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How can I be so precise?
Because March 18 is the date of the next meeting of the Federal Reserve’s interest rate setting Open Market Committee. And in the last two days financial markets have stampeded to a belief that the Fed will enact an emergency interest rate cut at the March meeting in response to the coronavirus pandemic and its effects on the global (and U.S.) economy.
Today the CME FedWatch tool, which calculates the odds of a Fed move by looking at prices in the Fed Funds futures market, projected the odds of a 25 basis point (one-quarter percentage point) cut in the Fed’s benchmark interest rate at 63.1%. Odds that the Fed will hold rates steady were 36.9%.
On February 25, the odds were almost exactly reversed for those two alternatives. The futures market on that day was pricing in 33.2% chance of an interest rate cut  and a 68.8% chance that the Fed would hold rates steady.
In other words, the financial markets have been so shocked by the plunge of the last two days that they are counting on an emergency interest rate cut from the Fed to stop the carnage. Remember that until very recently the consensus Wall Street view was that the Fed would hold rates steady until September or December with the strongest odds on December because of the Fed’s traditional reluctance to move on interest rates in a Presidential election year.
This sets up the March 18 meeting as a very big deal. If the Fed meets and cuts interest rates–and gives the impression that the markets can look for another cut later in 2020–then I think we’ll see an oversold rally that will last (or not) until the next big piece of coronavirus news. If the Fed meets and doesn’t cut, then a lot of investors, especially big Wall Street investors, are going to be disappointed. No bounce. No oversold rally. And quite possibly a continued move lower for stocks and yields (which means a move higher for bond prices) on worries that the coronavirus will take a bigger bite out of company revenue and earnings than the consensus expects right now.
Jerome Powell’s therapist has stopped answering my emails so I don’t know what the Fed chair is thinking.
But the situation has put the Fed in a very tight jam.
If the Fed moves now to support the stock market after President Donald Trump has made higher stock prices such a big part of the argument for his re-election, then, yes, the Fed will take a lot of flack from the President’s opponents for playing election-year favorites.
The Fed could make a very strong case for not moving in March because it wants to see data showing the effect of the coronavirus on the U.S. economy and because the central bank wants to save its limited interest rate cutting ammunition (remember the Fed’s benchmark rate is already down to 1.50% to 1.75%.) in case it is really needed later in the year.
The central bank should also be afraid of what happens to its credibility and consumer, stock market, and economic confidence if it moves and a cut in interest rates doesn’t fix the problem. There’s a good chance it wouldn’t because a lot of the economic damage isn’t simply a question of falling demand that can be fixed by lower interest rates, but lower demand because hundreds of millions of people (and more each day) have been quarantined or are afraid to shop, eat out, travel–or go to work–because of the coronavirus. A 25 basis point interest rate cut doesn’t address that real world fact.
The Fed also knows that by not cutting rates it could be making an economic problem worse. And I’m sure the bank knows that if it doesn’t move President Trump will come gunning on Twitter. One smarmy way out of the political squeeze would be to cut interest rates now–in March–well ahead of the November election. That might defuse some political criticism. But it would create a situation where cutting interest rates again in September because the economy has slipped significantly would be even more politically fraught and even more damaging to the Fed’s credibility.
Watch over the couple of weeks to see if the Fed tries to talk down expectations for a March 18 interest rate cut. (The Fed doesn’t have much time since it faces a 10-day quiet period of “no comment” before the meeting.) At a 63.1% chance of an interest rate cut for the March 18 meeting, the Fed is near the 65% inflection point where so many investors have decided on a position that disappointing those expectations would do real damage to prices in the financial markets. And if I’m sure of anything, it’s that the Fed doesn’t want to be blamed for a big sell off on its March 18 decision. So one possibility, if the Fed is inclined not to cut rates at that meeting, would be a raft of speeches and remarks from Fed officials downplaying the need for another interest rate cut this early in the crisis.
Ready to read the tea leaves?
