Fed Slashes Rates To Zero, Starts QE

March 16, 2020

In a surprise and stunning move Sunday afternoon, the Fed slashed rates dramatically for the second time this month. Unwilling to wait even three days til its scheduled meeting, the Federal Reserve cut its benchmark federal funds rate by 1% (100 basis points)—highlighting how quickly the economic outlook has deteriorated due to the fast-spreading coronavirus. 

The Fed’s move brought the overnight lending rate down to a range of 0-0.25%— effectively zero—for the first time since 2015. The Fed first cut rates to zero during the financial crisis in 2008, and kept them there for seven years.

Fed Funds Rate (Lower Bound)

Second Cut In Two Weeks

It was the second time in less than two weeks that the central bank made an emergency rate cut outside of a regularly scheduled meeting. On March 3, the Fed cut rates by 0.5% (50 basis points). But economic and financial market conditions have turned much more dire since then, with coronavirus cases topping 153,000 worldwide and 3,000 in the U.S.

Economies in Europe have effectively shut down and commerce around the world has been severely curtailed. As the Fed noted, “the coronavirus outbreak has harmed communities and disrupted economic activity in many countries, including the United States. Global financial conditions have also been significantly affected.”

The Central Bank promised 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.”

The giant rate cut wasn’t the only action the Fed took at its emergency Sunday meeting, which took place in lieu of its scheduled Tuesday-Wednesday meeting. The Central Bank also unveiled a $700 billion quantitative easing program that will include at least $500 billion of Treasury purchases and $200 billion of mortgage-backed security purchases.

Additionally, the Fed removed reserve requirements for depository institutions like banks, and announced that they can borrow from the central bank’s discount window at a rate of 0.25% for up to 90 days.

Market Reaction

While perhaps earlier and a bit larger than some may have expected, most on Wall Street were expecting the Fed to make a splash this week. The actions were welcome and necessary, but likely not enough on their own to put an end to the coronavirus fears that have been pervading the markets.

In the hours after the rate cuts and QE announcement. The 10-year Treasury bond yield, which moves inversely to the bond price, sagged 20 basis points to last trade around 0.76%; the 2-year Treasury yield dipped 14 basis points to 0.35%; and the 30-year Treasury yield fell by 15 basis points to 1.38%.

Last week, the 10-year and the 30-year hit record-low yields of 0.31% and 0.70%, respectively, so they are still well above those levels. But with investors increasingly worried about the virus’ impact on growth, including the possibility of a recession, those rates could eventually probe new lows.

Treasury bond ETFs, such as the iShares 7-10 Year Treasury Bond ETF (IEF) and the iShares 20+ Year Treasury Bond ETF (TLT), spiked 4% and 2%, respectively, in price today as yields plummeted.

Meanwhile, the SPDR S&P 500 ETF Trust (SPY) tumbled 11% as investors fretted that the Fed’s move may not be enough to stem the economic bleeding. Volatility will almost surely remain high for the foreseeable future; the S&P 500 rose by 9.3% on Friday, its largest single-session gain since 2008.

Email Sumit Roy at [email protected] or follow him on Twitter @sumitroy2

 

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