Fed minutes detail aggressive policy actions; more actions to come

The minutes of the emergency March 2 and March 15 FOMC meetings provide a detailed look into the emergency actions taken by the Fed to facilitate the flow of credit to households and businesses and help prevent the health crisis from turning into a financial crisis. The minutes suggest that the Fed has clearly learned from its responses during the 2008-2009 financial crisis and it has been significantly more aggressive against signs of dysfunction. Moreover, through budget spending authorized by the recently enacted CARES Act, Congress has provided the Fed the ability to provide unprecedented financial support to private corporations and to municipalities.

A summary of the Fed’s crisis response actions to date is presented in the table below. Many of the Fed’s actions of liquidity provision are similar to those introduced during the 2008-2009 financial crisis. However, some bold initiatives, including the ability to purchase corporate bonds and to provide liquidity to the financial systems that support small businesses and municipalities, are new.

The Fed did not publish its quarterly Summary of Economic projections (SEPs) as scheduled at this meeting due to the very large degree of uncertainty associated with the economic outlook, but all Fed members at the time “saw U.S. economic activity as likely to decline in the coming quarter.”

Most Fed members supported the 100bp reduction in the target for the Fed funds rate to 0-0.25% at the March 15 meeting, as risk-management dictated that a forceful monetary policy response was appropriate in light of the significant downside risks to the economic outlook. Fed members generally agreed that its policy rate would be at the effective lower bound (ELB) until the economy had recovered and was on track to meet the dual employment and inflation mandates.

Based on our expectation of a modest rebound in economic activity, reflecting cautious spending on many non-necessities and services, a slow labor market recovery, continued declines in business production and capital spending, we expect the Fed’s policy rate to likely be at the ELB for several years.

The minutes emphasized the Fed’s dislike of negative policy rates as a monetary policy tool. A few Fed members, worried that investors would expect it to introduce negative interest rates after it reduced its policy rate to its ELB, noted that “such expectations would run counter to participants' previously expressed views that they would prefer to use other monetary policy tools to provide further accommodation at the ELB.” The Fed obviously remains concerned about the mixed impacts of the negative policy rates that have been imposed by the European Central Bank and the Bank of Japan.

Participants commented on the turbulent financial market conditions, in particular, the “high volatility and illiquidity characterizing the markets for U.S. Treasury securities, especially off-the-run longer-term securities, and for agency MBS.” This led the Fed to restart QE, large-scale asset purchases of Treasury and agency MBS purchases. The minutes highlighted the issues in the commercial paper (CP) and corporate bond markets. The Fed subsequently followed up with facilities to increase liquidity in these markets (Table 1).

Several Fed members opined that “banks should be discouraged from repurchasing shares from, or paying dividends to, their equity holders” in light of the Fed’s extensive policy actions.

The Fed is in the process of deploying additional policy tools. The recently enacted CARES Act gives the Fed the authority to establish facilities to provide liquidity to the financial system that supports lending to eligible businesses, states, or municipalities by purchasing obligations directly from issuers; purchasing obligations in secondary markets or otherwise; and making loans, including loans or other advances secured by collateral. Congress has authorized $454 billion to the Treasury to support this Fed program, which would translate into several trillion dollars of loans and loan guarantees from the Fed, based on budgetary accounting.

Sources: Federal Reserve and Berenberg Capital Markets

Mickey Levy, mickey.levy@berenberg-us.com

Roiana Reid, roiana.reid@berenberg-us.com

Member FINRA & SIPC
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