Virus 'wildcard' threatens to drag central banks into action

Global central bankers are mainly biding their time as the coronavirus fallout reverberates through the world economy, which they had hoped was stabilizing after its worst year since the financial turmoil of 2009.

While the Bank of Thailand on Wednesday cut its key interest rate to a record low, most monetary policymakers have stuck to expressing concern and signaling a willingness to act if the virus delivers a sustained triple blow to demand, inflation and financial markets.

On Wednesday, the Philippine central bank governor hinted a similar move to Thailand's was imminent and the Monetary Authority of Singapore said there was "sufficient room" for its currency to ease if the virus weakens its economy.

At the Federal Reserve, Vice Chairman Richard Clarida last week described the impact of the virus as an economic "wild card." Bank of Japan Governor Haruhiko Kuroda said Tuesday he wouldn't hesitate to shield his economy. Reserve Bank Australia Governor Philip Lowe, the developed economy most exposed to China, said he's prepared to lower rates if needed, while stressing that it's important not to "catastrophize."

The economic pain is playing out in real time. Nike Inc. became the latest company to warn of a hit, saying it had closed about half of its company-owned stores in China as a result of the outbreak, which it expects to have a "material impact" on its operations in the country. World Bank President David Malpass warned Tuesday of an enormous amount of uncertainty.

The upshot is that after racing to the rescue of swooning economies in 2019, central bankers are again having to assess a fresh downside risk to their outlook and a new disinflationary impulse. Their hope is that the virus will soon be contained, enabling a swift bounce back in global growth, without them having to ease already loose monetary policy even further.

"Typically, what's happened in the past, there may be a short-term impact of an epidemic or a pandemic, but longer term it seems to have relatively little influence, and I think many observers are hoping that will be true this time," former Fed Chair Janet Yellen said Tuesday in Washington. "But we don't know where this is going, and to my mind it is clearly a source of uncertainty and risk to the global outlook."

A dilemma for central banks is that their key rates are already at or near historical lows. Bloomberg Economics estimates show that benchmarks across major advanced economies are already back below neutral, the rate that balances full employment and low inflation.

That may leave central banks reluctant to cut for fear of using up ammunition they might need to fight a future downturn. But they also could choose to cut in hopes of warding off a renewed economic downturn.

The SARS experience 17 years ago may offer reason not to panic. According to James McCormick, a strategist at Natwest Markets, the 2003 "impact on growth and markets was short-lived and once it had passed, the global economy resumed its solid uptrend into the end of year."

Less confident is Erik Nielsen, group chief economist at UniCredit Bank, who had already been among the few economists to predict the Fed would cut rates this year before the virus hit the headlines.

"If the outbreak does not dissipate soon, the authorities in both China and elsewhere are likely to extend travel bans, people will stay at home, and the increase in uncertainty will cause consumers to delay consumption and firms to defer investment," said Nielsen. "In other words, we think it's way too early to dismiss this outbreak as just a brief interruption of constructive markets -- as much as we wish it is."

The Fed's Clarida stressed that it was too soon to take a firm view on the spillovers to the U.S., while making clear that the country could absorb a temporary stutter.

"If this were to result in, say, a one or two-quarter slowdown in growth, that's probably not something that changes the big picture," he said Friday in an interview on Bloomberg Television. "But I do agree it's a challenging situation. We're going to keep on top of it."

The Fed kept rates steady last week after cutting three times in 2019 and signaling it would probably keep policy on hold through this year. Investors have responded to the virus's spread by increasing bets that officials would cut rates in 2020, according to federal funds futures contracts, though they still only fully price one quarter-point cut.

"The odds of Fed cuts are surely going up, and cuts will happen if the consequences of the virus prove large enough," said Roberto Perli, a partner at Cornerstone Macro LLC and a former Fed economist. His view is that if the Fed does cut, it will do so by more than the traditional 25 basis points.

"The idea of cuts is not far fetched at all -- the bar for cutting rates was previously fairly high, but the coronavirus is bringing it down significantly," Perli said.

European Central Bank Vice President Luis de Guindos said this week that it's too early to jump to conclusions. "We are in the first stage of this outbreak and know very little about the characteristics of the virus so far," he told Greek television station ERT. Bank of England Mark Carney described it last week as a "fast-moving issue."

China's central bank took its first concrete steps to cushion the economy and plunging markets this week, providing short-term funding to banks and cutting the interest rate it charges for the money. More measures may come in the weeks ahead, with much hinging on how quickly authorities can contain the virus.

"This remains for now a tail risk and a wildcard," said Ben Emons, managing director of macro strategy at Medley Global Advisors. "But central banks will not lag in their response."