Institutional Perspectives
The Fed’s Big Cut: What It Means for Investors
We surveyed Lord Abbett investment leaders for their views on the U.S. Federal Reserve’s policy move on March 15, 2020.
“Extraordinary times call for extraordinary measures.” In its latest response to the economic and market fallout from the COVID-19 coronavirus outbreak, the U.S. Federal Reserve held true to that maxim on March 15 by announcing a full-point cut in the federal funds rate, along with an additional $700 billion in bond purchases. The move, which brings the benchmark U.S. interest rate to near zero, came hard on the heels of the Fed’s half-point cut on March 3. Policymakers also detailed measures related to the discount window, intraday credit, bank capital and liquidity buffers, bank reserve requirements, and, in a nod to the global reach of the current crisis, facilitated U.S. dollar liquidity swap line arrangements in coordination with other central banks. (Read the full announcement.)
“The fact that the Fed is acting aggressively, and the world’s central banks, government officials, and political leaders are communicating and collaborating should matter to all risk markets,” says Robert Lee, Lord Abbett Partner & Chief Investment Officer.
As part of our continuing coverage of the current market volatility, we asked Lord Abbett investment leaders to place the Fed’s latest decision in context for investors. Edited versions of their comments follow.
Steven Rocco
Partner & Director of Taxable Fixed Income
The Fed provided more than the market was expecting, including the currency swap line with five other central banks, $700 billion in quantitative easing, the 100 basis point rate cut, and loosening of reserve requirements. That’s a pretty big “bazooka.”
However, in our view, more needs to be done to support funding markets on the corporate bond side--perhaps the 2020 equivalent of financial-crisis era programs such as the corporate paper funding facility (CPFF) in the United States or targeted longer-term refinancing operations (TLTROs) in the eurozone would be timely. I expect to see more fiscal action possibly in coordination with the Fed. We believe a stimulus of 2% or more for U.S. gross domestic product is appropriate given the magnitude of the expected shock.
The flattening of the COVID-19 infection curve will be what everyone is watching and waiting for. The policy actions on March 15, and others likely in the coming days, will hopefully allow markets to reach that point without any unforeseen accidents.
Giulio Martini
Partner, Director of Strategic Asset Allocation
By supplying liquidity to support the de-risking currently going on in asset markets, the Fed is acting to reduce the negative tail risk that would arise from a breakdown in liquidity. That is a clear positive. But the Fed’s actions do not directly address the risks stemming from the harm to the economy that actions being taken to stop the spread of COVID-19 will inflict.
Since the full extent of these actions is still unknown, we believe it is impossible to price the risks stemming from them. Volatility is likely to remain very high, and risk asset prices are likely to continue to experience downward pressure, until these risks can be properly priced.
Leah Traub
Partner & Portfolio Manager
The Fed’s move is just the latest in a salvo of responses from global central banks since March 9:
Central Banks around the World take Action to Infuse Markets with Liquidity
Notable monetary policy actions taken since March 9, 2020
Sources: NewYorkFed.org, March 12, 2020; ECB.Europa.eu, Monetary Policy Decisions Statement, March 12, 2020; BankofEngland.co.uk, Measures to respond to the economic shock from Covid-19, March 11, 2020; BoJ.or.jp, Market Operations toward the End of March, March 13, 2020; bankofcanada.ca, Bank of Canada Announces the Expansion of its Bond Buyback Program and Term Repo Operations, March 12, 2020; rba.gov.au, Reserve Bank of Australia, March 13, 2020; norges-bank.no, Rate Decision 2020, March 13, 2020.
None of these actions are occurring in a vacuum, of course. The additional move by the Fed and other central banks to establish dollar liquidity swap lines points to the degree of global coordination that will be necessary to respond to the unfolding crisis.
Focusing once more on the Fed, while its latest move is not an end-all solution for the impact of the COVID-19 virus, it should help provide liquidity to banks, which will then hopefully help transmit the stimulus through the rest of the economy. We believe fiscal policy is still necessary to provide bridges for companies and households as they face cash flow problems over the next few months. We believe this would help the economy come out the other side not too permanently impaired.
The value of investments in fixed-income securities will change as interest rates fluctuate and in response to market movements. Generally, when interest rates rise, the prices of debt securities fall, and when interest rates fall, prices generally rise. U.S. Treasuries are debt obligations issued and backed by the full faith and credit of the U.S. government. Income from Treasury securities is exempt from state and local taxes. Although Treasuries are considered to have low credit risk, they are affected by other types of risk—mainly interest rate risk (when interest rates rise, the market value of debt obligations tends to drop) and inflation risk. The municipal bond market may be impacted by unfavorable legislative or political developments and adverse changes in the financial conditions of state and municipal issuers or the federal government in case it provides financial support to the municipality. Certain sectors of the municipal bond market have special risks that can affect them more significantly than the market as a whole. Income from municipal bonds may be subject to the alternative minimum tax. Federal, state and local taxes may apply. Any capital gains realized may be subject to taxation. There is a risk that a bond issued as tax-exempt may be reclassified by the IRS as taxable, creating taxable rather than tax-exempt income. The value of investments in equity securities will fluctuate in response to general economic conditions and to changes in the prospects of particular companies and/or sectors in the economy. The securities markets of emerging countries tend to be less liquid, especially subject to greater price volatility, have a smaller market capitalization, have less government regulation and may not be subject to as extensive and frequent accounting, financial and other reporting requirements as securities issued in more developed countries.
Forecasts and projections are based on current market conditions and are subject to change without notice. Projections should not be considered a guarantee.
This article may contain assumptions that are “forward-looking statements,” which are based on certain assumptions of future events. Actual events are difficult to predict and may differ from those assumed. There can be no assurance that forward-looking statements will materialize or that actual returns or results will not be materially different from those described here.
Treasuries are debt securities issued by the U.S. government and secured by its full faith and credit. Income from Treasury securities is exempt from state and local taxes.
A basis point is 1/100 of a percentage point.
The discount window helps to relieve liquidity strains for individual depository institutions and for the banking system as a whole by providing a reliable backup source of funding. Much of the statutory framework that governs lending to depository institutions is contained in section 10B of the Federal Reserve Act.
The Federal Funds Rate (fed funds rate) is the interest rate at which a depository institution lends immediately available funds (balances at the Federal Reserve) to another depository institution overnight.
The New York Federal Reserve Banks’s Open Market Trading Desk (the Desk) executes repo and reverse repo operations. In a repo transaction, the Desk purchases Treasury, agency debt, or agency mortgage-backed securities (MBS) from a counterparty subject to an agreement to resell the securities at a later date. It is economically similar to a loan collateralized by securities having a value higher than the loan to protect the Desk against market and credit risk. Repo transactions temporarily increase the quantity of reserve balances in the banking system.
Tail risks include events that have a small probability of occurring, and occur at both ends of a normal distribution curve.
Yield curve is a line that plots the interest rates, at a set point in time, of bonds having equal credit quality, but differing maturity dates. One such comparison involves the two-year and 10-year U.S. Treasury debt. This yield curve is used as a benchmark for other debt in the market, such as mortgage rates or bank lending rates. The curve is also used to predict changes in economic output and growth.
The opinions in the preceding commentary are as of the date of publication and are subject to change. Additionally, the opinions may not represent the opinions of the firm as a whole. The document is not intended for use as forecast, research or investment advice concerning any particular investment or the markets in general, and it is not intended to be legal advice or tax advice. This document is prepared based on information Lord Abbett deems reliable; however, Lord Abbett does not warrant the accuracy and completeness of the information.
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