Even unlimited quantitative easing from the Fed can’t buoy markets

The U.S. Federal Reserve was supposed to be out of ammunition after it cut its benchmark interest rate to near-zero last week. Market watchers and economists warned there wasn’t much else the central bank could do to stop a downturn so destructive it now has some pundits worrying about a depression.

On Monday, the Fed revealed it still had more than one bullet left in the chamber. The only problem is that none of them seems capable of helping markets find a bottom.

Monday’s moves, announced before markets opened, included the removal of a self-imposed US$700 billion cap on its quantitative easing plan, essentially licensing it to buy as much government debt as it feels is needed. The central bank also said that, for the first time, it would buy corporate bonds.

Each of the Fed’s emergency interest rate cuts have been met with deep selloffs — and the market didn’t respond any more kindly to the new measures. The Dow Jones Industrial Average closed down more than three per cent, shedding an additional 580 points, while the the S&P 500 closed down more than four per cent.

“The Fed isn’t completely powerless yet,” said Capital Economics senior U.S. economist Andrew Hunter. “This is good news, but it’s not going to prevent the economy from contracting over the next couple of months. I don’t think there’s anything the Fed or Congress can do to stop that.”

While the U.S. government has been slow to react to the coronavirus outbreak on nearly all fronts, the Fed has been proactive in attempting to use the tools at its disposal and bringing out others some never thought it would use. From a quantitative easing perspective, it has already promised to spend more than it did at the height of the financial crisis when it put a US$600 billion cap on buying back government debt.

The solution in 2008 was simple, Citi chief U.S. economist Andrew Hollenhorst said. The Fed had all the tools it needed to directly confront the challenge of the day: ensuring that the flow of credit continued to move.

If people are staying home then you can’t expect anything in the near term

Andrew Hollenhorst, chief U.S. economist, Citi

But those same tools are incapable of directly addressing the problem of an economic shutdown, he said.

And so investors may simply be in the wrong for thinking that the Fed can backstop equity markets.

In fact, neither Hunter nor Hollenhorst believe that’s the central bank’s main goal. Instead, they say it is likely focused on ensuring that the conditions are present for a recovery whenever the time does come. 

“The Fed and fiscal policy are all very much focused on having a recovery when the disruption ends and (are) less focused on can you stimulate demand now,” Hollenhorst said. “You can send stimulus cheques and make credit available, but if people are staying home then you can’t expect anything in the near term.”

It’s difficult for Scotiabank deputy chief economist Brett House to foresee a scenario in which risk sentiment stabilizes due to monetary policy, but that doesn’t mean the Fed’s actions on Monday should be overlooked.

Through the Fed’s new Primary Market Corporate Credit Facility, high-grade corporations can issue new bonds, which won’t require them to pay debt service for six months, and know that the Fed is going to step in and buy them.

The Fed will also be buying bonds that are already on the market by snapping up ETFs that track corporate bonds.

While helping to bolster the health of corporate America, the Fed is also focused on the average household. Its Term Asset-Backed Securities Loan Facility will offer loans to holders of these kinds of securities, House said, in an attempt to stop them from liquidating and thereby pushing up interest rates on student, auto and credit card loans.

Going forward, House expects the Fed to continue to push its boundaries out and do whatever is needed to ensure that the economy can remain stable.

“There’s no rainy day to wait for,” House said. “It’s raining now.”

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