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The Federal Reserve’s Response To Coronavirus

“The coronavirus outbreak has harmed communities and disrupted economic activity in many countries, including the United States,” the Federal Reserve said as it cut interest rates to essentially zero and embarked upon a $700 billion quantitative easing program to shelter the economy from the effects of the virus.

The updated fed funds rate, which is a benchmark for short-term lending for financial institutions and as a peg to various consumer rates, will now target the 0%-0.25% range, down from a previous target range of 1% to 1.25%.

The Fed also decreased the rate of emergency lending at the discount window for banks by 125 basis points to 0.25%, lengthening the term of loans to 90 days. The window “plays an important role in supporting the liquidity and stability of the banking system and the effective implementation of monetary policy and supports the smooth flow of credit to households and businesses,” a separate Fed note said. As a part of the Fed’s function as the “lender of last resort” to the banking industry, institutions enjoy access to liquidity.

While the Fed cut reserve requirements for thousands of banks to zero, it also said that it joined with the Bank of Canada, the Bank of England, the Bank of Japan, the European Central Bank, the Swiss National Bank to enhance dollar liquidity around the world through existing dollar swap arrangements.

Banks lowered the rate on swap line loans and extended the periods for such loans. The Fed, in possibly its busiest day in its history since 1913, implemented all at once the many months worth of actions it took during the global financial crisis. In Mid-March, the Fed embarked upon multiple programs, rate cuts and QE all in a single day. Powell said the Fed would be in no rush to lift rates.

“We will maintain the rate at this level until we’re confident that the economy has weathered recent events and is on track to achieve our maximum employment and price stability goals,” Powell said. “That’s the test … some things have to happen before we consider … we’re going to be watching, and willing to be patient, certainly.”

The quantitative easing entails $500 billion of Treasury and $200 billion of agency-backed mortgage securities. The Fed started purchases on Monday with a $40 billion installment. Cleveland Fed President Loretta Mester voted no on the rate change. She wanted to set rates at 0.5% to 0.75%, a half percentage point decrease.

Over the first two weeks of March, the Fed implemented a 50 basis point emergency rate cut and expanded the overnight credit offering, or repo, for the financial system up to $1.5 trillion.

The Fed “is prepared to use its full range of tools to support the flow of credit to households and businesses and thereby promote its maximum employment and price stability goals.”

In just one week, the Fed had already blown through half of its $700 billion worth of bond purchases designed to provide emergency liquidity to financial markets. By March 20, the U.S. central bank had purchased $272 billion worth of government debt this week and another $68 billion in mortgage-backed securities, according to New York Fed data compiled by Bloomberg Intelligence and Bloomberg News.

The Fed announced on March 15 it would purchase “at least” $500 billion of Treasuries and $200 billion worth of mortgage-backed securities “to support the smooth functioning” of those markets. The Fed quickly underscored the “at least” part of that. The Fed had already discussed plans to buy $75 billion of Treasuries on Monday alone, and $100 billion more mortgage debt in just one week.

Powell told reporters March 15 on a conference call that the central bank was “going to go in strong.” He said Fed officials were “really going to use our tools to do what we need to do here, which is restore these important markets to normal function.”

$10 trillion of corporate debt in the U.S., in the form of bonds to loans, will be bought by the U.S. central bank. The Federal Reserve bought corporate debt as part of its intervention to support credit markets amid the dramatic economic impact of dealing with the coronavirus. The Fed said it would launch two credit facilities to back corporate markets: a Primary Market Corporate Credit Facility for new bond and loan issuances, as well as a Secondary Market Corporate Credit Facility to provide liquidity for outstanding corporate bonds.

The Federal Reserve’s purchasing of corporate bonds will focus on debt issued by investment grade U.S. companies and U.S.-listed exchange-traded funds that provide broad exposure to the market for U.S. investment grade corporate bonds.

The Fed said it will buy corporate bonds in the secondary market “at fair market value,” and only up to 10% of a single company’s bonds outstanding. Under its secondary market facility, which will initially be backed by $10 billion of equity from the government, the Fed said it would buy corporate bonds that have a remaining maturity of five years and are rated investment grade (BBB or greater) by two or more rating agencies—or one rating agency, if it only has a single rating.

