Over the past two weeks, we have seen unprecedented, by size and speed, Central Bank action. Here’s just some of what I’ve been able to capture:
· US cuts the Fed Funds rate target range to 0-0.25%, down 1.5% via two emergency cuts between scheduled meetings.
· US cuts the discount rate, the rate that it charges banks for loans from its discount window, to 0.25%, lower than during the great financial crisis.
· US re-launches quantitative easing (QE) of at least $700 billion with no cap on total or monthly purchases. In the past, they’ve always capped both. This includes at least $200 billion in mortgage-backed securities. It is purchasing both at ludicrous speed and on Friday, just five days after announcing the program and publishing a planned schedule, announced plans to accelerate from the planned purchases.
· US opened twice-daily short-term repurchase operations of up to $1 trillion. This basically tells banks “if you need any money at all for any reason, we will provide it.”
· US eliminated the bank reserve requirement, the amount of deposits that need to be on hand at any time (which is fine b/c banks can borrow from the discount window if needed), and encouraged banks to temporarily dip into regulatory and capital buffers if needed.
· US reduced the rate of interest on swap lines with foreign central banks in Canada, England, the Eurozone, Japan, and Switzerland (we give them dollars, they give us foreign currency, we charge them interest… now less interest) to ease any dollar shortages that result from a flight to safety.
· US opened swap lines with Australia, Brazil, Denmark, Korea, Mexico, New Zealand, Norway, Singapore, and Sweden.
· US launched the Commercial Paper Funding Facility (CPFF) which allows the Fed to buy commercial paper and for the treasury to cover up to $10 billion of losses. Read this as the Fed is backstopping the short-term corporate lending market.
· US launched the Primary Dealer Credit Facility (PDFC) which effectively provides low-interest loans to primary dealers in return for collateral which now includes corporate debt and municipal bonds.
· US launched the Money Market Mutual Fund Liquidity Facility (MMLF) which provides loans to money market mutual funds in exchange for loans that the funds hold. As individual and businesses liquidate money market funds during the current cash crunch because of the economic pause, this prevents the funds from having to sell illiquid short-term loans in a fire sale. Instead, now they can give them to the Fed for cash to handle fund redemptions and not “break the buck”. Treasury provides $10 billion for any losses.
· In summary, the Fed is either outright purchasing or accepting as collateral: treasuries, mortgages, commercial paper / corporate debt, and municipal bonds (state/local government debt). There are limits on term and quality which can be expanded. There are limits on who can borrow with collateral (banks and primary dealers), which can also be expanded further. As of right now, the Fed cannot purchase preferred stock or common stock under their current powers. I say “current” because powers can be changed by Congress or, in some cases (maybe with legal challenges) by Executive Order in times of emergency.
· Bank of Japan (BOJ) doubled its ETF purchase plans (that’s right, the BOJ actually prints money to buy funds that hold stocks, and they’re buying more!!!) for 2020. They increased their corporate bond buying plan by almost 50% for 2020.
· European Central Bank (ECB) expanded QE, is allowing banks to borrow cash at -0.75% (that’s right, the ECB will pay their banks to borrow money from them). They also launched a 750 billion euro Pandemic Emergency Purchase Programme to purchase the debt of EU countries, as well as lower quality debt. That’s ON TOP OF their existing purchase plans.
· Canada cut rates to 0.75% and launched QE via mortgage purchases.
· UK cut rates to 0.1%, increased existing QE bond purchases, eliminated their bank reserve requirement, and launched a new term funding arrangement that provides up to 100 billion pounds of 4-year loans to banks to provide low interest loans to individuals and companies.
· Australia cut rates to 0.5% opened a fund for lending to banks, and launched QE via purchases of government debt to controlthe 3-year borrowing rate at 0.25%.
This doesn’t even take into account the fiscal response across the world as virtually every government spends money it doesn’t have to help their economy get through this. The buying of government debt by central banks via quantitative easing is what makes that possible. So what’s the end game here? Central banks and national governments have shown their respective hands. In a coordinated manner, they will do everything to not let the global economy spiral into deflation. Deflation causes the price of everything to come down, encouraging anyone who wants to buy or invest to wait until prices fall further, which inevitably makes prices fall further due to lack of demand. It is a chain reaction that can lead to long-lasting depressions. If they print money to afford government spending and cash to individuals as support for this economic pause, they can offset the economic damage the pause would cause. This risks massive inflation in the future since increasing the supply of money and giving everyone their share of it, just increases demand for everything, thereby pushing up prices. In the simplest example, imagine if the government decided to match dollar for dollar, what everyone has in net worth. Everyone would feel richer. Bids for homes would rise immediately. Stock prices would rise due to flood of investment. Commodity prices would rise as global demand for everything increased. Everyone would be spending money at a pace never before seen leading to shortages everywhere from increased demand. The only response will be prices increasing sharply and dramatically until they are about double where they were before the government’s action. Then everything stabilizes (gross oversimplification) right back to where it was before with two times the money available and everything costing twice as much. In a sense, government and central bank action is walking a tightrope of trying to offset reduced demand due to the economic shock without causing too much demand that creates inflation. On which side will they land? Like I said, they tipped their hand already. Expect more from central banks as needed to get through the crisis. At some point, financial markets will realize what lies on the other side… a whole lot of money looking for a place to go.
Note: As I wrote this, the Financial Times announced that the UK plans to buy stock in their airlines and other companies affected by the pandemic. The bazooka keeps getting bigger, from the monetary and fiscal sides.