Home 2020 The Big Q: What does the Fed have in store next week?

The Big Q: What does the Fed have in store next week?

The Big A: We expect the Fed to roll out measures beyond interest rate cuts and bond purchases to ensure financial markets keep operating smoothly and banks have ample liquidity during the coronavirus outbreak.

The Fed can innovate!

Last week, the Fed delivered an emergency rate cut and is expected to lower them more when it meets next week, has already taken steps to ensure liquidity in the banking system by substantially increasing the support it provides to overnight lending markets.

But, the Fed has a number of other emergency lending facilities and tools that it used during the Ys 2007-2009 financial crisis that it could turn to if needed to keep credit markets from freezing up in here.

Some steps the Fed can take under its existing authority, others may require partnering with the Treasury Department or expanded authority from Congress.

But here is a look at some of the tools that could be adjusted or revived to support markets if credit conditions worsen significantly, as follows:

Discount Window: The Fed’s lending tool of last resort is rarely used because banks are worried that borrowing from the window could make them appear weak. But policymakers could start by reminding banks that “the discount window is open, please use it.” Fed officials could also make the credit more attractive by lowering the rate they charge or extending the length of the loans offered from 1 to 30 or 90 days.

Term Auction Facility (TAF): The Fed rolled out the TAF in Y 2007 as a way to offer loans to banks that were too hesitant to turn to the discount window. The TAF lacked some of the stigma associated with the discount window because of the way the loans were issued.

Financial firms had to bid for the funding, which meant that the rate they paid would be viewed as being determined by the market, and not as a penalty rate.

The money also was not disbursed until 3 days later, suggesting that the banks who borrowed in that way were not in immediate need of cash.

The Fed closed that facility in March 2010.

Commercial paper funding facility (CPFF): In the financial crisis, establishing the CPFF was the closest the Fed came to making direct loans to non-financial businesses.

The commercial paper market is a key source of short-term funding for a range of businesses. When it froze up in Y 2008, the Fed created the CPFF to help reopen that market by purchasing high-rated, asset-backed commercial paper at three-month maturities.

That facility too was closed in Y 2010.

Some measures of potential stress have appeared in this market. The spread on borrowing rates between the highest-rated non-financial borrowers and the next tier below them has widened notably this month. It is now the widest in nearly 2 years.

It is too early to say if the current stress will grow to an extent that allows the Fed to reopen such a facility under the “unusual and exigent circumstances” section of the Federal Reserve Act, which allows it to lend to businesses and individuals.

Central bank liquidity swaps: The Fed has standing agreements with five other major foreign central banks; the Bank of Canada, European Central Bank, Bank of England, Bank of Japan and Swiss National Bank that allows them to provide USDs to their financial institutions during times of stress. These were converted from temporary to standing arrangements in Y 2011.

The Fed could roll out more agreements with other central banks not currently party to the standing agreements to increase access to dollars if needed.

And what else?

The central bank could create new tools more tailored to today’s market the Fed can be innovative.

Have a terrific weekend

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S. Jack Heffernan Ph.D. Economist at Knightsbridge holds a Ph.D. in Economics and brings with him over 25 years of trading experience in Asia and hands on experience in Venture Capital, he has been involved in several start ups that have seen market capitalization over $500m and 1 that reach a peak market cap of $15b. He has managed and overseen start ups in Crypto, Mining, Shipping, Technology and Financial Services.