The markets woke up this morning to a new era of zero interest rates in the US, and a coordinated effort with 5 other central banks to ensure liquidity in international markets.
The Federal Reserve slashed its benchmark interest rate to near zero on Sunday and said it would buy $700 billion in Treasury and mortgage-backed securities in an aggressive bid to prevent market disruptions from aggravating what is likely to be a severe slowdown from the coronavirus pandemic.
The Fed’s rate-setting committee said in a statement Sunday “The coronavirus outbreak has harmed communities and disrupted economic activity in many countries, including the United States. The Federal Reserve is prepared to use its full range of tools to support the flow of credit to households and businesses.”
As we’ve talked about before, it’s not entirely clear what these moves are intended to accomplish in the broader economy. The slowdown wasn’t caused by a lack of liquidity in the market. We have an unprecedented simultaneous drop in both demand and supply due to the corona virus outbreak.
It’s not like the drop in interest rates is going to stimulate me to hop on a cruise ship next week.
The Federal reserve is basically allowing the banks to buy treasury bills, up to $500 billion worth. In addition, they’re going to take $200 billion in mortgage backed securities onto the Federal Reserve’s balance sheet.
In his remarks, the Federal Reserve Chairman Jerome Powell said that he was seeing stresses in the market for Agency Mortgage backed securities, specifically Fannie Mae and Freddie Mac. He said this was necessary to enable refinance activity and enable buyers to continue to buy new homes.
So the Fed is clearly seeing a credit crisis emerging from the economy screeching to a halt in a matter of days.
The Fed also said firms could use their capital and liquidity buffers to lend, and reduced reserve requirement ratios to zero percent effective on March 26.
That’s an astounding statement. Think about it, the banks are no longer required to maintain a deposit reserve. The Fed is going to print an infinite amount of money, and it’s going to allow the banks to print an infinite amount of money, backed fully by the authority of the US Federal Government.
Fed said the financial institutions should feel comfortable tapping into the discount window as a tool for addressing “potential funding pressures.” In the past, banks have been hesitant to tap into the direct lines of funding because of the stigma associated with relying on the Fed for emergency funds. The Fed also reduced the interest rate for the discount window to 0.25% and these lines can be accessed for up to 90 days.
We’ve seen the Federal Reserve pump over $400B into the Repo market earlier this week.
Despite the aggressive move, the market’s initial response was negative. Dow futures on Sunday pointed to a decline of some 1,000 points at the Wall Street opening on Monday morning. The stock futures hit a limit which automatically stopped trading activity whenever there is a decline of 5% or more.
Treasury Secretary Steven Mnuchin said his agency would advance funds to businesses so they can meet paid sick-leave requirements under a new House bill to combat the Covid 19 outbreak. He said employers will be able to use cash deposited with the IRS to pay sick-leave wages. In essence, the funds on deposit with the IRS for payroll could be used as a line of credit for paying sick leave. For businesses that wouldn’t have sufficient taxes to draw from, the Treasury would make advances to cover the costs, he said. It’s important to remember that this sounds like a loan, and the terms for repaying the loan are not at all clear.
Now is the time when businesses need to be taking the necessary steps to conserve cash and reduce expenses.