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Fed Rate Cut Odds Surge as Coronavirus Spread Clips Growth Forecasts

Traders are pricing in at least two Fed rate cuts between now and the end of the year, pushing 10-year bond yields to the lowest levels since 2016, as the coronavirus threatens to evolve into a global pandemic.

The Federal Reserve could cut interest rates in the coming months if the coronavirus spread accelerates and global economic growth slows, futures prices indicated Monday, amid the weakest reading for domestic services sector activity in at least seven years. 

The CME Group's FedWatch tool, which assigns rate cut odds based on futures prices, suggests investors are pricing in at least a 50% chance of an April rate cut, a move which would lower the Fed's target rate to a range of 1.25% to 1.5%. The chances of a cut in June, however, have risen to as high as 90%, suggesting investors are fearful that the virus, which has spread to Western Europe and Central Asia, will hobble global economic growth over the first half of the year.

International Monetary Fund Managing Director Kristalina Georgieva told the G20 meeting of finance ministers and central bankers in Riyadh Sunday that the spread of the virus could shave at least 0.1 percentage points from global growth forecasts, but cautioned that "we are also looking at more dire scenarios where the spread of the virus continues for longer and more globally, and the growth consequences are more protracted." 

The increased rate cut odds, which were pegged at just 27.1% a week ago and 12.4% in late January, have hammered U.S. Treasury bond yields. Benchmark 10-year notes, for example, traded at a July 2016 low of 1.382% in European dealing, while 30-year bonds were seen at a fresh all-time low of 1.873%.

Earlier this month, Fed Chairman Jerome Powell told Congressional lawmakers that the central bank was "closely monitoring the emergence of the coronavirus, which could lead to disruptions in China that spill over to the rest of the global economy."

"As long as incoming information about the economy remains broadly consistent with this outlook, the current stance of monetary policy will likely remain appropriate," Powell added. "Of course, policy is not on a preset course. If developments emerge that cause a material reassessment of our outlook, we would respond accordingly."

Powell's comments, however, came prior to data last week from IHS Markit, which showed the weakest reading for service sector activity in at least seven years over the month of February, as well as near contraction levels for manufacturing output.

“With the exception of the government-shutdown of 2013, US business activity contracted for the first time since the global financial crisis in February," said IHS chief economist Chris Williamson. 

"The deterioration in was in part linked to the coronavirus outbreak, manifesting itself in weakened demand across sectors such as travel and tourism, as well as via falling exports and supply chain disruptions," Williamson said. "However, companies also reported increased caution in respect to spending due to worries about a wider economic slowdown and uncertainty ahead of the presidential election later this year."