The Federal Reserve Steps Up (Again)

Dave Donabedian, CFA

March 16, 2020

The Federal Reserve took significant actions over the weekend to improve liquidity and cushion markets from the economic fallout of COVID-19.

As often happens during crises, the big stuff happens over the weekend. At 5 P.M. EDT, on Sunday, the Federal Reserve (Fed) announced a huge and multifaceted monetary policy move along with another substantial liquidity injection (details below). Meanwhile, the trend in social distancing accelerated dramatically around the world. While these prudent measures are a hopeful development for the ultimate health outcome, we are also wary of the potential damage in store for the economy in the months ahead. There were clear warnings that Americans should expect a very substantial increase in confirmed COVID-19 cases beginning this week.

The Fed took significant action on Thursday and again on Sunday. The Fed, along with many other global central banks, acted to improve liquidity and cushion markets from the economic fallout of COVID-19. What follows is a summary of the central bank’s most impactful actions taken on Sunday:

  • Zero interest rate policy
    The target band for the federal funds rate was cut to 0.00% - 0.25%. The Fed has now brought short-term rates back to where they sat for seven years following the Great Financial Crisis.
  • Quantitative easing
    The Fed announced at least $700 billion of additional asset purchases ($500 billion in Treasuries and $200 billion in mortgage-backed securities).
  • Discount window access
    The Fed lowered the primary discount rate by 150 basis points to 0.25%. This encourages banks to turn to the Fed to assure they have necessary funding and liquidity.
  • Lower reserve requirements
    Bank reserve requirement ratio was cut to 0.00% effective March 26. This action eliminates reserve requirements for thousands of depository institutions to encourage lending to households and businesses.
  • Expanded swap lines
    Coordinated action with the Bank of Canada, the Bank of England, the Bank of Japan, the European Central Bank and the Swiss National Bank to make U.S. dollars more accessible globally.

In a press conference following the announcement, Chairman Jerome Powell noted that the Fed had not yet sought approval from Congress to purchase other types of assets such as corporate securities. He also said that the Federal Open Market Committee is not considering implementing a negative interest rate policy.

If Chairman Powell hoped to boost investor confidence, the immediate reaction was disappointing.

The stock market opened Monday morning down sharply, and Treasury yields plummeted. These are signs of investor risk aversion. It is hard to imagine markets were expecting much more from the Fed as this was a very substantial set of moves. Some may have interpreted acting on a Sunday evening as a sign of panic—there is also concern about how much more ammunition the Fed has to fire. It is also true that there is not much the Fed can do to reverse the likely plummet in consumer and business demand in the short-term.

The Fed has additional tools available in the form of more quantitative easing and liquidity programs to funnel assistance directly to corporate borrowers. The Fed could also employ some of the tools that have been discussed as part of a policy framework review, such as interest rate caps or more lenient inflation targeting. We would be shocked if Sunday’s actions are the last we hear from the Fed.

Chairman Powell specifically mentioned the importance of more aggressive fiscal policy. There is currently little clarity from the White House or Congress on what a big fiscal stimulus would look like. The President’s payroll tax proposal seemed to be losing steam in recent days. We believe that skittish financial markets will ultimately force a major fiscal stimulus. But, in a bitterly divided Washington—and especially with election year jockeying—it is unlikely to happen fast enough for investors’ liking.

Similar to past crises, the Fed’s emergency moves are targeted toward boosting liquidity and the availability of low-cost capital to the banking system and financial markets. In those prior episodes, the transmission of benefits to the broader economy and riskier assets required time as confidence was restored. Immediate market reaction aside, we believe the Fed’s actions on Sunday were absolutely essential. We will be focusing on the functioning of credit markets and short-term funding operations starting Monday and through the week. This will be the first test as to whether the Fed’s dramatic package is working.