While the Federal Reserve’s commitment to open-ended quantitative easing removes some uncertainty facing investors, two key concerns remain.
Since the global outbreak of the coronavirus, many of the measures taken by governments and central banks around the world have been described as “unprecedented”. The latest such measure has been the announcement from the US Federal Reserve that they will engage in unlimited quantitative easing and start to lend directly to certain US businesses.
In the surprise statement on Monday (23 March), the Federal Reserve said that it would buy unlimited amounts of US government bonds and other financial assets, making quantitative easing (QE) “open ended.” However, the Federal Reserve’s QE buying will not just include the usual government debt. For the first time, the central bank will be able to buy corporate bonds, including through the purchase of bond ETFs. The intention of these previously unimaginable measures is to ensure borrowing costs remain low and financial markets stable.
The Federal Reserve also announced it would provide direct funding to certain companies, through its new “Main Street Business Lending Program”. This is huge change from how it usually operates. Typically, the central bank lends to other banks, whose job it is to lend to other businesses in the rest of the economy. Now, however, as Kevin Boscher, chief investment officer of Ravenscroft notes: “The Federal Reserve is now effectively the direct lender of last resort to both the real economy and the financial system.”
The US market cared little for these unprecedented announcements, with markets in the US once again closing down on Monday’s trading (23 March). The S&P 500 closed down 2.9%, the Dow Jones Industrial Average 3% and the Nasdaq 0.3%. Both the S&P 500 and the Dow Jones have now given up all their gains since Donald Trump became president at the start of 2017.
According to Pantheon Macroeconomics, while the Federal Reserve’s commitment to open-ended quantitative easing and the purchase of corporate bonds removes some uncertainty facing investors, two key concerns remain. First, the extent and duration of the spread of coronavirus is still unclear. Monetary policy does not remove this key uncertainty.
Second, the fiscal response of the US to the virus is still unknown. As Paul Donovan, chief economist at UBS Global Wealth Management notes, the crucial part of the Federal Reserve’s new measures is its commitment to unlimited purchase of bonds and other assets. With this, says Donovan: “The Federal Reserve allows fiscal policy to be funded.”
Unfortunately, the US Congress once again failed to pass a proposed $2 trillion bailout plan. Broadly, members of the Democrat Party see the plan as being too generous to businesses and not doing enough to help workers. Senior Democrat politician Nancy Pelosi has unveiled a rival $2.5 trillion proposal.