The last two weeks has seen markets abruptly catch up with the reality of the coronavirus crisis, with bond and equity markets forcing the US Federal Reserve’s hand to cut interest rates suddenly. This was the first inter-meeting change in rates since the 2008 financial crisis.
The Fed cut interest rates by 50 basis points in an emergency move bringing the lower bound of the rate to 1.0 per cent. This was very much a pre-emptive step to guard against an economic slowdown, with demand now becoming just as negatively affected by the global impact of the virus as supply.
Fed chairman Jerome Powell said the central bank took action after officials saw the coronavirus outbreak was having a material impact on the economic outlook. While the G7 held a conference call to co-ordinate its responses and the Fed said it was ready to act further, not much co-ordination appeared in evidence with only limited monetary policy responses elsewhere, as well as some fiscal support from the International Monetary Fund and the World Bank.
The Reserve Bank of Australia and the Bank of Canada were the only other prominent central banks to make similar moves to the Fed and the markets are awaiting decisions from the Bank of England and the European Central Bank (ECB) in the coming weeks. It was quickly apparent, however, that markets were not satisfied with the Fed’s move as equity markets and bond yields continued to fall. Expectations are that the Fed will cut interest rates again at their next meeting on March 17 to 18, and perhaps once again after that. But even these are not guaranteed to reverse negative sentiment given the overwhelming sense of uncertainty.
It could also leave the Fed dangerously exposed should the economic situation begin to really deteriorate, as it would leave the lower bound of US interest rates close to zero. Although US jobs data held up strongly in February with 273,000 new jobs created, the closer the Fed gets to the zero bound will see concerns legitimately grow about its ability to respond to further shocks. It will also cast doubt on its ability to escape from the scourge of zero and negative interest rates further down the road, given the experience of the ECB and the Bank of Japan in recent years.
The last fortnight also saw our region move into gear in terms of its responses to the coronavirus outbreak with travel restrictions increasing, schools closing and other arrangements made to slow down the spread of Covid-19.
The cut in US interest rates was welcome from the GCC’s perspective as it has been apparent for some time that monetary policy set by the Fed has been too tight for the Gulf economies given the slow pace of economic growth and the distinct lack of inflation. However, as with the impact of the Fed’s move, it remains to be seen if the cuts in regional interest rates will significantly alter the general level of unease being felt on account of the virus.
While the non-oil economies of the GCC will be affected to differing extents by Covid-19, largely reflecting their relative exposure to Chinese economic growth, a more common vulnerability will be felt through the oil sector. Markets have been awaiting a decision by Opec+ over oil production for almost a month now in the wake of the oil price plunge to below $50 a barrel, but the inability of the group to agree such a cut in Vienna last week again highlights the difficulty of achieving co-ordinated responses in the face of a huge global challenge.
After oil prices fell 10 per cent in the aftermath of the talks, to their lowest levels in three years, it is hard to see the dynamics pressuring the oil price lower changing for some time to come, adding further strain to regional budgets and ultimately to growth.
Russia looks likely to raise output from April once the current production deal expires, but with Saudi Arabia apparently also seemingly prepared to raise production, markets could be on course for the return of a price war with untold consequences.
Tim Fox is Chief Economist & Head of Research at Emirates NBD
