After lowering the Fed Funds Target Rate to near zero in mid-March, central bankers have kept themselves busy. Exhausting their main monetary policy weapon early meant that the Fed had to get creative with new ways to support the economy. So, what has the Fed been up to recently? And what can we expect from Powell and company at the June FOMC meeting?
The Fed’s Actions Thus Far
In the absence of further interest rate adjustments, the Fed has been extending its lending programs to many different types of borrowers. Since the Fed was tasked with finding banks willing to administer Paycheck Protection Program (PPP) loans, they are providing liquidity to those lenders through the PPP Lending Facility (PPPLF).
The Fed had also extended lending programs to money market mutual funds, commercial paper markets, and municipalities. This money printing has ballooned the Fed’s balance sheet to just under $7.1 trillion as of May 27th. That is nearly a $3 trillion increase since late February and more than triple the size of the balance sheet at any point during the 2008-09 recession. The Fed is far from alone in this regard. The European Central Bank’s balance sheet has also increased by $800 billion over the same period, and there is little sign of slowing.
The stock market has rallied over 30% since the March 23rd lows, coincidentally the same day that the Fed announced plans to increase activity in multiple credit markets. This has happened while the four-week moving average of initial unemployment claims has remained above 2.5 million and the Atlanta Fed’s GDPNow forecasts a second quarter GDP decrease of 52.8%.
The Fed’s Main Street Response
After much deliberation, the Fed is ready to roll out the much-anticipated Main Street Lending Program [MSLP]. This program is slated to provide $600 billion in loans to small and medium sized businesses that were substantially harmed by COVID-19. While this sounds very familiar to the PPP, there is an important difference. PPP loans can be forgiven if such loans are spent primarily on payroll. MSLP loans, however, will not be forgiven, and this could potentially turn away small businesses that are afraid of the costs.
The Fed’s most recent Beige Book echoes business owner worries around getting employees back to work in a timely manner. Health concerns, limited childcare and generous unemployment benefits are just a few reasons that some economists are less optimistic about a rapid, “V-shaped” recovery.
What more can the Fed do to manage interest rates?
Looking back at the Fed’s 2008 recession playbook, the only major unused tool to push rates lower would be a promise to keep rates low for an extended period. This could help to further lower the long end of the yield curve, bringing down long-term lending rates, like mortgages, with it.
A new monetary policy tool that the Fed is “thinking very hard” about is called yield curve control. This strategy has been used in Japan for a few years. It involves the central bank adjusting yields for specific term Treasuries buy buying or selling them on the open markets. Along with the control of overnight rates, the Fed could lower the entire yield curve as low as it wanted to ensure borrowing costs are at rock-bottom.
Of course, there is still the option of negative interest rates, like those seen recently in Europe and Japan. While central bankers have not ruled out this option, there is reason to question the efficacy of punishing banks for holding reserves when the root cause of the slowdown is seen as a health crisis.
What to expect at the June Fed meeting?
With rates already at zero, and a reluctance for U.S. central bankers to embrace negative rates, it seems unlikely that the fed will reduce rates further anytime soon. Besides rolling out the MSLP, look for the Fed to try and bring down long-term rates with forward guidance like that of the 2008 recession. It is also possible that they may target specific Treasury offerings, begin to buy those securities, and broaden control of the yield curve on the long end.
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