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Back at the Zero Bound


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 100bps (basis points) – as markets expected – moving the lower end of the range to 0%. The Fed expects this to stay put “until it is confident that the economy has weathered recent events.”

At least $700 billion in fresh Quantitative Easing

The Fed also announced “over the coming months” that it will buy $500 billion in Treasuries and $200 billion in agency mortgage-backed securities. Today (3/16/2020) alone, the Fed is set to conduct $40 billion of Treasury purchases. We would not be surprised to see a monthly program re-established once the $700 billion 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 150bps (50bps 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 U.S. dollar liquidity swap arrangements by 25bps and extended the term of these facilities.

A forceful response

Fed Chairman 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 should consider looking to signals on fiscal policy for the best gauge as to whether the eventual recovery will be “V-shaped” or “U-shaped.”

 CRN: 2020-0302-8074 R

The opinions and views of this commentary are that of Insight Investment and are not necessarily that of AAM.


This commentary is for informational purposes only. All investments are subject to risk and past performance is no guarantee of future results. Please see the Disclosures webpage for additional risk information at commentary-disclosures. For additional commentary or financial resources, please visit www.aamlive.com.

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