What Might the Federal Reserve Do Next?


The Federal Reserve has certainly taken swift action to deal with the horrific economic impact of the coronavirus. A big part of this has been from its traditional toolset – that is, rate cuts.

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More than a week ago, there was an emergency meeting in which the federal funds rate was cut by 1% to a range of 0% to 0.25%. Unfortunately, the move did little to calm things down. The stock markets would soon dive into bear territory.

“The markets response was truly sobering,” said April M. Knill, Ph.D. SunTrust Associate Professor of Finance and Courtesy Professor of Law at Florida State University, in an email to InvestorPlace. “Indeed, even with the Fed’s response, major U.S. stock indexes on [March 12] suffered their worst one-day loss since the ‘Black Monday’ crash in 1987.”

So yes, the Federal Reserve would go on taken other aggressive actions, which harken back to what was done during the financial crisis of 2008 to 2009. For example, to provide liquidity to the financial system, the Federal Reserve has been buying government bonds, with the purchases having gone beyond $500 billion. There was also the purchase of $200 billion in mortgage securities.

Next, the Federal Reserve initiated a program to bolster the commercial paper market (the amount is for up to $1.1 trillion). This involves short-term securities – with maturities of 30 days or less – to handle working capital needs. These types of securities are for large corporations that have proven credit ratings like Exxon Mobil (NYSE:XOM), Caterpillar (NYSE:CAT) and IBM (NYSE:IBM).

The Federal Reserve also setup the Money Market Mutual Fund Liquidity Facility (MMLF). This will allow for the purchase of money market securities to ensure their overall safety. The market is definitely massive, at $3.8 trillion. The Fed’s program will last through September 2020 and will be funded up to $800 billion.

But of course, the Federal Reserve went all-in on Monday. For the most part, the policy is unlimited liquidity. This includes the unprecedented action of providing loans to business and local governments.

Let’s face it, the U.S. economy is facing a likely depression. Economies are now saying that GDP may collapse by 20% to even 50%. Unemployment will also skyrocket, perhaps over 30%.

Here’s the statement that the Fed put out:

It has become clear that our economy will face severe disruptions. Aggressive efforts must be taken across the public and private sectors to limit the losses to jobs and incomes and to promote a swift recovery once the disruptions abate.

It’s almost hard to believe.

What’s Next?

In terms of next steps, it’s really about throwing out the traditional playbook.  Right now, the Federal Reserve will experiment and get even more aggressive with current programs.

“With the extreme turbulence in the treasury market, the Fed should continue to intervene in the overnight repo market in order to provide liquidity to firms,” said Jason Reed, who is the assistant department chair and director of undergraduate studies in the Finance Department at the University of Notre Dame. “We have seen the Fed inject large amounts of overnight capital, and they likely will have to maintain elevated levels of repurchases.”

Now the Federal Reserve also has the advantage of being in a position to direct financial institutions to make changes to their lending policies.

“Encouraging financial institutions to ‘work constructively with borrowers and other customers in affected communities’ by stating that ‘prudent efforts that are consistent with safe and sound lending practices should not be subject to examiner criticism’ will help to decrease pressure on borrowers,” said David A. Maslar, Ph.D., assistant professor in the Department of Finance at the University of Tennessee’s Haslam College of Business.

Yet it’s important to keep in mind that all these measures will still likely have minimal impact on reviving the economy — at least during the near-term. For the most part, the monetary policies require some time to course throughout the economy. Then again, the Fed’s actions will still probably provide more stability in how the banking system and financial markets function.

More Rate Cuts?

There is one action that does look unlikely, though: negative interest rates. The Federal Reserve has already indicated a strong aversion for this. After all, the experience in Europe has shown that negative interest rates tend to result in economic stagnation and provide for the wrong incentives.

“With the Treasury yield curve so low across the board, traditional Fed actions aimed at pushing down interest rates simply won’t have much impact,” said Robert DeYoung, who is the Koch Foundation Distinguished Professor and Harold Otto Chairman at the KU School of Business at the University of Kansas.

“This holds for cutting the short-term policy rate as well as for quantitative easing aimed at long-term rates. Pushing Treasury rates—either short-term or long-term—into negative territory will probably spook markets more than expand markets.”

Tom Taulli (@ttaulli) is the author of various books on investing and technology, including Artificial Intelligence BasicsHigh-Profit IPO Strategies and All About Short Selling. He is also the founder of WebIPO, which was one of the first platforms for public offerings during the 1990s.  As of this writing, he did not hold a position in any of the aforementioned securities.

Article printed from InvestorPlace Media, https://investorplace.com/2020/03/what-might-the-federal-reserve-do-next/.

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