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Fed committed to using full range of tools

FED12.06

Although primarily, the coronavirus outbreak is a health crisis, the impact left on the global economy and financial markets has been significant. Preventive lockdown measures employed to mitigate the spread of the pneumonia-like virus triggered a deep economic downturn.

To limit the economic damage from the pandemic, the Federal Reserve (Fed) stepped in, putting forth a broad array of policy tools to limit the economic hit from the epidemic, including up to $2.3 trillion in lending to support state and local governments, corporations and businesses, financial markets, and households.

Policy tools deployed to make possible a quicker economic recovery and support financial markets included but were not limited to near-zero interest rates, asset purchases, encouraging banking institutions to buoy up the economy through lending, and supporting a broad spectrum of businesses.

To lower the cost of borrowing, the Fed cut its target for the federal funds rate – the rate depository institutions pay to borrow from each other on an uncollateralized basis, by 1.5 per cent, bringing it down to a range of 0 to 0.25 per cent while offering forward guidance on the future path of its key interest rate.

Similar to the Fed’s course of action in the 2008 financial crisis, to alleviate financial markets and thus restore smooth market functioning so that credit can continue to flow, the Fed resorted to unconventional monetary policy. Albeit initially vowing to purchase at least $500 billion in treasury securities and a further $200 billion in government-guaranteed mortgage-backed securities, the Fed, later on, made its purchases open-ended, expanding its purchases also to include commercial mortgage-backed securities.

Also, to keep the credit markets functioning during this stressful period, the Fed, for a limited period, offered low-interest rate loans through its Primary Dealer Credit Facility (PDCF) to several large financial institutions, better known as primary dealers.

Moreover, in a bid to encourage banking institutions to increase their lending and thus provide the necessary liquidity for businesses and corporations to weather the hiccups brought about by recent events, the Fed temporarily relaxed regulatory requirements related to regulated capital and liquidity buffers.

The aggressive move to unlock credit markets and keep money moving in this unprecedented crisis has been highly applauded, with investor sentiment becoming more optimistic, leading to recovery.

Despite the recent recovery in employment figures and market rally, Jay Powell, Chair of Federal Reserve and his fellow policymakers, in a policy meeting on Wednesday afternoon maintained a dovish tone, portraying a gloomy scenario. In their economic projections, Federal Reserve officials noted that by 2022, the U.S. would still be facing a level of unemployment, at far higher than the pre-coronavirus levels. Core inflation, which excludes food and energy prices, is estimated to lie at 1.7 per cent – below its 2 per cent target.

While reinforcing their dire assessment of the country’s economic prospects for the coming years, Federal Reserve officials predicted that they expect to keep interest rates close to zero at least till the end of 2022. In the policy statement, the Federal Open Market Committee (FOMC) – a committee within the Fed responsible for crucial decisions on interest rates and money supply noted that the Fed is “committed to using its full range of tools to support the U.S. economy in this challenging time, thereby promoting its maximum employment and price stability goals”.

Following Wednesday afternoon’s meeting, the US 10-Year Treasury yield, which moves inversely to price, pointed downwards as the demand for safer assets increased. Albeit far from levels previously witnessed at the end of March, credit spreads, once more, widened, deepening the recent downturn in the high yield market.

This article was issued by Christopher Cutajar, credit analyst at Calamatta Cuschieri. For more information visit https://cc.com.mt/. The information, view and opinions provided in this article are being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice.

The Calamatta Cuschieri Traders Blog is available daily on CC WebTrader. Other market coverage including coverage of the International Bond Markets is also available.

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