Rates Are Now At Zero- What Else Can The Federal Open Market Committee (FOMC) Do?

by Rajesh Chainani (RC) Managing Director- NYLAF Cash Management Group

I hope that you, your families, and your friends are all safe and healthy.  I am also very hopeful that by the time you read this article, the world is very different in a positive way compared to what we are currently experiencing.   I realize that is more of an optimistic wish, but there is nothing wrong with having hope.

Our entire world changed in the month of March, not just in the financial markets, but from a personal standpoint as well.  The Federal Reserve (“the Fed”) has been aggressive in doing all that they can do to stabilize the financial structure of our economy.  Reducing interest rates was merely one of many tools at their disposal to utilize.

Noted below is quick snapshot (directly from the FOMC) what has been pledged as of March 27^th, 2020:

• Support for critical market functioning. The Federal Open Market Committee (FOMC) will purchase Treasury securities and agency mortgage-backed securities in the amounts needed to support smooth market functioning and effective transmission of monetary policy to broader financial conditions and the economy. The FOMC had previously announced it would purchase at least $500 billion of Treasury securities and at least $200 billion of mortgage-backed securities. In addition, the FOMC will include purchases of agency commercial mortgage-backed securities in its agency mortgage-backed security purchases.
• Supporting the flow of credit to employers, consumers, and businesses by establishing new programs that, taken together, will provide up to $300 billion in new financing. The Department of the Treasury, using the Exchange Stabilization Fund (ESF), will provide $30 billion in equity to these facilities.
• Establishment of two facilities to support credit to large employers – the Primary Market Corporate Credit Facility (PMCCF) for new bond and loan issuance and the Secondary Market Corporate Credit Facility (SMCCF) to provide liquidity for outstanding corporate bonds.
• Establishment of a third facility, the Term Asset-Backed Securities Loan Facility (TALF), to support the flow of credit to consumers and businesses. The TALF will enable the issuance of asset-backed securities (ABS) backed by student loans, auto loans, credit card loans, loans guaranteed by the Small Business Administration (SBA), and certain other assets.
• Facilitating the flow of credit to municipalities by expanding the Money Market Mutual Fund Liquidity Facility (MMLF) to include a wider range of securities, including municipal variable rate demand notes (VRDNs) and bank certificates of deposit.
• Facilitating the flow of credit to municipalities by expanding the Commercial Paper Funding Facility (CPFF) to include high-quality, tax-exempt commercial paper as eligible securities. In addition, the pricing of the facility has been reduced.

Even with the support of the Fed, the “Flight to Safe-Havens” has continued.  An example of that is the 90 Day T-Bill rate.  It was yielding 0.93% on March 3^rd, 2020 and has declined to a negative yield -0.05% as of March 27^th, 2020.  Matter of fact, all US Treasury Bills maturing in the full calendar year of 2020 are trading at a negative yield.  Even in 2008 we did not see this level of “Flight to Safe-Havens”.

So exactly what does this negative yield mean?  Essentially, investors are willing to take less money back than they invested in order to protect their cash as much as they can.  They are not willing to invest in highly rated A1+/P1 Commercial Paper (even with the Fed’s support) unless they are getting rates of return close to 2% (as of 3/27/20).  That is a premium of 200 basis points to take on that additional risk of being in a “credit backed” security compared to a “Principal and Interest Guaranteed by the US Treasury” (secured) investment.  In the past few weeks, investors have reallocated investments to “U.S. Government Money Market Funds” from other options at a historical level.

Even with the Fed’s pledge of “Unlimited Support”, the reality is that this issue today is related to a health crisis, and not a financial one.  The financial sector is well positioned due to the changes that were implemented after the Financial Crisis to initially deal with many scenarios.  That is very good news!  A glimmer of hope as we all race towards the unknown challenges of tomorrow.  We all just have to be in a position to “ride out this storm,” which is very different than 2008.  In our view, safety (in more aspects than just investments) has to be the top priority at all times. 

Please continue to be safe as we are all in this storm together!