David Page, Head of Macro Research at AXA Investment Managers, comments on the recent developments at the Federal Reserve:
• Fed announces series of policy easing measures on Sunday ahead of market opening this week.
• Fed cuts FFR to 0-0.25% (-100bps), announces QE of $700bn, reduces Discount Window charges, scraps the reserve requirement and reduces charges on overseas dollar swap lines.
• Fed easing follows a range of measures from government over the weekend.
• Fed easing precedes meeting this week. We expect no further action on Wednesday, but do expect Fed Chair Powell to suggest likely future action – a form of forward guidance.
• We consider it likely that the Fed will increase the scale of QE over the coming months. We see advantage to the Fed seeking Congressional approval to purchase corporate debt.
On Sunday afternoon – in moves reminiscent of pre-opening, weekend policy stimulus during the 2008 financial crisis – the Federal Reserve launched a further package of measures to provide support to the broader economy and financial system as the impact of the Covid-19 outbreak globally, and increasingly in the US, increased. The package was widespread and attempted to provide both broader stimulus and targeted relief to the banking system to facilitate lending to the private sector as the scale of impact from Covid-19 was expected to rise. The Fed took the following steps:
• Cut its Fed Funds Rate (FFR) target by 100bps back to 0.00-0.25% for the first time since December 2015.
• Announced asset purchases (QE) to the tune of $700bn, split between US Treasury purchases ($500bn) and mortgage-backed securities (MBS, $200bn).
• The Fed reduced the loan rate on the Discount Window by 150bps to 0.25%. 100bps of this reflected the cut, but a further 50bps reduced the penalty rate of access to emergency funding.
• The Fed scrapped the reserve requirement, effective from the next reserve round on 26 March. The Fed also urged the commercial banking system to use capital and HQLA buffers to maintain spending and urged the use of intraday lending facilities where necessary.
• The Fed also reduced the charge on swap line lines with other central banks by 0.25% to 0.25% over OIS. Relatedly it stated that foreign central banks that held weekly dollar tenders (BoC, ECB, BoE, BoJ and SNB) would now offer 84day as well as 1 week dollars.
• This comes after a significant increase in repo liquidity offered last week (>$1trn), that included a de facto return to QE with Fed using longer-than-T-bill maturity purchases to boost excess reserves.
The package of measures followed a range of measures from government over the weekend. These included:
• Declaring a state of emergency that would provide over $40bn in funding to the Federal Emergency Management Agency (FEMA).
• Instructing purchases by the Strategic Petroleum Reserve (SPR) fund.
• The White House also approved a bill passed by the House last week. This looks likely to quickly gain Senate approval, the bill included:
o Covering Covid-19 testing costs in Medicare and Medicaid
o $50bn (0.25% of GDP) increased fiscal support for Medicaid
o Instruct firms <500 workers to instate sick pay and family pay for up to 12-weeks for Covid-19 related absence, to be recouped through a tax credit provision
o Extended unemployment insurance and interest-free loans to States to fund these payments
o Extended food stamps programme (SNAP)
Additionally, the government is said to be considering deferring student loan interest payments ($40bn/year) and US Treasury Secretary Mnuchin discussed support for travel industries, specifically airlines, hotels and cruise ship operators.
The combined response reflects the increasing impact Covid-19 is expected to exact on the US economy, both as global economic activity slumps from regional disruption, but also as the US outbreak numbers 3774, at the time of writing. The US outbreak has triggered some severe local reactions, echoing shutdowns in Europe, including in New York. However, there is an ongoing concern that the number of reported in the US is still being kept low by difficulties in testing suggesting a wider problem.
Against this background, the Fed has once again proven itself to have been amongst the swiftest to respond. While the Fed’s policy actions cannot be expected to offset the sharp drop in activity likely to be faced over the coming months, it is designed to provide levels of support. First, the Fed’s aggressive loosening can mitigate the scale of tightening in financial conditions, trying to offset the additional headwind to activity this would cause. Second, the Fed’s more technical measures are designed to help US banks maintain and increase lending to broader US business as it faces a sharp contraction in demand. This policy is aimed to help firms get through the shock and be around to resume business after the outbreak has passed. Third, monetary policy easing will lay the groundwork for a broader recovery in economic activity over the coming quarters and years to replace the lost demand likely over the coming months.
It is a measure of the scale of the crisis that the Fed believed it necessary to provide such stimulus just days before a scheduled meeting (Tuesday/Wednesday this week). We believe that this would have been intended to try and support the optimism that underpinned the 9.3% bounce in the S&P 500 index on Friday and offset a renewed wave of financial market pessimism. To that extent, this week’s meeting and press conference will prove key. We do not expect further measures to be announced on Wednesday. However, Fed Chair Powell’s press conference will provide an opportunity to deploy a further policy tool: forward guidance. We expect Fed Chair Powell to suggest that the Fed has additional weaponry in its arsenal. The Fed has the scope to purchase additional US Treasury securities – it does not face the same constraints, for example as the ECB. However, with 10-year US Treasury yields at 0.79%, there is only so much scope before Treasury yields are reduced to their lower bound. This is no doubt why the Fed additionally announced MBS purchases. We consider this unusual and suboptimal, as while these securities were purchased during the financial crisis, this was mainly due to dislocation in the mortgage markets, with housing the epicentre of the 2007-2009 crisis. This is not the case now. As such, we wonder whether the Fed will consider other asset class purchases, and particularly consider corporate debt. For now, the Fed is not authorised to purchase corporate debt. However, we will watch the upcoming press conference to see if the Fed Chair suggests this might be something that the Fed would seek in the future. As it stands, we would expect the Fed to provide additional easing via extra asset purchase announcements over the coming months. We also think that seeking Congressional authorisation for corporate debt purchases would be a powerful support to stressed credit markets as uncertainty over the scale of Covid impact remains high.