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Version 1 Version 2
Fed May Need to Buy Other Assets to Replenish Tool Kit, Official Says Bonds Hit Historic Lows, Prompting Fed to Ponder: What More Can We Do?
(about 2 hours later)
The Federal Reserve may need to buy assets other than government bonds to counter the next downturn, a Fed official said Friday, a dramatic suggestion meant to bolster the central bank’s increasingly depleted tool kit for fighting a downturn. Jerome H. Powell, the Federal Reserve chair, watched warily as diagnosed cases of coronavirus ticked higher and the stock market sank lower through the final week of February.
In coming years, “vision and boldness will be needed by all policymakers if we have to consider how policy should react to any large, adverse shock to the economy,” Federal Reserve Bank of Boston President Eric Rosengren told a room full of monetary policymakers and economists in New York. Economists around the world were lowering their growth estimates as factories delayed production and quarantines spread from Asia to Europe. Businesses in the Fed’s extended network of contacts were voicing concerns about a disease that, weeks before, had hardly registered on their radar.
He spoke as rates on the closely-watched 10-year Treasury bond dropped well below 1 percent on Friday, hitting lows never before seen in the United States. Investors are fleeing to the safety of government bonds as the coronavirus spreads and threatens global growth. Not all Fed officials were concerned — the president of the St. Louis Fed, James Bullard, told CNBC that the virus would most likely be a blip — but as markets gyrated, Mr. Powell decided that the central bank needed to signal readiness.
Stocks also continued to fall on Friday, with the S&P 500 tumbling more than 1.5 percent. The sell-off comes just days after the Fed slashed interest rates by a half point, an emergency measure aimed at helping to protect the economy against the growing risks from coronavirus. On Friday, Feb. 28, he issued a statement making clear that the Fed was carefully monitoring virus developments. Then he started working the phones, both touching base with his counterparts abroad and calling his colleagues to discuss the need to act. On Tuesday, the policy-setting Federal Open Market Committee announced its first emergency interest rate cut — and its biggest one-time move — since 2008, with officials approving it unanimously.
But Wall Street appears to be recognizing the Fed’s limited ammunition, making Mr. Rosengren’s comments particularly relevant. The swift action lowered interest rates to a range of 1 percent to 1.25 percent. The change could help insulate the economy by keeping borrowing cheap when business conditions worsen, as they are expected to do as the virus spreads.
Slumping longer-term interest rates leave the Fed with dangerously little room to stimulate the economy should things worsen. Their primary tool, the federal funds rate, lowers short-term rates and is already very low. Their backup measures, like mass bond-buying, work to push down longer-term rates. As those fall to rock-bottom, the Fed has little room to maneuver. But it also leaves Fed officials with historically little room to cut short-term rates: They lowered borrowing costs to near zero from above 5 percent in the 2007-09 downturn. And yields on longer-term government debt have been slumping, weakening the Fed’s second-string tool — bond buying, which works by lowering long-term rates.
Mr. Rosengren said that if the Fed cuts its policy interest rate to near-zero, it is possible that the 10-year Treasury rate would follow. Those constraints have set off a new round of soul-searching among central bankers, who were already reviewing their tool kit for fighting economic shocks and now find themselves running against the clock.
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Analysts warn it is increasingly plausible that the spreading coronavirus could end the United States’ record-long expansion, though that would be a severe outcome. While monetary policy is not ideally suited to fight a virus that is disrupting supply chains and quarantining workers, Congress and the White House do not appear to be poised to spring into action to help: President Trump regularly points to Mr. Powell and his colleagues when asked about the government’s economic response.
“I think what happens is the Fed should cut and the Fed should stimulate,” Mr. Trump said on Friday when asked about the need for stimulus. Despite the half-point cut on Tuesday, he complained that “we have a Fed that is not exactly proactive.”
It is not yet clear that coronavirus will create a prolonged shock. But if infections continue to spread, it could keep workers at home and production at bay, causing a more extended drag on growth. Market indicators suggest about a 40 percent chance that a U.S. recession could start in the next year, based on JPMorgan Chase models.
As Wall Street recognizes the Fed’s limited ammunition and the growing risks, investors are increasingly pessimistic. Stocks were down 1.7 percent on Friday, though the S&P 500 was up for the week.
If the bad economic outcome that investors are penciling in materializes, and the Fed’s depleted options aren’t supplemented by a big fiscal push, that would pave the way for a more painful downturn — one that costs jobs and subdues business for a longer period.
“The question here is: Can we design a new monetary system here?” Andrew Levin, an economics professor at Dartmouth, said on a panel in New York on Friday. “We can’t just say, ‘None of these things are very good, so we’ll just throw up our hands and hope that fiscal policy comes to the rescue.’”
