On Sunday afternoon, in another extraordinary move, the Federal Reserve cut the target range for its short-term federal funds rate by a full percentage point. That moved the new range for the key interest rate to 0% to 0.25%.
As much attention as the unprecedented second consecutive inter-meeting rate cut got, the central bank's other actions could have even more importance. Nevertheless, as the market plunges following the Fed announcement, it's clear that investors want something more concrete beyond simple monetary policy.
The Fed's reasoning for its rate cut
The Fed gave its rationale for reducing rates, arguing simply that "the effects of the coronavirus will weigh on economic activity in the near term and pose risks to the economic outlook." With no inflationary pressure -- especially given the recent crash in crude oil, which should soon contribute falling prices for gasoline and other energy products -- the Fed felt comfortable that it could meet its dual mandate to support the economy without sending prices through the roof.
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Yet there was one crack in the unified front at the Fed's Federal Open Market Committee. Cleveland Fed president Loretta Mester dissented, arguing that a less extreme half-point cut would've been sufficient. In doing so, Mester apparently agreed with those who've advocated for more fiscal stimulus from Washington rather than tying everything to the central bank's monetary policy.
What else the Fed did
At the same time, the Fed also took three other measures. One was to reinstate quantitative easing, with the intent of buying $500 billion in Treasury bonds and $200 billion in mortgage-backed securities to maintain liquidity in the credit markets. While the federal funds rate concentrates on short-term rates, quantitative easing should spur longer-term rates to fall, all while meeting the goal of letting people and businesses borrow the money they need.
In addition, banks will have greater capacity to get capital into the hands of borrowers. The Fed will offer its discount window to provide additional funding for banks that want to lend. Interestingly, it also encouraged financial institutions to "use their capital and liquidity buffers as they lend to households and businesses" -- essentially telling banks not to be as conservative and safe in their lending practices as they've been over the past decade in the aftermath of the financial crisis.
Finally, the Fed worked with its counterparts in Europe, Japan, the U.K., Switzerland, and Canada to ensure sufficient liquidity in foreign exchange markets. With the rate drop in the U.S. potentially putting pressure on currencies, the central banks want to ensure that they don't inadvertently add a currency crisis on top of everything else that's going on.
Is the Fed out of ammo?
Pushing rates down to the 0% to 0.25% range leaves the Fed where it can't cut rates further without going negative. The question of whether the Fed would follow in the footsteps of the European Central Bank (ECB) has been around for a while now, but at least for now, it seems the U.S. central bank hopes to avoid that. As Fed chair Jay Powell said, "We do not see negative policy rates as likely to be an appropriate policy response." Instead, sticking with the once-tested quantitative easing program appears to be more comfortable for monetary policymakers.
Even so, that's no guarantee that investors won't have a different view. Demand from bond market participants was what sent rates in Europe negative before the ECB implemented its negative-rate policies, and the Fed's actions so far have merely recognized what the bond market had already anticipated. If the economy sinks into a deep recession, then it'll be interesting to see if the Fed has to get even more creative in its efforts to support businesses and households if it wants to outlast the impact of the coronavirus.
