Coronavirus, the Fed, and the steady 2020 that wasn't

Regardless of the ultimate effect of the coronavirus on the economy, lower rates today will be a negative for bank profits

Eric Compton 5 March, 2020 | 1:04AM
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2020 started off as another seemingly normal year for the economy. There were, of course, the quotidian worries about slowing manufacturing output in certain parts of the world, a generalized but moderate slowdown in global GDP, and if we could ever get inflation trending higher again. These really weren’t new concerns; these were the normal, daily economic apprehensions of a formerly placid 2020. This has all changed quite dramatically due to the global outbreak of the coronavirus.

Officially recognizing these evolving risks, the Federal Reserve has cut its target rate by 50 basis points, to the 1-1.25 percent range. The Fed released a statement on Feb. 28, stating that it was closely monitoring the situation and that it would “act as appropriate to support the economy.” The markets interpreted this statement as a direct signal that the Fed would imminently cut rates, and the markets have been proved right, as the Fed released another brief statement the morning of March 3 stating that the Fed was lowering its target rate by 50 basis points. The vote was unanimous.

The Fed’s rate cut was not part of our original rate outlook for our banking coverage. Originally, before the outbreak of the coronavirus, we had been predicting that rates would remain flat for 2020. With this new development, banks are in a tough place. The average USD LIBOR had already dropped roughly 60 basis points since January, and 10-year U.S. Treasury yields have dropped roughly 80 basis points since the start of the year. Regardless of the ultimate effect of the coronavirus on the economy, lower rates today will be a negative for bank profits. If the coronavirus has a materially negative impact on the economy, this will be another negative. There is no way for the banks to escape this unscathed. We will incorporate the new rate outlook into our traditional bank coverage and estimate that our current fair value estimates may drop by a low-single-digit percentage, on average.

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About Author

Eric Compton

Eric Compton  Eric Compton, CFA, is an equities strategist for Morningstar Research Services LLC, covering the U.S. and Canadian banking sectors, including the U.S. money center banks, U.S. regional banks, and the Big Six Canadian banks.

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