Over the weekend the Federal Reserve took some aggressive policy actions, the likes of which we haven’t seen since the 2008 financial crisis. Not only did they cut interest rates by 1%, but also launched a new quantitative easing programme in an attempt to stabilise the markets.
But what does this mean and what exactly has been done?
First of all, we need to give the US a warm welcome to the zero-rate club, with the target range for the Fed funds rate now sitting at 0% to 0.25%, following the second emergency rate cut in the space of 2 weeks.
Jerome Powell, chairman of the Federal Reserve, said they will keep rates at this level until the economy navigates through the current events and gets back on track to achieve its goals. This will benefit borrowers immediately with some relief but will benefit the economy more once it starts to recover.
As if rates going to zero wasn’t aggressive enough action on its own they also launched another rocket into the financial system by announcing an additional $700 billion in quantitative easing (QE), $500 billion for treasuries and $200 billion for mortgage-backed securities.
The reason they’re restarting QE is to provide more liquidity into the financial system, with the aim of ‘restoring market function’, to allow the markets to continue working smoothly and to provide credit to companies and consumers which will be desperately needed as the economy slows down during the pandemic.
There is a concern that previous rounds of QE have led to a deterioration in the potential impact of using this sort of aggressive extraordinary measure. This may mean that the Fed will need to increase the level of QE, which is something I think the market is already anticipating and has already been hinted at.
It seems the Fed hasn’t seen great results from its activity recently. We have seen them have to ramp up their activity in the repo market since there was still a shortage of liquidity despite them pumping funds into the system and we’re really starting to see the problems developing with the so-called ‘plumbing’ of the financial world.
In fact, the Fed has actually eased reserves restrictions on banks, to hopefully encourage them to help consumers and businesses make it through the economic slowdown. They dropped bank reserve requirements to 0% so that banks can use those buffers for more lending.
This can be seen as a little risky, but the Federal Reserve is focused on increasing liquidity to support the financial system and economy and avoid it amplifying the problems caused by the pandemic.
Finally, the markets have experienced a lot of problems recently with US dollar liquidity; in other words, how easy it is to access dollars for institutions outside the US. The Fed announced a global coordinated response with a number of central banks to make sure global US dollar liquidity is maintained, by lowering the cost of borrowing dollars.
Overall this was the biggest single-day set of moves the Fed has taken. Before this pandemic started, this sort of action would have been unthinkable. But it’s clear the Fed has learned from past mistakes, such as the extra damage that occurred in 2008 from a delayed response. This time, they’re willing to go all-in to avoid the system going into absolute free-fall.