The Fed’s ‘whatever it takes’ moment

Fed cuts rates in surprise move
The market’s immediate reaction was positive, but the ultimate impact of this ‘insurance cut’ is unclear.

Monday morning, March 23, the Federal Reserve (Fed) announced one of the most aggressive monetary easing programs in the history of central banking. The set of measures announced includes open-ended purchases of Treasury securities and agency mortgage-backed securities (quantitative easing or QE), and programs to support the flow of credit to consumers and employers. 

In the new QE program, the Fed “will buy Treasuries and agency mortgage-backed securities in the amounts needed to support smooth market functioning and effective transmission of monetary policy to broader financial conditions and the economy…”.1  The size, duration and speed of purchases has been left open to ensure maximum flexibility, nimbly address market functioning across market segments, and proceed rapidly. This week alone, the Fed will buy $375 billion of Treasury securities and $250 billion of mortgage-backed securities. The total amount for one week is greater than the Fed’s so-called “QE2” program in 2012. This is the Fed’s “whatever it takes” moment. 

Additional measures seek to support the flow of credit

The Fed also announced several measures to support the flow of credit to the economy: 

  • The Primary Market Corporate Credit Facility (PMCCF) would support new bond and loan issuance, and the Secondary Market Corporate Credit Facility (SMCCF) would provide liquidity for outstanding corporate bonds in the secondary market, including US-listed exchange-traded funds (ETF) in the investment grade corporate bond space. 
  • The Fed revived the Term Asset-Backed Securities Loan Facility (TALF), which enables the Fed to provide loans to investors to buy asset-backed securities backed by student loans, auto loans, credit card loans, and loans guaranteed by the Small Business Administration. 
  • The Fed also extended its support to the municipal bond and commercial paper markets by extending the securities it can buy and improving pricing. 
  • Finally, the Fed announced the Main Street Business Lending Program to support lending to small and medium-sized businesses with details still to come. 

While Fed measures in the government markets (Treasuries and mortgage-backed securities) are open-ended, in private sector markets, new loans are limited to $300 billion, with the Treasury to cover up to $30 billion in losses. But it is highly likely that there is more to come. In the current draft Senate bill, there is a proposal to allocate $425 billion to the Treasury’s Exchange Stabilization Fund (ESF). While the exact amount is currently being negotiated and may be smaller, Congress may agree on an allocation that would expand the ESF. In that case the Fed, just as it is doing now, can lever the guaranteed amount to significantly expand its current credit support programs. 

Market reaction was mixed

The market’s reaction to these extraordinary measures was mixed.  Investment grade corporates performed strongly on the news that the Fed would be entering that market.  Treasuries and mortgage-backed securities also reacted positively.  The US dollar rallied against emerging market and developed market currencies.  However, other risky assets, such as high yield bonds and equities, did not rally on the news.  Investors in higher-risk securities may need to see more clarity on the path of economic growth before these assets improve. 

Turgut Kisinbay is a Director of Fixed Income Research and James Ong is a  Director of Derivative Portfolio Management.


^1 Source: Federal Reserve, March 23, 2020