The Fed Goes All-in, Markets Eye “Lender of Last Resort” Moves

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The Fed decided not to wait for the planned March meeting and over the weekend announced fresh large-scale monetary stimulus. Trying to be ahead of the curve, the Fed has sharply cut federal funds range and officially launched QE. In fact, this is an all-in bet after which it is not yet clear how the Fed can participate further in putting out the fire if we do not consider possible “Japanization”, for example through direct purchases of the stock market. Despite the extreme easing (the second in a month), the unplanned move has only fueled panic – futures on S&P 500 and DOW hit the daily limit down collapsing 5% after which trading was halted.

The Central Bank has reached zero bound at a stroke, slashing the interest rate by 100 base points but delivered vague message on the duration of zero interest rates environment – “until we become confident that the economy has weathered recent events.” In addition to this, the Fed has returned to QE in the amount of $ 700 billion with purchases done “in the coming months.” Although here the Fed tried to keep a little of the necessary uncertainty and flexibility of the policy, abandoning guaranteed purchases in the form of “N billion/month.” The distribution of the QE program between security types is as follows: 500 billion US Treasury bonds and 200 billion MBS.

Talking about potential depth of QE it is worth to recall that at its peak in 2015 the Fed’s balance sheet totaled $ 4.5 trillion, which was approximately 25% of GDP. After a brief period of quantitative tightening, assets in the Fed’s books to 18% of GDP ($ 3.8 billion). In order for assets to again hit threshold of 25% of GDP, the Fed needs to buy about $ 1.62 trillion of assets, that is, there should be pretty much space to ramp up and maintain purchases.

The Fed will also increase direct lending to banks through the so-called discount window. This credit facility has long remained an unimportant factor in controlling the money supply since the interest rate in it (discount rate) was typically set higher than federal funds rate in order to discourage banks from constantly borrowing from the Fed distorting demand for the federal funds. Now these rates will be almost equal. It is clear that the activation of discount window facility is a sign that in spite of substantial easing of credit access and repo operations, large banks continue to hoard cash instead of supplying it in the money markets.

Lending through the discount window has been long associated with “lender of last resort” activity of central bank which creates additional sense of anxiety.

The dollar ceded ground to other majors and is likely to lose more today if we assume that there are still a significant portion of foreign investors in US stocks. Stock index futures, which have already hit limit down, suggest that the S&P 500 may reverse Friday gains and capital outflows will add selling pressure on greenback.

World central banks such as Fed, ECB, BOJ, BOC, BOE, SNB also agreed to work together to provide liquidity through foreign exchange swaps.

Fed measures will certainly not save the United States from the coronavirus, but they will be able to somewhat mitigate the risk of defaults of financial markets participants, firms and households. The Central Bank seems to have done its utmost, so the next market guideline is government support, i.e. rumors and news about fiscal stimulus.

Disclaimer: The material provided is for information purposes only and should not be considered as investment advice. The views, information, or opinions expressed in the text belong solely to the author, and not to the author’s employer, organization, committee or other group or individual or company.

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