In a dramatic move on Sunday evening the FOMC took a series of policy actions intended to forestall the economic slowing that is anticipated as a result of the coronavirus spread in the U.S., and the governmental and private sector policies seeking to address it. Just to recap a few points from Federal Reserve Chair Powell’s press conference: the FOMC cut its Fed Funds policy rate by an historic 100 basis points, to a 0.0% to 0.25% range, as well as cut its bank borrowing cost from the discount window by 150 basis points, to 0.25%, with term funds to be offered. Additionally, the Fed is committing to $500 billion of Treasury purchases and $200 billion of mortgage-backed securities purchases, in a program it styles less as quantitative easing and more as operations to improve market functioning.
To that end, the central bank also set new parameters on its foreign exchange swap lines, and will conduct repo open market operations at 0.0%, while also taking supervisory action to support the flow of credit. Finally, rather than place a pre-determined time limit on its accommodative policies the Fed stated that: “The Committee expects to maintain this target range until it is confident that the economy has weathered recent events and is on track to achieve its maximum employment and price stability goals.”
The Fed Chair emphasized that the central banks’ market operations are now, appropriately in our view, purchasing assets all along the yield curve, and while the coronavirus’ effects on the economy are uncertain, the Fed’s toolbox is still full of equipment. Indeed, the Committee has scope to expand purchases or continue to purchase at a brisk pace to provide further policy accommodation, to the degree it is perceived as effective. “We think we have plenty of policy space,” Chair Powell suggested in the press conference, also citing the continued “room for more forward guidance and more asset purchases.” In a very real sense, this is the more understated Chair Powell’s “Mario Draghi Moment” where like the former President of the European Central Bank, he’s effectively committed to “do whatever it takes” to aid the economy through this stressful period.
Alleviating stresses in the short-term markets
Then, on Tuesday morning, the Fed announced its decision to reinstate funding facilities for commercial paper, which we had expected it would likely have to do. That’s because the financial plumbing system has been quite challenged. As a case in point, volatility in the overnight funding markets was on display on March 16, when the intraday trading range for Treasury general collateral was a remarkable 300 basis points (-0.25% to 2.75%). The overarching theme in the funding space is a simple lack of balance sheet capacity- primary dealers are being stretched, and while general collateral has been trading in a more orderly manner yesterday and today, we’re still trading at a wide spread to IOER.
In an illustration of the fast-moving pace of policy adjustment, by Tuesday evening the Fed had also established a Primary Dealer Credit Facility (PDCF) with the 24 institutions that serve as primary dealers. In some respects this facility mimics the Fed’s discount window in the broad range of collateral these dealers can post for funds (including commercial paper, investment-grade debt, municipal bonds and equities, in addition to Treasuries), which should aid with balance sheet inventory constraints by allowing overnight and term funding for up to 90 days. Most recently, the Fed has set up the Money Market Mutual Fund Liquidity Facility (MMLF), which provides1.25% non-recourse, no haircut, loans to banks in nearly unlimited size to buy commercial paper. Vitally, it also makes these loans exempt from risk-based capital and leverage ratio requirements, eliminating balance sheet penalties for using the program. This initiative should go a long way towards re-liquifying the commercial paper markets, in our view.
Overall, the Fed repo operations, reinstated commercial paper funding facilities, the establishment of the PDCF, as well as the MMLF, and the attempt by major U.S. banks to destigmatize the use of the Fed’s discount window should all help calm short-term markets, but in the end, more secondary market purchasing may be what’s required to complete the job. Ultimately, banks are looking to the Fed for flexibility on risk-weighted assets and liquidity coverage ratios in order to make their balance sheets available.
A monetary policy stake in the ground
We think that with its recent actions, the Fed has put a stake in the ground as the lead central bank in the world, while simultaneously it has shown itself to be a partner with the rest of the world. If required, the Fed can go bigger, or longer, in the execution of its programs, but it’s also critical to emphasize the policy areas that Chair Powell suggested the Committee wasn’t interested in going to. Specifically, Chair Powell indicated that negative policy rates were not appropriate for the U.S. economy, whereas asset purchases and forward guidance were held up as more appropriate policy tools. In our view, this is very important, since following in the path of Europe or Japan, in terms of negative rate policy, would be counterproductive in our view.
Finally, the Fed Chair acknowledged the tremendous uncertainty facing the country as a whole during this health crisis, and so it probably made some sense to decide to cancel the regularly scheduled FOMC meeting and press conference on March 18. In a sense, it keeps the Committee from having to attempt to commit to “dot plot” estimates on growth, unemployment and inflation in the face of so many open questions on the economic impact of the virus containment strategy. This Statement of Economic Projections will return at the June meeting and by then we should have a good deal more visibility on how the economy is faring through this period. Moreover, the fiscal policy that is moving its way through the legislative process should have been passed and implemented by then, which will help in being able to get a better handle on the medium-term economic trajectory.
Rick Rieder, Managing Director, is BlackRock’s Chief Investment Officer of Global Fixed Income and is Head of the Global Allocation Investment Team.