The FOMC Fires its Bazookas

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Financial markets have been rocked for the last several weeks due to the potential economic impact of the coronavirus. In response, the Federal Open Market Committee (FOMC) made a very unusual Sunday announcement of several measures designed to improve the liquidity and function of US markets and ease monetary conditions.

Emergency measures taken by the Fed:

  • Cut the federal funds rate down by one percentage point or 100 basis point (bp), taking the target to a range of 0.00% to 0.25%.
  • The discount rate received a 150 bp cut to 0.25%, with depository institutions able to borrow for periods as long as 90 days.
  • Outright purchases of at least $500 billion in Treasury securities, roughly in line with the composition of Treasury securities outstanding. Purchases will begin Monday, March 16, 2020 with $40 billion in purchases of nominal coupon securities and Treasury Inflation-Protected Securities (TIPS).
  • Outright purchases of at least $200 billion in agency MBS. Additionally, the FOMC will reinvest all principal runoff from its MBS holdings (the FOMC had been allowing $20 billion per month to run off). Purchases will begin Monday, March 16, 2020, with expected purchases totaling $80 billion in frency MBS (inclusive of $23 billion in reinvested principal) over the next 30 days.
  • A coordinated reduction in the pricing on US dollar liquidity swap arrangement by 25 basis points (bps) to the US overnight index swap rate plus 25 bps, the addition of an 84-day maturity offering on a weekly basis, in addition to the current one-week offering.
  • Encouragement of depository institutions to utilize intraday credit extended by reserve banks, on both a collateralized and uncollateralized basis, to support the provision of liquidity to households and businesses and the general smooth functioning of payment systems.
  • In light of the ample capital and liquidity regime built-up since the financial crisis, the FOMC is encouraging banks to use their capital and liquidity buffers as they lend to households and businesses affected by the coronavirus. To help facilitate this, the FOMC is reducing bank reserve requirement ratios to zero percent, effective March 26.
  • Previously, reserve requirement ratios were as follows:
    • Deposits up to $16.9MM: 0%
    • Deposits between $16.9MM – $127.5MM: 3%
    • Deposits above $127.5MM: 10%
  • Repo operations will continue to be offered for at least $175 billion on overnight repo each day, at least $45 billion in two-week repo twice per week, and $500 billion in one-month term repo and $500 billion in three-month term repo each week.

These measures are significant, and comprise the majority of the tools in the FOMC's arsenal. It's also worth noting that in his press conference, Chairman Powell indicated he did not believe negative interest rates would be appropriate now or in the future for the US. The FOMC's initial efforts appear to be targeted at stabilizing the functioning of the US Treasury and agency mortgage-backed security (MBS) markets, as well as to facilitate bank lending in general. While initially most positive for Treasury and agency MBS, this should eventually bleed over to help improve the liquidity and functioning of other markets, too.

Clearly, the Fed's announcement represents a full-on monetary policy response to the coronavirus situation. Although the FOMC could undertake additional QE measures and asset purchase programs in the future, the committee has chosen to use most of its remaining ammo in what amounts to a very large salvo. We suspect this will, eventually, be perceived positively by the markets, but it may take some time for lower-quality fixed income sectors and equities to respond.

Unfortunately, we still do not know what the overall economic impact on the coronavirus will be, nor do we know when this will be over. Admittedly, the FOMC's actions won't prevent schools from closing, airplanes from flying, or businesses from shuttering their doors for a time, fiscal action will also be necessary. However, with its actions Sunday, the Fed has done what it can to prepare the financial system, and presumably, set the stage for a speedy recovery once life inevitably returns to some semblance of normal. In the meantime, everyone should put their handwringing to good use by washing frequently!

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Calvin Norris, CFA

About Calvin Norris, CFA

Calvin Norris, CFA, is a rates strategist responsible for guiding the firm's interest rate strategy. He is also a portfolio manager responsible for the overall strategy, portfolio management and trading of money market, short-term cash, ultra short duration, government bond and US Treasury Strips portfolios.