Fed cuts benchmark interest rates in response to coronavirus scare

Amongst the first major action taken to neutralize the economic impact posed by the coronavirus outbreak the Federal Reserve on Tuesday cut the US benchmark interest rates by half a percentage point. These are now set in a 1 per cent to 1.25 per cent range. The magnitude of the rate cut, not seen since the 2008 collapse of Lehman brothers, shows how concerned the central bank is regarding the financial and economic impact of the virus outbreak. Federal Reserve chairman Jerome H. Powell shortly after the rate cut announcement said in an interview that the action was warranted as it was felt that the outbreak had reached a proportion where it posed a risk to the future of the US economy.

The coronavirus outbreak in the past one and a half months has caused significant trade disruptions across the world. The city of Wuhan, the epicentre of the outbreak is in a virtual lockdown, transportation in parts of China has been severely crippled and exports from the country has been stopped in order to check the spread of the virus to other parts of the world. There are thousands of companies across the world which source machinery and intermediate products from China. A short supply of these products essentially means that manufacturing activity in the destination countries is also adversely affected. Moreover, China is also the world’s largest consumers of basic commodities like mineral ores. There are several Asian countries whose economies are heavily dependent on exporting mineral ores to China and an import restriction from the latter means production stoppage in the source countries. Reduction in the movement of goods internationally is also having a telling impact on the global shipping industry, and several container ships are either stranded in Chinese harbours waiting for approval to unload their cargo or are stranded in their source country harbours in the absence of any clear instructions to sail towards China. Among the more severely impacted industries is the global aviation industry and the tourism industry, both of whom have been witnessing falling customer numbers as more and more people are preferring not to travel due to the fear of contracting the virus.

The global economic situation at the break of Dawn on 1^st January 2020 was not very strong either to start with. The Trade war situation between China and the United States, brewing over the past several months, had slowed down commerce between the world's largest and the second-largest economies. China, on the other hand, had also been slowing down on account of lower demand and excess production capacity resulting from several decades of high economic growth. In Europe, the Brexit situation had kept the economic situation in the entire continent subdued for an elongated period of time. The reduction in business activities in Europe especially had been caused by a gloomy business sentiment on account of the uncertainty surrounding a no-deal Brexit. Britain’s withdrawal from the European Union after forty-seven years of being together forced many companies to curtail their businesses as the advantage on account of a single tax and regulatory regime was lost.

Had it not been for the outbreak of the Coronavirus, however, the situation on all of the above fronts would have started to improve. The United States and China had agreed to desist from mutually destructive tariff and counter tariff impositions. The United States put on hold a new set of tariffs that were set to be imposed on Chinese commodities entering the United States in October 2019 while China agreed on its part to allow American financial institutions greater access to the Chinese markets. As an ensuing effect of the above deal, the Chinese economy was expected to bounce back and see an increased level of capacity utilization and exports. The Brexit situation became less intense with the British parliament passing the Benn Act, which ensured that The United Kingdom did not part ways with the European Union without an appropriate deal to protect the interests of the thousands of businesses functioning on both sides of the economic block. The victory of Prime Minister Boris Johnson in the ensuing elections ensured that the draft deal agreed between him and the European Union officials is adopted by the British parliament and became a law ensuring a clear passage of the Brexit event on 31 January 2020. Several leading economic indicators thus had started to look upwards in the last couple of weeks of 2019, raising hopes of an economic recovery in the new year.

The Bank of England in January 2020 held on to its policy rates buoyed by the improving economic conditions in the United Kingdom while it was widely anticipated that the bank would cut rates further. However, with the virus outbreak, a reversal in trend is being witnessed; the Japanese central bank has indicated that it would inject more liquidity into the country and the Reserve Bank of Australia cut rates to historic lows of half a per cent. After the Federal Reserve’s rate cut announcement, several more countries are also expected to announce rate cuts with a significant amount of liquidity set to enter into the international markets. This increased amount of liquidity in the international markets, though intended to spur demand and growth, may not have the desired effect. The present threat faced by the world economy is a structural one; manufacturers and not able to carry on manufacturing activities although there is demand, goods are not reaching their intended destinations although supplies are short. The increased money supply thus could lead to heightened inflationary conditions, which in the medium-term could prove to be harmful.

The virus outbreak at present is showing no signs of abatement. The longer the situation persists the more damage it will do to the global economic activities. Central bank actions will have a limited impact in arresting the deteriorating economic situation. As with the previous outbreaks of the different strains of viruses, the spread of infections is expected to be contained with the onset of summer and most of the impacted countries are expecting to counter this threat by that time.

Financial markets across the world have reacted very badly to the threat. A meltdown was witnessed last week in most of the global indices as more and more companies issued revenue and profit warnings. The concern of a global slowdown is a real threat now. Coming out of a bad economic period and landing in another which has been structurally slowed down, the global economy is indeed in a tender spot at present. A concerted global effort to fight the virus spread is the only way to alleviate the threat. Health authorities are in a heightened state of the alert world over. International travellers are being subjected to enhanced screening at airports and any individual carrying evidence of being infected is immediately put in quarantine. Till the beginning of March 2020, nearly than three thousand people have succumbed to this outbreak and around ninety thousand have been confirmed to be infected. The virus has already spread to more than seventy countries with new cases being reported almost every day. The infection, however, is now showing signs of slowing down and the rate of growth in the number of new infections has come down, despite its spread to new geographies.

The Federal Reserve has indicated that it might revisit the interest rates again if the threat continues to persist or becomes more serious. Policy measures have also been announced by the Trump administration both to stimulate the economy as well as to fight the epidemic. The Fed rate cut did spur a rally in the major US indices, but it was short-lived as the fears of the epidemic far outweighed the euphoria and the markets tumbled again. The next few weeks are going to be critical with regards to fighting the epidemic and containing its adverse economic impact on the global economy. The rate at which new infections grow will indicate how soon the epidemic can be contained. A vaccine or a confirmed treatment will immediately bring down the number of infected people and alleviate the fears of the international traveler.

Further liquidity infusion into the international markets would have a limited positive effect. The outbreak brings to light how vulnerable the global economy is to a threat like this. It emphasizes on the need for an internationally coordinated structured response to such threats and minimization of the loss of human lives and disruption of business activities in the future.