03.16.20 - In an emergency announcement on Sunday the Fed has decided to cut it’s benchmark interest rate to zero along with the announcement of an asset purchase program of $700B to buy government and mortgage bonds. This action was made amid liquidity fears in money markets due to increasing economic uncertainty. The move comes on the heels of a $1.5 Trillion repurchase announcement on Thursday March 12th.
Simply explained repurchase agreements or Repos are nothing new and are a common mechanism for financial institutions to make liquidity available quickly. For our unfamiliar readers, a repurchase agreement is a collateralized loan that is settled in a short amount of time. The Federal Reserve loans a financial institution money in exchange for collateral like Treasury Bonds. The institution will then buy back the bonds from the Federal Reserve at a pre-determined price within 24 hours to 30 days. The Repo market also has wide ranging impact on yield curves which the mechanism is used to help stabilize and correct yield curve inversions and market benchmark abnormalities.
The move to cut to zero will likely send borrowers in a mad dash to refinance debts and lock in rates at these historic lows.
It is unclear whether these actions will do anything to calm market fears, but in terms of providing much needed market liquidity in a time of investor uncertainty the move was necessary. The rate cuts to zero leave the Fed largely unarmed in the face of a potential financial crisis as the week unfolds it will be evident whether caving to administration and market pressures to cut rates was the right move or if the Fed just wasted it’s last bullet.
Source: Wall Street Journal
