Fed cuts to zero, announces QE, and provides onshore and offshore liquidity

Finally the Fed eliminated reserve requirements, while also encouraging banks to use their capital and liquidity buffers to support the economy. Bringing forward its meeting scheduled for later this week, the Fed chose to make its new set of announcements before markets opened. Given recent developments, a new and aggressive move was widely expected as keeping interest rates above zero at this point made little sense, especially in a context of renewed asset purchases. In reducing the target range for fed funds to 0-0.25%, the Fed has essentially reached its effective lower bound, as it seems unwilling to consider negative rates.

The Fed will now purchase at least USD 500 bn of Treasuries and USD 200 bn of Mortgage-backed securities MBS, with immediate effect (purchases starting today, 16 March). Chair Powell emphasised that illiquidity issues in UST and MBS markets were of particular concern to policymakers, given their key role in the functioning of financial markets and in the flow of credit to the real economy.

In a coordinated announcement with other major advanced-economy central banks (ECB, BoE, BoJ, SNB, BoC)¹, the Fed also announced cheaper access to US dollars through USD swap lines, which had proven to be a critical policy response during the global financial crisis. The coordinated announcement reduced the cost to just 25 bps over the overnight index swap rate, and expanded the swap lines’ availability from one-week maturity to four-month operations.

Encourage discount window lending, cutting the discount rate by 150 bps to 0.25%, and expanding lending maturities to up to 90 days. In encouraging the use of its discount window, the Fed is seeking to ensure that banks’ funding needs will be met, and that the penalty and associated stigma for accessing the discount window will be practically eliminated.

Finally, the Fed encouraged banks to tap its intraday credit facilities and to make use of their capital and liquidity buffers to support affected borrowers. The banking system rebuilt substantial buffers through the post-crisis period, and policymakers highlighted that their purpose was precisely to lend to households and businesses in periods of need – exactly like the current one.

This is the latest – and possibly not the last – step by the Fed in its efforts to ease financial conditions while markets are facing severe stress, to provide confidence that policy is taking appropriate support measures, and to establish the right conditions for a recovery once the coronavirus epidemic starts to abate

The announcement offers a comprehensive set of measures, even if they alone will not suffice given the challenges the economy is currently facing. Targeted fiscal measures that offer more immediate support to the affected sectors is a key part of the response we are looking for; even more crucially, we are seeking a public health policy that helps contain the spread of the virus and buys time to avoid cases overwhelming hospital capacity.

While negative news flow - which is likely to continue for several days as new cases continue to rise around the world- will make for a challenging environment, we note that we are seeing signs of policy response moving in the right direction. We will continue to monitor closely developments on both the course of the epidemic and the policy measures taken in response to it.

¹ European Central Bank, Bank of England, Bank of Japan, Swiss National Bank, Bank of Canada

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