In a piece on Thursday, we asked ourselves how close the Fed was to a policy response on the back of the corona markets sell-off. We argued that if equities tanked 5%-point more, we would reach the same levels of financial conditions indices as when the Fed cut rates three consecutive times during H2 2019. That scenario has since unfolded (see chart 1). We therefore expect an easing package in March.

Chart 1: Financial conditions have tightened and are now back at levels seen in H2 2019, when the Fed cut three times

The equity sell-off has also prompted a response from Chair Powell who in a statement late Friday night said that “the coronavirus poses evolving risks to economic activity. The Federal Reserve is closely monitoring developments and their implications for the economic outlook. We will use our tools and act as appropriate to support the economy.”

Besides the obvious of issuing an extraordinary statement, the latter sentence clearly indicates that easing is on its way. The sentence is thus very close to the sentence “(The Fed) will act as appropriate to sustain the expansion”, which the Fed used during H2 to warn markets about an upcoming rate cut.

In our view, it is therefore no longer a question of whether the Fed will ease, but when and by how much.

Chart 2: Chinese PMIs released on Saturday indicate a rather gloomy outlook for the US economy. V-shaped recovery or not?

Looking at the market pricing, 38 bp of easing is priced in by March and 90 bp by year-end. Hence, if the Fed does not act in March, it will effectively tighten financial conditions further – something the Fed learned in Q4 2018 comes at significant costs to the real economy.