Federal Reserve slashes interest rates to almost zero

Mar 16th, 2020 | By | Category: Fixed Income

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Following an emergency meeting on Sunday afternoon, the Federal Reserve has cut short-term interest rates by 100 basis points in a bid to combat the negative impact of the coronavirus outbreak on the US economy.

Federal Reserve seeks to boost market immunity with emergency rate cut

The Federal Reserve has slashed its key short-term interest rate to zero.

The move, which sees the federal funds rate fall to a range of 0.00% and 0.25%, follows just two weeks after the central bank implemented an emergency cut of 50bp to its base rate.

The Federal Reserve has effectively adopted a zero interest rate policy, replicating the record low rates that the US endured for seven years following the financial crisis in 2008.

It did not stop there, however.

Highlighting the severity of the expected disruption, the Federal Reserve plans to further stimulate the economy through $700 billion in quantitative easing. The program will see the Federal Reserve purchase approximately $500bn worth of US Treasuries as well as $200bn in mortgage-backed securities.

Additionally, reserve requirements for depository institutions have been scrapped, while banks will be able to borrow from the Federal Reserve at a rate of 0.25% for up to 90 days.

Market impact

ETFs providing exposure to US Treasuries are expected to open significantly higher on Monday as the cut in yields push prices higher.

The largest US-listed ETFs in this space are provided by BlackRock. They include the $20.9bn iShares 1-3 Year Treasury Bond ETF (SHY US), as well as the broad maturity $18.7bn iShares US Treasury Bond ETF (GOVT US).

In Europe, investors may obtain similar exposures through the $5.2bn iShares $ Treasury Bond 1-3yr UCITS ETF (IBTA LN) and the $600m SPDR Bloomberg Barclays US Treasury Bond UCITS ETF (TRSY LN).

Beyond Treasuries, the impact of the rate cut on the fixed income market is less certain. While lower yields will theoretically feed through across bond markets, investors will undoubtedly be re-evaluating the riskiness of corporate credit given the increasing likelihood of an economic recession.

Turning to equities, the Federal Reserve will be hoping its policies will help stave off further stock market sell-offs. The S&P 500 Index is down approximately 20% from its February high while volatility has sky-rocketed – the index recorded an average daily move of 7.2% last week including 9% back-to-back swings on Thursday and Friday. Approximately $100bn was wiped off the SPDR S&P 500 ETF (SPY US), the largest ETF to track the bellwether index, during the turmoil.

What hopes the Federal Reserve may be holding, however, may already be dashed. US stock futures have fallen roughly 5% over the weekend, triggering their loss-restricting circuit breakers.

While the Federal Reserve’s bold moves will be widely welcomed, it appears as though the onslaught of negative news over the weekend – soaring infection rates, the forced closure of businesses, and the continued roll-out of travel restrictions – will play the stronger hand.

Investors will have to wait until the start of ETF pre-market trading in New York to gauge the market’s full reaction.

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