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Saving the faltering US economy: The Federal Reserve came into action

Amidst the coronavirus pandemic, the current US economy is making progress in dribs and drabs. Following the massive defence expenditure and sustaining the global image as a superpower, United States must take preventive measures to halt this economic stagnation. Stock markets have been plunging that has further aggravated the situation. If the current momentum is not taken care of, the US may lose its economic hegemony anytime soon.

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The Federal Reserve swept into action on Sunday to save the U.S. economy from the fallout of the coronavirus, slashing its benchmark interest rate by a full percentage point to near zero and promising to boost its bond holdings by at least $700 billion.

In remarks underlining the sense of urgency, Fed Chairman Jerome Powell told a hastily assembled press briefing by telephone that the disruption to lives and businesses meant second quarter U.S. growth would probably be weak and it was hard to know how long the effects would last. That left a clear role for fiscal policy to help cushion the blow.

“The thing that fiscal policy, and really only fiscal policy can do, is reach out directly to affected industries, affected workers, and we’ve seen some of that so that’s an important job,” he said. “We do know that the virus will run its course and that the U.S. economy will resume a normal level of activity. In the meantime, the Fed will continue to use our tools to support the flow of credit.”

The Fed pulled out some of the biggest weapons in its arsenal. It’s key rate is now zero to 0.25%, matching the record low level it hit during the 2008 financial crisis and where it was held until December 2015.

The central bank also announced several other actions, including letting banks borrow from the discount window for as long as 90 days and reducing reserve requirement ratios to zero percent. In addition, it united with five other central banks to ensure dollars are available around the world via swap lines. Powell said that he did not think negative rates, which have been used in Europe and Japan, would be appropriate policy in the U.S.

President Donald Trump, who as recently as Saturday attacked the Fed for not lowering rates faster and further, quickly expressed support for the move.

Trump ‘Very Happy’

“It makes me very happy and I want to congratulate the Federal Reserve,” he said. “That’s a big step and I’m very happy they did it.”

Treasuries surged and U.S. equity futures tumbled at the start of another volatile week as investors responded to the rapidly escalating economic impact from the coronavirus and bet it will overwhelm the policy response. The Bank of Japan said it was bringing forward to Monday a meeting scheduled for later this week.

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The Fed’s emergency action came as more and more evidence emerged that the U.S. economy is being hit hard by the virus. On Sunday alone, Ohio ordered all bars and restaurants closed indefinitely, Nike shuttered all its stores at least through March 27 and airlines announced drastic cuts to their international flight schedules. Businesses are instructing staff to work from home, and travel and entertainment are being particularly affected as people take steps to observe social distancing to avoid infection.

As the fallout spreads across the economy, the risk of a recession is mounting. Goldman Sachs slashed its GDP forecasts on Sunday. It’s now predicting zero growth in the first quarter and a 5% contraction in the second.

Powell, who said he planned to do some telecommuting himself to set a good work-from-home example, told reporters on the call that the rate decision Sunday is in lieu of the Fed’s regularly scheduled meeting this week, planned for Tuesday and Wednesday.

No Dot Plot

He also said that the quarterly forecasts that would have been released at that meeting had been scrapped in light of the current uncertainty caused by the virus and would probably next be updated in June.

With Sunday’s announcement, the Fed is firing some of the biggest guns in its arsenal, but economists say without a similar, forceful response from the government, the country’s record 11 year expansion could end in recession. Stocks have already tumbled into a bear market.

https://twitter.com/gatewaypundit/status/1238482172723507207

“The Fed had to make this move, and waiting would have been a grave mistake,” said Michael Darda, market strategist at MKM Partners. “The problem is there is a tsunami coming and the Fed is likely to be overwhelmed by it, and the markets know that.”

The Fed said it will keep interest rates near zero “until it is confident that the economy has weathered recent events and is on track to achieve its maximum employment and price stability goals.”

The central bank acted the day before leaders from the Group of Seven nations, including Trump, are set to discuss their virus response on a teleconference. Central bankers and investors have pressed governments to do more to support their economies given monetary ammunition is running low and because fiscal policy can be targeted at corners of an economy that need it most.

“The Federal Reserve is prepared to use its full range of tools to support the flow of credit to households and businesses and thereby promote its maximum employment and price stability goals,” it said.

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To support smooth functioning in the Treasury and mortgage backed securities market, the Fed said it would lift its holdings of Treasury securities by at least $500 billion and of MBS by at least $200 billion.

Cleveland Fed President Loretta Mester cast a lone dissent, preferring rates were instead cut to a 0.5%-0.75% range.

The Fed’s actions followed the Trump administration and Congress’s first comprehensive steps Friday to assure the public that it has a coordinated public health and fiscal policy response.

The dramatic Sunday evening move was not the Fed’s first big attempt to provide support. On Thursday it sought to ease strains in the Treasury debt market through massive injections of liquidity and broader purchases of U.S. securities — a measure reminiscent of the quantitative easing it used during the financial crisis.

The Fed’s action also comes less than two weeks after it slashed rates by a half percentage point in an emergency move that failed to reassure nervous investors, in part because it was not accompanied by steps from other policymakers. That move — alone — failed to comfort investors and stocks ended the day down almost 3%.

“The Fed’s mantra has been to go early and aggressive, so this is the best thing they could have done, they’re really inventing new stuff,” said Diane Swonk, chief economist at Grant Thornton in Chicago.

She also emphasized that more action is needed from fiscal authorities.

“This is not enough,” she said. “The Fed is showing its commitment a lot more than the federal government is. They’re going to have to step it up a lot more.”

Stock futures tanked in overnight trading on Sunday, triggering “limit down” levels to reduce panic in markets.

Contracts on the S&P 500 dropped 5%, reaching a “limit down” band made by the CME futures exchange to prevent further losses. No prices can trade below that threshold, only at higher prices than that down 5% limit.

Dow Jones Industrial Average futures plunged more than 1,000 points, also triggering the limit down level. The halt occurs during non-U.S. trading hours — that is before the 9:30 a.m. ET open of regular trading.

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The brutal sell-off in the futures market came even after the Federal Reserve cut interest rates to near zero in an aggressive bid to save the U.S. economy from the coronavirus fallout.

The limit down rule has been tripped multiple times in the past few weeks as investors exited the market with the coronavirus outbreak disrupting global supply chains and fueling fears of a recession. The stock market has tumbled into a bear market, or down more than 20% from their recent highs.

If the sell-off accelerates on Monday during the regular trading hours, the so-called circuit breakers could kick in once again.

What is a circuit breaker?

According to the New York Stock Exchange, a market trading halt may occur at “three circuit breaker thresholds” on the S&P 500 due to large declines and volatility. The exchange classifies this at three levels based on the preceding session’s close in the S&P 500.

The rules, which apply to regular trading hours only, are as follows:

Level 1: If the S&P 500 drops 7%, trading will pause for 15 minutes.

Level 2: If the S&P 500 declines 13%, trading will again pause for 15 minutes if the drop occurs on or before 3:25 p.m. ET. There will be no halt if the drop happens after that. (This would occur Monday if the S&P falls 386 points).

Level 3: If the S&P 500 falls 20%, trading would halt for the remainder of the day. (This would occur if the S&P falls 594 points).

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The Level 2 and 3 circuit breakers have never been triggered in their current form during regular trading hours. The prior circuit breaker system was revamped after it failed to prevent the May 2010 flash crash. The current set of breakers were put into effect in February 2013.

The NYSE imposed a Level 1 halt on Dec. 1, 2008, when the S&P 500 closed 8.9%.

AFP with additional input by GVS News Desk

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