Did the Fed have no other choice? (Part two)

Timely insights from portfolio managers and industry experts on key financial, economic and political issues.

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      By Eric Stein, CFACo-Director of Global Income, Eaton Vance Management

      The US Federal Reserve (Fed) cut 100 basis points in an emergency meeting on Sunday and expanded quantitative easing (QE) to $700 billion.
      We believe coordinated action with other central banks will have positive effects on funding markets.
      Don't expect negative rates, but the Fed may explore other creative measures to calm jittery markets.

      Boston - I think the Fed did what it had to do by cutting 100 basis points and expanding QE to $700 billion, among other things. And most importantly, they coordinated action with the Bank of Canada, Bank of England, Bank of Japan, the European Central Bank and the Swiss National Bank for liquidity provisions, specifically lowering the price of liquidity by 25 basis points.

      The new rate is the overnight index swap (OIS) plus 25 basis points and the OIS should be between zero and 25 basis points. That step was quite strong. We might get some immediate effects in the funding markets. I've already seen that, which has been the one positive from a market perspective.

      Obviously, stock markets and global markets around the world are down significantly. Again, I think the Fed did what it had to do and in the press conference, Powell still highlighted that health policy and other policies are going to carry the day.

      Lowering rates isn't going to change economic activity much and, frankly, it hasn't. But at the margins, lower rates could help to support financial conditions.

      Looking ahead, the narrative will be that the Fed is out of bullets and to some extent they are, in terms of traditional rates cuts. They could go negative but I don't think that will be the case.

      Here are two things I would watch:

      1. Can the Fed support the commercial paper market? They would have to use their powers under section 13.3 of the Federal Reserve Act. Powell has suggested that this is on the table, potentially as a crisis playbook.
      2. As Boston Fed President Eric S. Rosengren has mentioned, could they get Congress to change the Federal Reserve Act so they could buy equities and corporate bonds? That would be very far outside of what is allowed under its current mandate

      Bottom line: The Fed did what it had to do to ease financial conditions, but that's not going to change the trajectory of the economy. We are living in unprecedented historical times with the economy basically in shutdown mode. Hopefully, at the margin, the central bank's liquidity injection can help dollar funding markets now.