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Fed Prints Its Own 3D Arsenal

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The Federal Reserve invented a new bazooka and is “prepared to use its full range of tools to support the flow of credit to households and businesses.”

Members of the Federal Open Market Committee (FOMC) voted Sunday to cut short-term interest rates to zero, eliminated reserve requirements for banks, extended loans for banks to 90 days (to alleviate panic in overnight lending markets), initiated $700 billion in new quantitative easing ($200 billion in mortgage-backed securities and $500 billion in Treasuries) and coordinated moves with central banks around the world. [Only one FOMC member dissented: President Loretta Mester of the Cleveland Fed agreed with all the other moves but preferred the Fed to cut by one-half percentage point instead of a full percentage point.] Additionally, some of the country’s largest banks announced that they would suspend all share buybacks and focus more on lending through the crisis.

The Fed’s move was unprecedented as it supplanted the previously scheduled meeting on March 17-18. It also allowed the Fed to at least temporarily suspend reporting its forecasts for the future and the infamous “dot plot,” which shows their expectations of rates. If rates are going to be zero for a long time, the forecast is irrelevant. Outliers on the Fed have also used the dot plot to make a point, which would have only muddied the waters of Fed communications at this critical stage of the crisis.

The Fed’s move was timed for late Sunday afternoon before the markets in Asia opened, a lesson learned from the financial crisis to try to stem panic. It is also clear from the press conference on COVID-19 that it was timed to stem the panic related to efforts to intensify “social distancing.” Chicago, Seattle and New York have already largely shut down. Look for more measures to close restaurants and bars, especially ahead of the St. Patrick’s day holiday.

There are fears that the Fed may know more than anyone else and that the situation is worse than anyone thought; it is. The Fed can only do so much; we need more from our elected officials. It is no coincidence that Chairman Jay Powell started his comments with a plea for fiscal policy to do more to bridge COVID-19 tainted waters. Powell also underscored that the cut in rates to zero would do more to seed the rebound after the crisis has passed than to avert a recession today.

Separately, Powell waved off a move into negative territory on interest rates, something the president has demanded. The markets were fearing a drop into negative territory would destroy bank balance sheets, so this should reassure some on that front.

Why is what the Fed did so important?

  1. Cutting rates to zero eases credit market conditions that were seizing up. Powell said credit market conditions had tightened “markedly.”
  2. Longer loans help diminish panic in short-term lending markets, keep banks lending and help to avoid mass layoffs as we saw during the 2008-09 financial crisis.
  3. Elimination of reserve requirements encourages banks to make loans and leverage the Community Reinvestment Act (CRA) emergency measures the Fed put into place with its first preemptive cut in early March - waiving late fees, easing of credit for cash-strapped firms and consumers.
  4. $700 billion in new quantitative easing (QE) allows elected officials to focus on stop-gap measures because the Fed has their backs. It also keeps the Treasury market functioning; it has experienced a lot of problems in recent weeks, and, last but by no means least, it ensures mortgage refinancing continues. This is critical to shore up the withering balance sheets of consumers and set the stage for a more robust rebound on the other side of the health crisis. The housing market is finally picking up and could actually be a driver out of a recession once it is over. This couldn’t happen in 2009 as housing prices were still falling.
  5. Moves were coordinated with other central banks and with the largest banks in the U.S. to stem panic and shore the commitments by banks to lend.
  6. The Fed committed to do more and for as long as needed. Reserved more direct forward guidance for use later.
  7. Fed research has shown that bold, aggressive moves are the only way to go when the economy falters.

Bottom Line
The Fed did its job. Now it is up to members of Congress to do theirs. They have a very long way to go. We will need bailouts and cash in people’s hands to cover basic needs of food and shelter. The cost-benefit analysis on this is simple. If Congress fails, the recession will be deeper and the carnage it triggers will be longer. Pandemics have end dates; financial crises do not.

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