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Industry Voice: Strong Fiscal Response Needed After Fed Moves on Liquidity
Investors fear central banks have reached the limit of their influence
Aggressive global central bank moves to blunt the financial impact of the coronavirus outbreak have failed to reassure equity and credit markets, putting pressure on governments to come up with a more emphatic fiscal response to the crisis.
What has happened over the past few days?
The Fed's decision on Sunday, March 15, to slash its main policy rate by 100 basis points (bps) and announce at least USD 700 billion in asset purchases was followed on Monday by the Bank of Japan's announcement that it aimed to double its purchases of exchange‑traded funds to JPY 12 trillion.
Despite these moves, which were without parallel since the global financial crisis, stock markets suffered heavy losses on Monday morning following a weekend of worsening news over the coronavirus. This implies that investors fear that central bank support is close to being exhausted and that a robust fiscal response to the demand shock remains elusive.
The Fed's announcement can be summarized as follows:
- Policymakers cut the federal funds rate by 100 bps. Following the 50‑bps cut on March 3, this takes the policy rate to the zero lower bound, targeting the 0.25 bps range not seen since 2015.
- The central bank announced at least USD 700 billion of open‑ended asset purchases in the form of USD 500 billion of Treasuries and USD 200 billion of agency mortgage‑backed securities, indicating no nominal amount or time limit. The discount window rate has been reduced by 150 bps to 25 bps, and banks will be allowed to borrow from the discount window for up to 90 days. In the past, banks would often only borrow from the discount window when under financial stress. As such, the Fed
also took measures to try to remove the negative stigma of drawing on this borrowing facility. While we are digesting the details of this announcement, on our initial read, the 90‑day feature could have important positive implications for the bank funding of America's small businesses. This is critical as small businesses will likely face
the most economic pain from the societal measures needed to better contain the coronavirus. - The Fed reduced the reserve requirement ratio to 0% to help support the credit needs of households and businesses.
- The Fed also reached an agreement with the five other major global central banks (euro area, Japan, Canada, UK, and Switzerland) to enhance the terms of a standing swap line
facility. This facility, which had its origins in the 2008 global financial crisis, allows for the borrowing of U.S. dollars in non‑U.S. currencies to support the international supply of dollars. In amending the terms, the officials agreed to reduce the pricing of these swap lines by 25 bps and increase the length of these facilities from seven days to 84 days.
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