Fed cuts rates to near zero, eases bank lending rules
The Federal Reserve took emergency action on Sunday to help the economy weather the coronavirus by lowering its benchmark interest rate to near zero and declaring it would buy $ 700 billion worth of Treasury bonds and mortgage.
The Fed’s surprise announcement signaled its fears that the viral outbreak will slow economic growth in the coming months and that it is ready to do whatever it takes to counter the risks. He has said he will keep his key rate in a range of zero to 0.25% until he is convinced the economy can survive what has become a virtual sudden halt in activity. economic in the United States.
The central bank will buy $ 500 billion in treasury securities and $ 200 billion in mortgage-backed securities – an effort to mitigate market disruptions that have made it difficult for banks and large investors to sell government bonds. Treasury as well as maintain long term borrowing rates. down. The turmoil in the Treasury market pushed the 10-year Treasury yield up last week, an unusual move that threatens to push up borrowing costs for mortgages and credit cards.
By aggressively lowering its short-term benchmark rate to near zero and pumping hundreds of billions of dollars into the financial system, the Fed’s measures on Sunday served as a reminder of the emergency action it took at its height of the financial crisis. Starting in 2008, the Fed cut its key rate to near zero and held it for seven years. The central bank has now lowered this rate, which influences many consumer and business loans, to its all-time high.
On “Make Me Smart,” we discussed what the Fed can – and cannot – do on its own to mitigate the economic damage from the COVID-19 pandemic.
Some of the Fed’s new measures are aimed at freeing up money for banks to lend. As businesses across the country see their incomes dwindle while consumers stay at home, they will be looking for short-term loans to keep their payrolls going. The Fed said it had abandoned its normal requirement that banks hold liquidity equal to 10% of its customers’ deposits, allowing banks to lend those funds. He also said that banks can use additional cash buffers that were imposed after the 2008 financial crisis for loans.
“The Federal Reserve is ready to use its full range of tools to support credit flows to households and businesses and thereby promote its maximum employment and price stability goals,” the central bank said.
“This confirms that the Fed sees the economy falling… very sharply” towards recession, said Adam Posen, president of the Peterson Institute for International Economics.
The Fed also announced that it had cut interest rates on dollar loans as part of a joint action it took with five central banks abroad. This is to ensure that foreign banks continue to have access to the dollars they lend to foreign companies.
All in all, the Fed’s actions amount to an acknowledgment that the US economy is facing its most perilous times since the recession ended more than a decade ago.
Yet with the virus spreading causing a large halt to economic activity in the United States, the Fed faces a daunting task. Its tools, intended to ease borrowing rates, facilitate lending, and build confidence, are not ideally suited to compensate for fear-induced spending and travel stoppages.
“We have to hope that the Fed guarding against events, let alone other central banks, pushes the economy in the right direction,” Posen said. “Most of the work to stimulate and prevent lasting economic damage has to be done on the fiscal side. That’s the nature of this shock. ”
Posen advocates fiscal measures such as granting sick leave and paying workers quarantined and renewing bank loans to small and medium-sized businesses hit hard by the epidemic.
“It won’t be the quick fix that saves everything,” said Timothy Duy, a University of Oregon economist who tracks the Fed.
But it sends a signal to Congress that the economy needs urgent stimulus. Duy also predicted that the Fed would follow up with other measures, including possibly changing its inflation target to allow for more stimulus and more support for commercial paper – the short-term notes that companies issue to cover their expenses.
“I don’t think they’re over yet,” Duy said.
Duy said the asset purchases are an “effort to keep the markets from freezing”.
Earlier, Treasury Secretary Steven Mnuchin said the central bank and the federal government have tools to support the economy.
Mnuchin also said he doesn’t think the economy is still in a recession. However, most economists believe that a recession is already here, or soon will be. JPMorgan Chase predicts the economy will shrink 2% in the current quarter and 3% in the April-June quarter.
“I don’t think so,” Mnuchin said, when asked if the United States was in a recession. “The real issue is what economic tools are we going to use to make sure we get through this. “
On Saturday, President Donald Trump reiterated his frequent demand that the Fed “get on board and do what it needs to do,” mirroring his argument that US benchmark rates should be as low as in Europe and Japan, where they are now negative. . Negative rates are generally seen as a sign of economic distress, and there is little evidence that they help boost growth. Fed officials have indicated they are unlikely to cut rates below zero.
With the virus depressing travel, spending and business investment, and forcing the cancellation of sports leagues, business conferences, musicals and Broadway shows, economists increasingly expect the economy to contract for at least one or two quarters. A six-month contraction would fit an informal definition of a recession.
Two weeks ago, in a surprise move, the Fed sought to offset the disease’s brakes on the economy by lower its short-term rate by half a percentage point – his first break between political meetings since the financial crisis. Its benchmark rate is now in a range of 1% to 1.25%. Some analysts have predicted that the Fed will cut its rate by only half or three quarters of a point on Wednesday, rather than a full point.
But policymakers have widely accepted research that once its benchmark rate approaches zero, it would produce a greater economic benefit to cut completely to zero rather than just a quarter or half a point above it. This is because it takes time for rate cuts to make their way into the economy. So, if a recession threatens, faster action is more effective.
Part of the attention will likely be on Wednesday on the steps the Fed is taking to make bond markets even easier to work, a topic that may seem esoteric but plays a fundamental role in how the economy works. The 10-year Treasury rate influences a range of borrowing costs for businesses and consumers, including mortgage and credit card rates. If banks and investors cannot trade these securities transparently, lending rates could rise across the economy.
“Even more important than the Fed’s rate-cutting function is the market’s calming function,” said David Wilcox, senior researcher at the Peterson Institute for International Economics and former head of research at the Fed.
The central bank took a big step in this direction Thursday, when he announced he would provide $ 1.5 trillion in short-term loans to banks. The central bank will provide liquidity to interested banks in exchange for treasury bills. The loans will be repaid after one or three months.
This program is a response to signs that the bond market has been disrupted in recent days as many traders and banks have sought to offload large sums of Treasuries but have not found enough willing buyers. This stalemate has reduced bond prices and increased bond yields, unlike what typically happens when the stock market plunges.
The Fed also announced last week that it would expand its $ 60 billion monthly treasury bill purchase program, launched last fall, to just short-term bills at all maturities. The Fed is already reinvesting $ 20 billion of its holdings of mortgage-backed securities into treasury bills of all durations, bringing its total purchases to $ 80 billion.
These purchases would help relieve the banks of the treasury bills they wish to sell. Some analysts expect the Fed to extend these purchases beyond their current second-quarter end date and even significantly increase in size.
Fed policymakers will also update their forecasts for the economy and interest rates on Wednesday. Pimco economists predict that Fed policymakers will collectively lower their estimate of growth this year from 2% to less than 1.5%. That figure would be consistent with an economic contraction in the first half of the year, followed by a sharp rebound, Pimco said.