Coronavirus triggers more Fed cuts and keeps 10Y yields at record-low levels for time being

New macro outlook: from V- to U-shaped recovery

We based the previous issue of Yield Outlook – Coronavirus to keep yields low for now but higher 10Y yields in H2 20 from 19 February on the view that the virus would mainly be a China issue and that we should see a V-shaped recovery in the Chinese/global economy. For more, see Research – V-shaped scenario for global growth on back of coronavirus, 3 March.

We admit this view turned out to be wrong. The coronavirus has now spread to a large part of the world and a rapid V-shaped recovery now looks overly optimistic. Hence, our macro economists this week updated their macro view. They now look for a U-shaped rather than a V-shaped recovery. For more, see The Coronavirus Crisis – U-shaped rather than Lshaped global recovery, 4 March.

Central banks have started to ease

Furthermore, markets have priced in aggressive easing from global central banks. This gained momentum after Fed Chair Jerome Powell's press release late on Friday 28 February, which said ‘The coronavirus poses evolving risks to economic activity. We will use our tools and act as appropriate to support the economy' and, subsequently, slashed rates by 50bp. Like Fed Chair Powell, President Christine Lagarde of the ECB has also published a press release saying ‘We stand ready to take appropriate and targeted measures, as necessary and commensurate with the underlying risks'. The G7 also met with global central banks to discuss the situation.

Following this week's 50bp emergency cut, we expect the Fed to cut rates twice more: by 25bp at each of the March and April meetings. Our forecast implies a cut of 25-30bp less than the market expects.

What will the ECB do?

We have already seen rate cuts from Australia, Canada and the US and more is coming. The Bank of England is widely expected to cut rates by 25bp or 50bp on 26 March. However, the big uncertainty is whether the ECB is willing to cut rates further at the ECB meeting on 12 March. Had the interest level been positive, we believe there would be little doubt that it would cut rates. However, with the depo rate at -0.50%, whether the ECB is willing to go deeper into the negative given the potential negative impact on the European banking sector is uncertain. The ECB has also argued that monetary policy in the eurozone is already strongly accommodative. Another solution could be to step up the monthly QE purchases in corporate and government bonds. This could mitigate negative developments in corporate bond spreads and, not least, mitigate Italian bond spreads not continuing to widen. In our view, the last thing Europe needs is a new debt crisis.

However, when we weigh up the pros and cons, we arrive at the conclusions that the ECB will be hesitant to go deeper into negative next week and that the ECB will see the current QE programme as adequate. Instead, we should expect targeted new liquidity measures to secure funding for banks. However, we underline that uncertainty is high, things can change quickly from day to day and we rule out nothing ruled out.

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