In its primary market corporate credit facility, the Fed said it would buy eligible corporate bonds from companies, while making loans available to them. The Fed will be taking market risks by buying the corporate bonds.

On March 20, Narayana Kocherlakota, former president of the Federal Reserve Bank of Minneapolis, penned an op-ed for Bloomberg suggesting the Fed may need to follow the example of a handful of European central banks and continue to cut interest rates into negative territory.

“Terrifyingly high unemployment and potentially rapid disinflation are powerful arguments in favor,” Kocherlakota wrote. “Next week, the Fed should take interest rates at least a quarter percentage point below zero.”

When the Fed cut its fed funds target rate to 0%-0.25% in March, Powell did not see negative interest rates happening. “We do not see negative policy rates as likely to be an appropriate policy response here in the United States,” Powell said.

On April 27, the Federal Reserve on Monday expanded its help for local governments, offering to buy bonds of up to three years’ duration from counties with as few as 500,000 residents and cities with as few as 250,000 residents.

In early April, the Federal Reserve initially limited the program to 2 million for counties and 1 million for cities––only about two dozen of the largest local governments. The Fed could start buying the municipal bonds of around 90 cities and more than 100 counties, including California’s Los Angeles County, with a population topping 10 million, to Glendale City, Arizona and its 250,702 population. State governments are also included.

Therefore, “substantially more” local governments could access the Fed “to help manage cash flow stresses caused by the coronavirus pandemic,” according to central bank. The Fed is also willing to purchase slightly longer-term bonds––three years’ instead of two years’––and said it would leave the facility open until December, instead of the planned September closing date, while also permitting certain “multi-state” entities to participate.

The Fed has considered extending the program to include local governments entities that use revenue bonds, which is a form of financing used by local utility authorities that have a revenue stream, while maintaining the Fed facility at $500 billion.

Private equity is even getting in on the federal handouts. These firms, whose executives are among America’s richest executives, have an all-time high of $1.5 trillion in cash on the sidelines. Some of the major investors in private-equity funds are public pension plans. At Blackstone, approximately one-third of the firm’s money comes from retirement plans set up to provide for more than 30 million working-class Americans. Teachers, firefighters, and health care workers depend on Blackstone’s investments performing.

The Fed is also sending billions of dollars abroad in the middle of a historic economic crisis, for the first time sending billions of dollars to central banks worldwide, opening 14 swap lines to Australia, Japan, Mexico, and Norway.

A “swap line” is like an emergency pipeline of dollars to to countries that need them. The dollars are “swapped”––that is, traded for the other country’s currency. In addition, the Fed has also started allowing around 170 foreign central banks that hold U.S. Treasury bonds to temporarily exchange them into dollars.

Foreign central banks are reliant on the world reserve currency––international loans, debts, and bank transactions are done in dollars––and they need US dollars to stabilize their financial systems.

When asked if there was a limit on how many dollars the Fed could create, Fed chairman Jerome Powell responded, “there’s no limit.”

The Fed is now acting as a central bank to the world for the second time this century, enabling swaps to countries can access the Fed’s limitless reserve of dollar, as though they were American banks in need of a loan. Countries like Russia, Iran, and China do not have access to these swap lines. Four emerging markets––South Korea, Mexico, Singapore, and Brazil––do have access. The “swapped” loans are designed to be short-lasting. Former Vice Chairman of the Federal Reserve, Princeton economist Alan Blinder, believes more swap lines would be a good idea.

In order to steady markets, Bank of America predicts the Fed could print $8 trillion dollars. Main Street won’t so much be the beneficiary of this program as Wall Street. The middle class never really recovered from the Global Financial Crisis, and nobody knows what happens when you lock down an economy. A paradigm shift that entails a restructuring of the economy towards entrepreneurship and production will be needed for the poor and middle classes to ever recover from the economic effects of the “Great Lockdown.”

The Federal Reserve’s coronavirus response obviously runs the risk of spiking inflation. Fears of inflation abounded when the Fed embarked upon quantitative easing to manage the global financial crisis. That never came to pass, perhaps imbuing in us the confidence that this go around the same results––that is, no inflation––would transpire.

David Kelly, chief global strategist at JPMorgan Asset Management, believes current Federal Reserve policies could “give us another opportunity to ignite the inflation bomb.”

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