrial Average shed 228 points, and the yield on the 30-year Treasury bond sank to a record low.
Those worries also drove up estimates in futures markets of a Fed rate cut later this year. According to the CME Group, traders envision a roughly 58% likelihood of at least one rate cut by June — up from less than 20% a month ago.
Last week, Chairman Jerome Powell reiterated that the Fed thinks the economy is in solid shape and is content with the current range of its benchmark rate, between 1.5% and 1.75%. That rate influences many consumer and business loans.
The gap between investor expectations for a rate cut and the policymakers’ own expectations has raised a longtime dilemma for the Fed: The central bank tries to guide markets about what it’s likely to do — or not do — in the months ahead. Yet it also considers signals from the markets about how the economy and the Fed’s rate policy are faring.
If the Fed were to ignore investor expectations for rate cuts, it could worsen market losses — particularly if the central bank turned out to be wrong in its economic assessments. On the other hand, if Fed officials were to tailor its policies mainly to satisfy traders, and against their own better judgment, that would risk inflating dangerous asset bubbles. Former Fed Chairman Ben Bernanke called it a “Hall of Mirrors” problem in a 2004 speech.