Seven Observations Concerning the Federal Reserve’s Pandemic Response

(1) Fed purchases of short-term Treasury Bills of less than one-year maturity, along with repurchase activity, have allowed for the smooth functioning of overnight funding markets critical to the efficiency of the financial system. These overnight markets no longer need any support, and the Fed has stopped purchasing short-term Treasury bills while sharply curtailing repurchase activity.

(2) Purchases at the long-end of the Treasury securities maturity curve of 10 years or longer have been extensive, $280 billion since late February, and have worked to stabilize yields and dampen volatility for securities with maturities of 10 years and longer. The Fed has not committed to a yield curve control program, however, the Fed has clearly wanted to and succeeded in dampening price volatility in the Treasury securities markets.

(3) The Fed’s largest purchases have been in intermediate Treasury maturities, ranging from one year to less than 10 years, totaling almost $1.3 trillion since late February and still climbing even as other asset purchase programs have been curtailed.  These purchases may have been made with the intention of relieving some pressure from the massive auctions of new debt by the US Treasury, and in that regard this is a fusion of fiscal and monetary policy.  Indeed, it is not at all clear that the large purchases of these intermediate maturity Treasury notes made much, if any, difference to the shape of the yield curve given the effectiveness of the Fed’s other activities to anchor the federal funds rate at zero, and to dampen volatility and stabilize yields on the long-end of the maturity curve.  [ Please see our research on Modern Monetary Theory ]

(4) The  effects of the announcement of the Fed’s entry into municipal bonds and corporate credit were more important than the actual purchases and dramatically impacted the price discovery process.  These programs were delayed in terms of implementation and the purchases have been small.  The market impact, however, was substantial and occurred at the time of the announcement, not at the time when the purchases were made.

(5) The Fed has sharply curtailed swap lines to central banks.  The currency markets are functioning smoothly and there is little demand for currency swap lines with the Fed from central banks around the world.

(6) The Fed also has reduced support to primary dealers in the bond markets.  There is ample evidence of excellent liquidity in these markets and primary dealers do not need the loans.

While the Fed may curtail its asset purchases in total and adjust the mix of securities within its portfolio, the federal funds futures market continues to show expectations for zero rates two years out or more.  And, there is significant growth in the trading volume and open interest for call-options-based Eurodollar deposit rate futures with strike prices implying zero or negative rates, suggesting that market participants expect the Fed to maintain short-term rates at near zero well into the future.