Fed on Fire

The Fed has reduced the benchmark rate by 100bp to 0-0.25% as expected, however, two days earlier than was expected. It will also increase its holdings of treasury securities by at least 500 billion USD and its holdings of agency mortgage-backed securities by at least 200 billion USD, which is equivalent to a QE5.

The Fed is not stopping here. It is also trying to encourage credit expansion through operations on discount window, intraday credit, bank capital and liquidity buffers and reserve requirements. It is lowering the primary credit rate by 150bp to 0.25%, narrowing primary credit spread by 50bp, which enables easy funding access to primary dealers, which is comprised of more than twenty large financial institutions. The Fed expects dealers to expand credit when they get easy funding, which is not necessarily going to happen.

Secondly, the Fed Is also encouraging depository institutions to utilize the intraday credit extended by Reserve Banks, on both a collateralised and uncollateralized basis, to support the provision of liquidity to households and businesses and the general smooth functioning of payment systems.

Thirdly, the Fed is supporting firms that choose to use their capital and liquidity buffers to lend and undertake other supportive actions in a safe and sound manner. The largest firms have $1.3 trillion in common equity and hold $2.9 trillion in high quality liquid assets. The Fed believes it is time for them to extend credit with their capital buffers.  Eight US big banks (Bank of America, Goldman Sachs, Bank of New York Mellon, Citigroup, JP Morgan Chase, Morgan Stanley, State Street and Wells Fargo) has immediately echoed the Fed, announcing they are halting buybacks to preserve capital and liquidity in support of families, business and the broader economy. The Big Eight has increased their capital buffer by more than 40%, to 914 billion USD, over the past 10 years.

The Fed has also reduced reserve requirement ratios to zero percent for thousands of depository institutions.

Finally, the Fed along with the Bank of England, European Central Bank, Bank of Japan, Bank of Canada and the Swiss National Bank, took coordinated actions to enhance the provision of offshore USD liquidity, through lowering offshore the USD swap rate by 25bp, to overnight USD rate + 25bp.

However, things do not go through so easily, as Fed actions will only ease liquidity conditions of the interdealer market and offshore USD market in developed countries. However, it remains a question whether dealers with easy funding access will really lend the money out to the businesses or not. While the Fed provides USD liquidity to developed countries, emerging markets continue to experience a lack of USD liquidity.

So it is more like a situation that the Fed removes its own responsibility with these measures which could not really resolve current problems, as the current situation could only be fixed by further credit extensions to families and business, probably directly by the Fed itself, however to be approved by Congress. So, it is more a problem of fiscal policy rather than monetary, more a political problem rather than financial. Now the ball is on the side of Congress, or Democrats. Will they help President Trump or not under such circumstances?  Maybe things will not turn better before they get worse.  Equity markets do not respond well to Fed’s latest actions as markets are wondering why the Fed acts so promptly, and whether there is anything unknown that the Fed has already foreseen.

Bitcoin will benefit from the tremendous liquidity to be released by the Fed, and the Fed’s balance sheet will soon surpass its highest level in 2015.  With positive liquidity news for Bitcoin in mind, remember Mt. Gox day is also approaching. We still wait to see whether 140,000 bitcoins released to their owners will happen soon or be postponed by another six months.

Source: US Federal Reserve https://www.federalreserve.gov/monetarypolicy/bst_recenttrends.htm