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Does the US Fed's 50bps rate cut point towards darker times?

Early Tuesday, Jerome Powell, the Chair of the US fed, announced an emergency 50bps rate cut, citing risks to economic activity from the coronavirus. This follows the 25bps rate cut from Australia's central bank citing similar issues. The US markets fell ~3% on the back of the move.

In today's post, we have a very brief view on the impact the coronavirus is having on industries across the globe, the effectiveness of a monetary policy response against the current happenings in the world, and why this could point towards much darker times ahead.

Which sectors is the coronavirus affecting most directly?

As the coronavirus begins to spread in countries across the globe, killing more than 3,000 people and infecting more than 90,000 this has increasingly been looked at as a very major threat to global growth. The travel and tourism industry is most directly affected, as people are now apprehensive to travel, first to countries that have seen high instances of the disease, but eventually to the rest of the world as the disease spreads. For countries like Italy that currently stands at #3 in terms of reported cases and which depends very heavily on travel & tourism (~14% of GDP), this comes with gruesome consequences.

The second level impacts will be felt in industries that have part of their supply chain linked to China. We had covered the impact of the virus on the auto industry in our post here. Auto, fashion, semiconductors, and consumer electronics will most likely be direct losers due to this switch. With select port cities beginning to close, trade will also come down sharply, bringing down with it, the costs of oil.

All of these factors have begun to bring down growth estimates for the year, with the global growth estimate now at 1.5%, expected to fall further. When growth begins to falter, the Central Banks often step in, dropping rates, providing an impetus for the economy to grow. But will that work here?

How effective will a monetary policy response be against the coronavirus?

While monetary policy can be extremely effective in certain cases, its utility falls drastically in others. We try to breakdown the factors described above into demand-side and supply-side factors. Most of the issues that we discussed as the second level impacts above are supply-driven. If an auto plant isn't able to complete the car because a key supplier in China is shut down, or a fashion company isn't able to complete their bag because they haven't received the material, these are issues that can only be resolved when the situation at the supplier location improves. It is fair to assume that the monetary policy move would have little impact there.

Travel & tourism slowdowns, while being demand-driven, is a fear-driven demand fall. People aren't traveling less because they are investing in attractive 10 year government securities. People are traveling less because they are genuinely concerned about their lives. Here too, monetary policy is unlikely to have too much of an impact.

A rate cut has two impacts - one real and one of perception. As discussed above, the real impact that this could have seems limited, especially given the nature of the problems we face.

Implications for the world

On the perception bit, the G7 statement and the subsequent moves by the US Fed and Australian Central Bank seems to indicate an intent to portray that both fiscal and monetary authorities will do what is needed to contain the impact. The sharpness and premature nature of the cuts, however, point towards much darker times. The markets, after an initial jump on the move announcement, seem to have caught on to this theme as well.

A lot will depend on the severity of the virus in the days ahead, the success of potential vaccines, and potential reduction in the summer months. If that plays out, March could well be the peak month for cases, and any supply chain disruption impacts should revert back to normal in 2-3 months post that. But it increasingly looks like this isn't the most likely scenario - because if it were, the Fed wouldn't have needed a cut as sharp as the one they executed. The sentiment in the Fed seems to be one of fear and panic. The signs on the wall are ominous. And it increasingly looks, like the worst is yet to come.

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About the Author: The post is written by Ganesh Nagarsekar. Ganesh is a graduate from IIM Calcutta and has worked with J.P. Morgan and Goldman Sachs, before founding GSN Invest.


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