Emergency rate cuts are nothing new for the US Fed. They did it three times in 2001 and another three times during the Lehmann crisis. After a gap of nearly 12 years, Fed again cut rates by 50 bps on Tuesday, March 03, 2020.
The aftermath of the virus
Clearly, the US Fed was worried by the rapid spread of the virus pandemic and also the impact it was already beginning to have on the US economy. Large swathes of the Chinese economy had been virtually shut down impacting the global supply and demand chain. From falling demand for cars and luxury goods to disruption in the supply chain of raw materials; all was happening at a rapid pace. It is to arrest this trend that the Fed opted to cut rates by 50 basis points. This was done at a time when there was a fortnight to the Fed policy.
What was the urgency?
The bigger question that arises is; what was the urgency when there was a Fed meeting coming up in mid-March. There were two reasons. The US runs a huge trade deficit with China and Chinese imports really feed the US supply chain in a big way. Secondly, the US yield curve had repeatedly inverted with the 3-year yield going above the 5-year yield. This had raised the fears of deflation in the minds of US policymakers. The rate cut was intended to build confidence among businesses and consumers.
RBI too may go for rate cuts
Since the Lehmann Brothers crisis of 2008, global monetary policy has been largely coordinated. One can argue that in 2019, the US had hiked rates by 75 bps while the RBI was had cut rates by 135 basis points. But 2019 was more of a normal year. The year 2020 began with the impact of the Coronavirus and that has hit global growth. IMF expects 30-40 bps to be shaved off. Indian GDP growth in the March quarter may also get affected as the Chinese pandemic hits everything from auto demand to pharma supply chains. With the status quo in the last two policies in Dec-19 and Feb-20, the RBI now has the leeway to cut rates hoping that inflation will also trend lower on the back of tepid crude.
Yield gap is still huge
Indian bond yields have fallen sharply to 6.18%, the lowest level in 12 years. But then the US bond yields have cracked to a 150-year low of 0.76%. That gives a 10-year bond yield spread of almost 5.42%. The historic spread has been between 400 and 450 basis points. That leaves the RBI with a comfort level to cut rates further. The need of the hour is to boost the confidence of business and of consumers and the best answer would be a rate cut. With transmission mechanisms in place since October last year, the RBI can even venture to go for an aggressive 50 bps rate cut. The yield gap should ease RBI’s concerns.