The official blog of BNP Paribas Asset Management

Message from the Fed to politicians: It’s up to you now…

In cutting the federal funds rate by one percentage point on 15 March and announcing USD 700 billion of quantitative easing, the US Federal Reserve had already moved aggressively to exhaust almost all its conventional monetary ammunition. Then on 17 March, the Fed re-introduced the Commercial Paper Funding Facility (CPFF) to alleviate strains in the commercial paper market.

US economic data
  • The US Federal Reserve announced a major expansion of its efforts to provide liquidity to financial markets and shore up the US economy.
  • The package involves unlimited, massive quantitative easing (QE) as well as purchases of investment-grade corporate bonds in the secondary market alongside measures to supply liquidity to the markets and support lending.
  • These measures are go well beyond the Fed’s response during the 2008-2009 great financial crisis. In effect, the Fed is “doing all it can” and waiting now for the politicians to act. 

On Monday, in announcing what amounts to open-ended quantitative easing (QE), the Fed has “done whatever it could” and passed responsibility to the politicians to act. These measures not being the circuit-breaker for a medical emergency delivering an unprecedented shock to the real economy.

Towards a more formal regime of monetary financing?

It could well be that we are moving towards a more formal regime of monetary financing, with central banks pledging to absorb all the additional issuance associated with virus-related fiscal measures and potentially a commitment to keep the bonds on their balance sheets for the foreseeable future (at which point, we are close to the concept of a helicopter drop).

In recent weeks, the Federal Reserve has acted aggressively, firing most of its conventional ammunition at an early stage in the crisis: cutting rates to the floor (see Exhibit 1 below) and announcing the resumption of asset purchases for monetary policy purposes.

Exhibit 1: The Fed has cut the US benchmark federal funds rate drastically in response to the health crisis - graph shows the upper bound of the fed funds target rate band from January 1990 to 17 March 2020 (in %)

Source: Datastream, BNPP AM

Over the last week, the Fed bought USD 272 billion in Treasuries. That amounts to over half of the USD 500 billion it said it would purchase on 17 March. The Fed has now turned up the dial in announcing open-ended purchases of Treasuries, agency mortgage-backed securities (MBS) and agency commercial MBS.

In addition, the central bank announced the following measures:

  • Financing of a Treasury facility that will purchases new and existing corporate debt, along with asset-backed securities (ABS) backed by student, car, credit card and business loans.
  • The Fed will now include municipal paper and bank commercial deposits (CDs) in its existing Money Market Mutual Fund Liquidity Facility (MMLF) and expand its commercial paper facility.
  • Finally, the Fed announced the establishment of a Main Street Business Lending Programme for small and medium-sized companies (SMEs). This is aimed at providing targeted relief to the most vulnerable and disrupted sectors of the US economy.

Fiscal policy should provide relief to particular populations and groups

By consistently moving so aggressively since the start of the COVID-19 crisis, the Fed appears to be sending a message to the politicians – we have done what we can, you must act.

Chair Powell suggested as much as at last week’s press conference:

We don’t have the tools to reach individuals and particularly small businesses and other businesses and people who may be out of work … this is a multifaceted problem and it requires answers from different parts of the government and society… I think fiscal policy is a way to direct relief to particular populations and groups... we do think fiscal responses are critical.

As these comments make clear, the Fed’s measures are not the circuit-breaker. Its efforts should, however, help ensure the health crisis does not spiral into a major disruption of financial markets.

Any views expressed here are those of the author as of the date of publication, are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may take different investment decisions for different clients.

The value of investments and the income they generate may go down as well as up and it is possible that investors will not recover their initial outlay. Past performance is no guarantee for future returns.

Investing in emerging markets, or specialised or restricted sectors is likely to be subject to a higher-than-average volatility due to a high degree of concentration, greater uncertainty because less information is available, there is less liquidity or due to greater sensitivity to changes in market conditions (social, political and economic conditions).

Some emerging markets offer less security than the majority of international developed markets. For this reason, services for portfolio transactions, liquidation and conservation on behalf of funds invested in emerging markets may carry greater risk.

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