Part Two: COVID-19 has the world on edge
Responding to extraordinary volatility in the markets, the Federal Reserve has moved monetary policy in the right direction, taking aggressive measures including lowering official rates, massively adding liquidity and removing policy uncertainty.
Since last week, we have seen continued pressure in the capital markets. The S&P 500 fell approximately 13% from March 9 to March 16 and, since February 19, nearly 30% in total. The VIX reached an all-time high of 83 on March 16. Week-on-week through March 16, the average credit spread on the Bloomberg Barclays US Aggregate Corporate Index (Agg) widened by 71 basis points (bps), to 242bps, a level not seen since the 2008 global financial crisis. On the commodities side, WTI Oil dropped to USD27/bbl. In the front end of the fixed income curve, three-month Libor-Overnight Index Swap (OIS) spreads widened to 78bps on March 16, indicating stress in the short-term bank funding market.
As financial conditions deteriorated dramatically, the Federal Reserve (Fed) was compelled to act before its scheduled March 17 and March 18 meetings. In the past few days, the Fed has taken measures to steer the markets back to proper functioning:
Implementing zero interest rate policy
- The Federal Open Market Committee (FOMC) lowered the fed funds target range by 100bps, to a new range of 0–0.25%.
- Interest on excess reserves (IOER) was cut to 0.10% and the reverse repurchase rate (RRP)-the rate at which our money market funds (MMFs) can transact repo with the Fed-was cut to 0%.
Restarting quantitative easing (QE)
- The Fed announced it will purchase at least USD500 billion in U.S. Treasuries (USTs) and USD200 billion in agency mortgage-backed securities (MBS).
- The Federal Reserve Bank of New York (FRBNY) bought approximately USD40 billion in USTs on Monday alone. During the third round of quantitative easing, QE3, in 2012–2013, the Fed was buying USD45 billion of USTs per month; this current pace of bond buying is aggressive by comparison.
Making available massive overnight and term funding for USTs
- FRBNY is offering the market at least USD175 billion in overnight liquidity via repo each day; at least USD45 billion in two-week term repo twice per week; USD500 billion in one-month term repo and USD500 billion in three-month term repo each week.
Offering strong forward guidance
- The FOMC stated that it is committed to keeping rates at zero until “it is confident that the economy has weathered recent events and is on track to achieve its maximum employment and price stability goals.”
- This commitment is flattening the money market curve and removes policy uncertainty for the foreseeable future.
Providing liquidity to banks
- he Fed lowered the primary credit rate at the discount window by 150bps, to 0.25%.
- Banks may borrow from the discount window at the primary credit rate, on a secured basis, for periods as long as 90 days. (Normally the window is used for daylight or overnight financing.)
- The Fed accepts a wide range of collateral at the window, including credit products, subject to margin requirements.
Giving banks relief on reserve requirements
- The Fed lowered required reserve ratios to zero, and encouraged banks to use their capital and liquidity buffers to lend to households and businesses affected by the novel coronavirus.
Providing liquidity for commercial paper (CP) issuers
- The Fed is setting up a special purpose vehicle (SPV) that will buy three-month maturity CP directly from issuers; the program will be open to buy for one year.
- The funding for the SPV will consist of a USD10 billion first-loss piece provided by the Treasury Department’s Exchange Stabilization Fund (ESF), and loans from the FRBNY via the Commercial Paper Funding Facility (CPFF). The full size of the SPV has not yet been announced.
- Loans for borrowers rated A-1/P-1/F-1 will be priced at OIS + 200bps, plus a facility fee of 10bps. CP rated A-2/P-2/F-2 is also eligible (if it was rated A-1/P-1/F1 on March 17, 2020), but pricing has not yet been announced.
Providing liquidity for broker dealers
- The Fed announced the Primary Dealer Credit Facility (PDCF), through which primary dealers will be able to access secured funding from the Fed.
- Assets must be USD-denominated.
- Asset types include collateral that is eligible for open market operations (OMO); investment grade credit, including commercial paper, international agency bonds, municipal debt, MBS, asset backed securities (ABS) and equities. Within these categories, some types of assets are subject to certain additional requirements
- This program starts on March 20 and will run for at least six months.
- Loans will have a term of 90 days and be priced at the primary credit rate of 0.25%; collateral will be subject to margin requirements, similar to discount window borrowing.
Increasing USD liquidity via central bank coordination
- The Fed enhanced cross-currency swap lines with the Bank of Canada, the Bank of England, the Bank of Japan, the European Central Bank and the Swiss National Bank, by extending terms from one week to up to 84 days, and by lowering pricing to OIS + 25bps.
Providing liquidity for prime money market funds
- The Fed is establishing the Money Market Mutual Fund Liquidity Facility (MMLF) to provide liquidity to prime money market funds.
- The program will allow banks and broker dealers to finance purchases of eligible securities from prime money market funds with non-recourse loans from the Federal Reserve Bank of Boston (FRB).
- Eligible collateral securing the loans includes U.S. government paper, U.S. agency paper as well as asset backed commercial paper (ABCP) and CP that is from U.S. issuers and rated A-1/P-1/F-1.
- Loans will be priced at 25 bps for government paper and 125 bps for credit paper and will match the maturity of the underlying securities up to 12 months.
- Bank regulatory agencies will neutralize the impact of these purchases in terms of capital and leverage requirements.
- The program will terminate on September 30 unless it is extended.
Most of these measures were announced only within the past few days. The market still has a way to go before price action and transaction costs return to normal, but monetary policy has moved in the right direction. We are providing liquidity for our clients in these challenging times.
If you have further questions about this or other topics of interest, please reach out to your Global Liquidity Client Advisor.