AV: What will lead the next leg of this? What does it mean if the Fed cuts rates and it wastes bullets because stocks close down anyway?
DONOHUE: “While the Fed has few bullets left in its arsenal, it is operating under the philosophy of an ounce of prevention is worth a pound of cure. The cuts to date have not stabilized the markets, but the hope is that they ease financial conditions and help boost business sentiment.”
FISHMAN: “Market participants are debating the efficacy of the Fed’s inter-meeting rate cuts alone. I think we need three responses here. First, we need a health response. Second, we need a monetary response designed to help offset the demand shocks — even if it may not provide an immediate observable benefit to the economy. Here’s where we’ve seen the most significant signal from the Fed this week. The third is a fiscal response. Pockets of the economy such as cruise lines, airlines and hotels could be helped through a targeted fiscal response, such as Small to Medium Enterprise (SME) loans, debt forgiveness, and debt guarantees.”
SPIRGEL: “If mortality rates pick up, that constrains growth and could put the US into a recession. The next question the Fed will have to answer is what tools will be deployed if more aggressive action is needed to calm markets now that we are already at the zero lower bound. They have said they still have power in their liquidity tools and room to adjust their policy.”
AV: In the last crisis, the government used programs like TARP to flood the banking system with cash. How could the Fed/Treasury increase the velocity of credit in pockets of the economy, like leisure/tourism?
FISHMAN: “In 2008, the government took two approaches in order to help stabilize the system: 1) the US Treasury injected capital in the banks via TARP; 2) the Fed created an alphabet soup of liquidity programs. This time around the stress in the system doesn’t stem from concerns with banks, but rather from fears of a slowdown in the real economy, which can manifest itself in reductions in economic activity.”
DONOHUE: “The Fed has been trying to stoke inflationary pressure for a while without much luck. We need to recognize the limits of policymakers’ actions. Inflation is a two-part equation: money supply times the velocity of money. The Fed really has control over money supply. But the velocity of money is controlled by factors like regulation, demographics, inequality and sentiment. Many of these cannot be directly influenced by the Fed. There just isn’t that much the Fed can do to increase velocity because the virus is turning into both a supply and demand shock, which will likely lead to sharp dips in velocity regardless of Fed actions.”
AV: What do you see as the implications of the Fed having acted aggressively to take rates to the zero lower bound. Will it work?
DONOHUE: “Clearly they were concerned at the sell-off in Treasuries last week and the stress in credit. The cut to zero and the additional $700bn in large scale asset purchases should hold Treasury and mortgage yields at lower levels. We are back to global central bank coordination to provide an abundance of liquidity to markets. This, coupled with the other actions such as bank capital relief and discount window borrowing availability, should help to calm markets. If not, expect them to continue to take action in order to do so.”
FISHMAN: “The Fed’s goal in taking this action, in addition to other policy fee cuts and easing measures, is to encourage the extension of credit and remove headwinds in response to worsening financial conditions. We’ve seen zero rates in the US before, during 2009-2014, and expect the market to adapt similarly.”
SPIRGEL: “The difference between rates at real zero and in a range of 0-0.25%, where the Fed took them on March 15, is significant because the latter means people will get paid something on their money. The Fed can take away the range and say the overnight rate is zero, but doing so would have broader implications for clients. They have already expanded their asset purchases.”
AV: With coronavirus and recent repo dislocation, is there enough T-bill supply to handle a huge influx into government-only funds in a flight to quality?
SPIRGEL: “There is a balancing act between the Treasury issuing more bills and the programs it has implemented to buy a range of Treasury maturities and mortgage-backed securities through its asset purchase program. It will have to issue its way around any supply problems. With tens of billions of dollars flooding into government money market funds since the start of the year, the supply to absorb those flows needs to come from somewhere. There has to be a mechanism to support increased demand of government securities in money markets.”
— Jonathan Spirgel, BNY Mellon Markets
FISHMAN: “Thankfully there are a number of outlets for government fund demand. Notably, the Federal Reserve’s overnight reverse repurchase program allows money market funds to invest at least $30 billion each overnight in repo with the Fed. There is also the FICC-sponsored repo program, which has offered the system a considerable amount of capacity in a capital-efficient manner.”
DONOHUE: “Seasonal issuance trends leading into the US tax filing deadline in April and the Fed’s continued purchases of T-bills do pose challenges to the supply dynamics in the short-term Treasury market. On the other side of the coin, a large fiscal stimulus package would likely lead to a significant increase in T-bill issuance. The Fed announced on March 12 that its monthly purchase program will now target a wider array of Treasury securities, including coupons, Treasury Inflation-Protected Securities, and Floating Rate Notes. This will certainly help lift some of the pressure on money market fund T-bill supply.”