AP Explains: What did the Federal Reserve do Sunday and why?
WASHINGTON (AP) — A day after the Federal Reserve unleashed a massive amount of stimulus to blunt the economic damage from the coronavirus, on Monday the stock market plunged by the most since the Black Monday crash of 1987.
But Treasury bond yields fell as their prices rose, a sign that at least some of the Fed’s tools worked to stabilize the Treasury market, one of the largest and most important in the world.
Late Sunday, the Fed slashed its benchmark interest rate to near zero and also said it will buy $700 billion in bonds.
The surprise intervention was an acknowledgement by the Fed that the economy seems suddenly on the brink of recession and a signal that it will do all it can to minimize the blow to households, companies and the economy.
Collectively, its actions are intended to keep markets functioning and lending flowing to businesses and consumers. Otherwise, as revenue dries up for countless small businesses that have suddenly lost customers, these employers could be forced to lay off workers or even seek bankruptcy protection.
The stock market, however, was further rattled. The S&P 500 index tumbled 12% Monday.
Chairman Jerome Powell acknowledged in a conference call with reporters that the Fed’s action isn’t likely to prevent the recession. The main reason: The economy is coming to a standstill because of the necessary behavioral changes being made across the country to stem the viral outbreak — an avoidance of travel, shopping and mass gatherings.
Rather, the economic outlook, the Fed recognizes, depends mainly on how quickly the United States can arrest the spread of the virus.
So what, exactly, did the Fed announce Sunday? And why?
THE FED SLASHED ITS BENCHMARK RATE TO NEARLY ZERO:
The Fed cut its short-term rate by a full percentage point, its steepest cut since the financial crisis in 2008, to a range of zero to 0.25%. That is the lowest level since December 2015, when the Fed raised rates for the first time after leaving them at nearly zero for seven years.
Over time, this move should lower a broad range of borrowing costs for things like homes, credit cards and autos. Powell said that while the move is intended to lower borrowing costs now, it would become even more important once the outbreak passes and consumers and businesses are confident enough to ramp up spending again.
President Donald Trump has urged the Fed to consider cutting rates below zero, but Powell said the Fed isn’t considering that now.
“We do not see negative rates as an appropriate policy in the United States,” he said on the conference call Sunday.
The surprise moves were reminiscent of the financial crisis in 2008, when the Fed unveiled numerous emergency programs. But there is at least one important difference.
Mark Cabana, a rates strategist at Bank of America Securities, said that in this case the Fed won’t be seen as bailing out banks that crashed the economy through excessive mortgage lending.
“This is nobody’s fault,” Cabana said. “This is a global pandemic. It’s an easier call for the Fed to make.”
IT WILL BUY AT LEAST $700 BILLION IN BONDS
On Monday, the Fed started buying at least $500 billion in Treasury securities and at least $200 billion of mortgage-backed securities issued by Fannie Mae and Freddie Mac. Those purchases are intended to smooth the functioning of the Treasury bond market and mortgage lending and to keep long-term borrowing rates down.
The Treasury market is the largest and most important such market in the world, because yields on Treasuries influence interest rates on many other loans and are used to price other global financial assets. Last week, banks and other large investors were unable to sell all the 10-year Treasuries they wanted to unload — pressure that inflated rates in that market. The Fed’s buying is intended to plug that gap and keep rates low.
“When stresses arise in the Treasury market, they can reverberate throughout financial markets and the entire economy,” Powell said.
On Monday, however, the yield on the 10-year fell to 0.73% in evening trading, down from nearly 1% late Sunday. That suggests that the Fed’s purchases, which it began Monday, have succeeded in unclogging transactions in that market.
IT WILL RELAX BANKS’ RESERVE AND BUFFER REQUIREMENTS
The Fed said it has dropped its requirement that banks hold cash equal to 10% of their customers’ deposits, thereby allowing banks to lend that money instead. It also said that banks can use additional cash buffers that were imposed after the 2008 financial crisis for lending. This move addresses complaints from many banks that regulatory limits were inhibiting their ability to lend when credit is in high demand.
THE FED AND 5 OTHER CENTRAL BANKS CUT RATES ON DOLLAR LENDING
The Fed is joining in a coordinated global action, with the Bank of Canada, the Bank of England, the Bank of Japan, the European Central Bank and the Swiss National Bank, to provide cheap dollar credit to banks overseas. The swap lines offer credit for a longer period of 84 days, instead of the standing offer of one week. This move is intended to ensure that foreign banks continue to have access to dollars that they lend to overseas companies.
IT WILL PROVIDE SHORT-TERM LOANS TO BANKS
Fed policymakers decided to open up a little-used tool, known as the “discount window,” that enables banks to borrow at very low interest rates from the Fed. It cut the interest rate for those loans by 1.5 percentage points, to just 0.25%, to encourage more banks to take advantage of the window, which carries a stigma because it’s typically used by banks only when they’re in trouble. It also said banks could borrow for 90 days.