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    Instant Insights: zero bound

    Instant Insights: zero bound

    March 16, 2020 Global macro, Instant insights
    The Federal Reserve (Fed) announced a number of new measures over the weekend to support credit and liquidity conditions amid continued coronavirus-related market disruption.

    Back at the zero bound

    The Fed cut rates by an entire 100bp (as markets expected), moving the lower end of the range to 0%. It expects this to stay put “until it is confident that the economy has weathered recent events.”

    At least $700bn in fresh QE

    The Fed also announced “over the coming months”, it will buy $500bn in Treasuries and $200bn in agency mortgage backed securities. Today alone the Fed is set to conduct $40bn of Treasury purchases. We would not be surprised to see a monthly program re-established once the $700bn is complete.

    Further liquidity and credit measures

    In an effort to improve the flow of credit to impacted sectors, the central bank cut the discount window by 150bp (50bp more than the official rate cut) to encourage more banks to use the facility.

    It also eliminated banks’ reserve requirements, which are essentially irrelevant in a system of ample available reserves. Behind-the-scenes, we expect the Fed has also been encouraging banks to provide liquidity to disrupted sectors. In coordination with other major central banks, it also lowered the rate on US dollar liquidity swap arrangements by 25bp and extended the term of these facilities.

    A forceful response

    Fed Chair Powell made it clear that the Fed’s objective is to support the “smooth” functioning of financial markets, with a clear focus on addressing last week’s liquidity issues.

    We believe this is clearly an attempt to act forcefully to calm markets, provide liquidity, and clear bank balance sheets of excessive inventory. As we mentioned last week, the Fed essentially has infinite resources to prevent a liquidity crisis, and is signaling it will do what is necessary.

    Passing the baton to fiscal policy?

    While the Fed is not entirely out of ammunition, Powell mentioned that negative rates are unlikely to follow. The committee has previously cited legal hurdles and skepticism on the efficacy of such policies.

    As we have mentioned before, although the Fed can directly impact liquidity and financial markets, its impact on the real economy is more indirect and less immediate. Powell stated the new measures "matter a lot more when the economy begins to recover." In essence, the Fed can support the eventual recovery, but can’t prevent a downturn.

    Powell therefore highlighted fiscal policy’s role in aiding individuals and firms directly impacted by social distancing measures, essentially passing the baton to Congress. We believe investors will need to look to signals on fiscal policy for the best gauge as to whether the eventual recovery will be “V-shaped” or “U-shaped”.

     


    Please note: any forecasts or opinions expressed herein are Insight Investment's own as of March 16, 2020 and subject to change without notice. This information may contain, include or is based upon forward-looking statements. Past performance is not indicative of future results. 

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