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Fed cuts rates to zero as part of sweeping crisis measures

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Via Financial Times

The Federal Reserve cut interest rates to zero before markets opened on Sunday and joined forces with other central banks in a bid to prevent a severe economic downturn caused by the coronavirus pandemic.

After three weeks of chaotic drops in global stock markets and alarming signs of dysfunction in the US government bond market, the Fed stepped in with tools it has not used since the financial crisis.

The sweeping measures underscore the severity of the damage that the coronavirus has already caused to economic growth, and the threat the virus poses to financial stability.

The Fed dropped its policy rate by a full percentage point to zero, a level not seen since 2015. It also announced wide-ranging actions to support financial markets, including an additional $700bn in asset purchases, expanded repurchase operations, dollar swap lines with foreign banks and a credit facility for commercial banks to ease household and business lending.

“The coronavirus outbreak has harmed communities and disrupted economic activity in many countries, including the United States. Global financial conditions have also been significantly affected,” read a statement from the Fed’s Open Market Committee. “The Federal Reserve is prepared to use its full range of tools.”

The moves follow a brutal spell in global markets, which saw some of the most abrupt declines in stock prices since the financial crisis of 2008, amid mounting fears the coronavirus pandemic would lead to a global recession.

Investors were particularly alarmed by signs that the US government bond market last week was showing signs of strain, with unusual periods when haven bonds weakened despite drops in stock markets. This made it difficult for fund managers to hedge themselves against the turbulence in other markets. The mortgage-backed securities market, which is the second-most liquid market in the world after Treasuries, also seized up.

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On Sunday, the Fed said it would increase its holdings of Treasury securities by at least $500bn and its holdings of agency mortgage-backed securities by at least $200bn, in order to “support the smooth functioning of markets” for “securities that are central to the flow of credit to households and businesses”.

“I think it’s a tremendous thing that took place just now, I didn’t know I’d be surprised on a Sunday,” President Donald Trump told reporters.

“I would think there are a lot of people on Wall Street that are very happy. And I can tell you that I’m very happy, I didn’t expect this. And I like being surprised.”

With three hours to go before he stepped down as governor of the Bank of England, Mark Carney and incoming governor Andrew Bailey said in a statement that the co-ordinated action would “improve global liquidity by lowering the price and extending the maximum term of US dollar lending operations,” easing strains in bank funding and aimed at avoiding a squeeze on credit.

The Fed’s announcement came just days after the New York arm of the central bank said it would pump trillions of dollars into the financial system in the form of short-term loans into the repo market — where investors borrow cash in exchange for high-quality collateral like Treasuries — to ease stress in funding markets.

The Fed has been buying Treasury bills at a pace of $60bn per month since October in order to increase the supply of cash reserves available to banks, and amid the market turmoil last week, it sped up the pace of its purchases.

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In a separate statement, the New York Fed said it would buy Treasuries of all maturities “at a pace appropriate to support the smooth functioning of markets”. It will begin on Monday by purchasing $40bn of coupon securities and Treasury inflation-protected securities, or Tips. Through April 13, the Fed said it aims to purchase around $80bn in agency mortgage-backed securities.

The Fed also opened its discount window to commercial banks, and urged them to dip into their own capital buffers to extend lending to households and businesses, as the personal-contact service sectors of the economy grind to a halt with social-distancing becoming the norm.

“These capital and liquidity buffers are designed to support the economy in adverse situations and allow banks to continue to serve households and businesses,” the Fed said in its statement. “The Federal Reserve supports firms that choose to use their capital and liquidity buffers to lend and undertake other supportive actions in a safe and sound manner.”

The US central bank also announced co-ordinated action with peers from Canada, the UK, Japan and Europe, including the Swiss National Bank, to lower the cost of borrowing dollars internationally via existing swap lines.

These swap lines effectively allow global central banks to get access to dollars in exchange for their own currency. The central banks announced that the cost of borrowing dollars would be lowered to 0.25 per cent above the fed funds rate. In addition to existing one week operations, the Fed announced a new 84-day liquidity line would begin from Monday.

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“The swap lines . . . serve as an important liquidity backstop to ease strains in global funding markets, thereby helping to mitigate the effects of such strains on the supply of credit to households and businesses, both domestically and abroad,” the Fed said in a statement.

Mohamed El-Erian, chief economic adviser at Allianz, said: “This is a massive, co-ordinated and multi-faceted central bank intervention that involves measures from the Federal Reserve that only two months ago would have been deemed unlikely, if not unthinkable. Their immediate aim is to forestall what many correctly feared would be an extremely volatile market open that could also cause damaging market malfunction.”

Gregory Peters, a senior portfolio manager at PGIM Fixed Income, said: “Tonight was an important first step needed to fix the Commercial Paper market, and credit next. The question is, will Fed officials ever get off of zero? It will be hard.”

Reporting by Brendan Greeley in Washington, Colby Smith in New York, Adam Samson, Joe Rennison and Katie Martin in London, and Jennifer Ablan in New York

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