He added, “We’ve got to be prepared, hope for the best, prepare for the worst.”
Also in New York on Friday, the president of the Federal Reserve Bank of Boston, Eric Rosengren, suggested a potential recourse — one likely to spark a conversation among his colleagues. Officials may need to buy assets other than government bonds to counter the next downturn, he said during a speech.
Bond-buying by the central bank bolsters the economy by lowering rates on long-term debt, making borrowing cheaper and encouraging spending. Because the yield on 10-year Treasury bonds dropped well below 1 percent on Friday, hitting lows never before seen in the United States, snapping up government-backed bonds could have far less impact in the future.
If the Fed cuts its policy interest rate to near zero, Mr. Rosengren said, it is possible that the 10-year Treasury rate will also fall to rock bottom.
“Such a situation would raise challenges policymakers did not face even during the Great Recession,” he said. And in such a case, “we should allow the central bank to purchase a broader range of securities or assets.”“Such a situation would raise challenges policymakers did not face even during the Great Recession,” he said. And in such a case, “we should allow the central bank to purchase a broader range of securities or assets.”
“Such a policy,” he noted, “would require a change in the Federal Reserve Act.”“Such a policy,” he noted, “would require a change in the Federal Reserve Act.”
Mr. Rosengren did not specify which type of assets he thinks the Fed might need to ultimately add to its portfolio. Mr. Rosengren did not specify which type of assets he thinks the Fed might need to add to its portfolio. But central banks in other nations can buy equities and corporate bonds, whereas the Fed is legally limited to government-backed debt, like mortgage-backed securities and Treasury notes.
While central banks in other nations can buy equities and corporate bonds, the Fed is legally limited to government-backed debt. In the 2007 to 2009 recession and its aftermath, it interpreted that to mean Treasury securities and certain mortgage-backed securities. Buying other asset classes would require opening legislation that empowers the Fed, as Mr. Rosengren noted. Central bankers have long been loath to suggest such a move, out of fear that it would endanger the Fed’s prized independence from partisan fighting.
Buying other asset classes would require opening the piece of legislation that empowers the Fed, as Mr. Rosengren noted. Central bankers have long been loathe to suggest such a move, out of fear that it will make the Fed a political football, risking its prized independence from partisan fighting. Short of Mr. Rosengren’s dramatic — and potentially unpalatable — suggestion, officials could potentially buy short-term municipal bonds, but doing so could amount to financing local governments. It can cut rates to zero, but officials have been fairly united in arguing that negative rates, used in Japan and parts of Europe, probably would not work well in the United States.
Mr. Rosengren also suggested that the Fed should strike an “explicit agreement with the U.S. Treasury Department” to protect the central bank against losses if it were to buy a broader range of securities or assets. And it could make targeted loans to businesses, as it did for Bear Stearns and American International Group during the financial crisis, though its powers in that arena have been curbed. The Fed could potentially still open loans to a broader set of companies, Michael Feroli, chief U.S. economist at JPMorgan Chase, said in an interview.
There may be other types of debt that the Fed can already legally purchase but has yet to buy. Chair Jerome H. Powell has been urged by Representative Rashida Tlaib, the Michigan Democrat, to consider buying municipal debt, for instance. Mr. Powell generally brushes off such suggestions. Officials are alert to both the coronavirus threat and their limited power. John C. Williams, president of the influential Federal Reserve Bank of New York, called the coronavirus a “very uncertain and quickly evolving situation” on Friday.
“I think a series of FOMC’s and Fed chairs in all kinds of different political environments have thought of that as something that’s not appropriate really for us in the sense that it’s government finance,” Mr. Powell said during testimony on Feb. 11. “Heightened uncertainty can cause people to pull back from investments,” he said. “It’s not a purely supply shock.”
Mr. Rosengren’s suggestion goes even further. As president of one of the Fed’s 12 bank branches, he has only a rotating vote on monetary policy, but he is a respected economist whose ideas carry weight with his colleagues. His ideas are likely to fuel discussion. And while public health officials and, potentially, fiscal policy have an important role to play, he and his colleagues also have a job to do, Mr. Williams said.
“I think everything is on the table here,” James Bullard, St. Louis Federal Reserve President, said earlier in the day on Friday. He was speaking on Bloomberg Television and had been asked about using the balance sheet in new ways. That may require not only a quick response, like the one Mr. Powell has already pursued, but a creative one.
But Mr. Bullard added that “it isn’t my base case at this point. My base case is this is a public health issue.” In coming years, “vision and boldness will be needed by all policymakers if we have to consider how policy should react to any large, adverse shock to the economy,” Mr. Rosengren said Friday.