Fed Chairman Powell Testifies in Washington Amid Coronavirus Concerns

A key recession indicator is blinking red this week as analysts slash China's growth prospects in the wake of the rapidly-spreading coronavirus.
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Federal Reserve Chairman Jerome Powell is likely to face pointed questions from lawmakers related to the impact of the spreading coronavirus on China on U.S. growth prospects 

Powell will begin his first day of semi-annual testimony to lawmakers on the House Financial Services Committee later today in Washington amid growing uncertainty over the impact of the virus, which has taken the lives of more than 1,000 people and infected at least 42,000 others in the world's second-largest economy.

The Fed Chair has repeatedly told markets, as well as Congressional lawmakers, that only a 'material change' in U.S. growth prospects would compel the central bank to alter its 2020 rate path, which sees its key lending rate holding in the range of 1.5% to 1.75% between now and the end of the year.

"Some of the uncertainties around trade have diminished recently, but risks to the outlook remain," Powell said in prepared remarks published on the Fed's website. "In particular, we are 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."

However, with analysts slashing China growth forecasts, and a key U.S. recession indicator flashing red once again, Powell's 'wait-and-see' stance on rates could face a stern test in the coming weeks, particularly if the number of coronavirus cases outside of China were to accelerate, or officials in Beijing prove unable to contain its advance on the mainland.

"Overall, the threat that the coronavirus outbreak poses in an environment of already subdued global growth underlines the potential for medium-term US economic weakness," said ING's chief international economist James Knightley. "It is impossible to forecast the path of the virus, but it increases the chances that the Fed will cut rates at least once more to provide some support to the economy."

The CME Group's FedWatch tool, which tracks market expectations of central bank rate moves, suggests a near 37% chance of a June cut, compared to just 18% at the beginning of January. By September, traders have priced in at least a 68% chance of a rate cut, with some bets even forecasting a Fed funds rate of between 1% and 1.25%.

Bond markets, too, are starting to show signs of concerns for U.S. growth prospects as a result of the coronavirus spread, which will make China's attempt to meet purchase commitments in the Phase 1 trade agreement even more difficult.

The yield difference between 3-month Treasury Bills and 10-year Treasury notes turned negative yesterday, creating a so-called inverted yield curve that many investors use as a warning signal for slowing -- or even contracting -- GDP data.

"The coronavirus clearly presents a risk to the global economy — the Chinese economy is four times greater than it was during the SARS outbreak and China has established itself as the most critical link in the global supply chain," said Danielle DiMartino Booth, CEO and Chief Strategist of Quill Intelligence and a former adviser to former Dallas Fed President Richard Fisher.

"With a city the size of Sweden’s economy offline for a third week, it would seem rate cuts are a given, which throws out Powell’s mid-cycle adjustment soft landing scenario," she added. "The bond market has recognized the risk but the stock market shrugged it off in two days — does blatant speculation based on the assumption that the Fed will simply grow its balance sheet concern Powell?"

However, the U.S. dollar index, which tracks the greenback against a basket of its global peers, has been finding favor in foreign exchange markets at the same time, rising to a four-month high of 98.88 in early Tuesday trading as investors bet on the relative outperformance of the domestic economy compared to its global rivals.

"For now, the consensus is that the U.S. could keep on growing at a healthy pace even considering the effects of the coronavirus, and that could mean that domestic stocks, Treasuries, and the dollar could continue to appreciate hand-in-hand," said Gorilla Trades strategist Ken Berman.