The Fed is 'putting a band-aid on once the bleeding has started': McCreath
The Federal Reserve offered a huge injection of liquidity to the Treasury market Thursday to counter signs of market dysfunction as investors panic over the spreading coronavirus.
The New York Fed, which conducts market operations on behalf of the U.S. central bank, said in a statement that it is aiming trillions of dollars in temporary loans at the banking system in coming weeks to relieve strains as investors sell government bonds to raise cash. It will also purchase a broader range of government securities than just short-term Treasury bills to make sure the liquidity gets into the cracks appearing.
The dramatic expansion comes amid widespread financial-market turmoil, which led to a seizing-up of the Treasury market Wednesday. The steps were taken at the direction of Fed Chair Jerome Powell, in consultation with his colleagues on the central bank’s rate-setting Federal Open Market Committee, to stem what it called “temporary disruptions.”
The moves were reminiscent of the Fed’s quantitative easing program, known as QE, during the financial crisis of 2008.
“This is really brought on by what I’m guessing were a flood of calls from the street in the last few days about how badly Treasury markets were functioning,” said Blake Gwinn, a strategist at NatWest Markets in Stamford, Connecticut.
U.S. stocks initially pared losses after the surprise announcement but then resumed their decline. The S&P 500 ended the day down a staggering 9.5% in its worst day since Black Monday more than three decades ago.
The turmoil in recent days has led to widespread unwinds of trading positions. Government bonds, due to their liquidity and the market’s sheer size relative to others -- like that for corporate bonds -- are the easiest thing to sell in turbulent times when investors need to raise cash.
That kind of selling led to an accumulation of inventories on the balance sheets of broker-dealers, who needed to turn to money markets to finance them, according to Gwinn, a former New York Fed trader himself. The heightened strain forced the central bank to intervene.
“The change here was really about addressing that concern -- finding a way to give an outlet for some of these securities, trying to take some of that paper off dealers’ hands -- to improve market functioning,” Gwinn said.
The New York Fed has been buying Treasury bills and offering temporary cash loans through so-called repurchase agreements, or repos, since September in a bid to increase the amount of liquidity in the banking system. Thursday’s announcement marks a sizable increase in liquidity provision on both fronts, and will swell the central bank’s balance sheet.
Joseph Abate, a strategist at Barclays in New York, said in a note to clients after the announcement that the “massive injection of liquitity” would help to restore confidence in funding markets.
“If primary dealers know that they can secure cheap term money from the Fed, they should become more willing to lend it out,” he said. “We expect the Fed’s operations to unglue funding markets and loosen up liquidity in the cash Treasury market, which should at least help calm market worries about risks to real activity through financial accelerator and credit channels.”
Still, because the moves were intended to address market functioning and not to provide stimulus to an economy facing down the potentially-severe impact of the outbreak, investors ended up clamoring for more Wednesday. Economists and central bankers around the world have been urging governments to act on fiscal policy but so far in the U.S. little has been enacted.
Investors further lost confidence Wednesday in the U.S. government’s ability to quickly produce a coherent policy plan after President Donald Trump addressed the nation with few details on fiscal stimulus measures, instead touting restrictions on travel from Europe to the U.S. that deepened the sense of alarm.
“President Trump set out to calm everyone’s concerns, and he added fuel to the fire,” said Jack Ablin, chief investment officer of Cresset Capital Management, a Chicago-based wealth-management firm. “Right now, if you look at the technicals, we had finally slipped into what I’d call panic.”
U.S. central bankers delivered an emergency half percentage-point cut last week and are expected to move again when they meet on March 17-18 in Washington, if not sooner, with some economists predicting they could slash rates to zero from 1% to 1.25% at the moment.
“Fed did its part today of helping with market functioning,” said Priya Misra, head of rates strategy at TD Securities. “We still need the fiscal help.”