The Fed yesterday delivered a major electroshock to the markets, announcing it will buy up to USD300bn in longer-term Treasury securities over the next six months. Moreover the Fed will more than double its planned purchases of mortgage-backed securities, to a total of up to USD1.25 trn, and will consider expanding the TALF to include existing impaired assets. The impact has been immediate, with 10Y UST yields dropping by about 45bp, leading a nearly 30bp flattening of the 2-10Y segment of the curve, and the USD plunging, with the sharpest one-shot move in EURUSD in a very long time, to over 1.34 from 1.31. The Fed has now really stepped in all guns blazing, showing its unequivocal determination to do all it takes to stabilize the economy and the financial sector, and fend off risks of deflation. I expect this to have a powerful impact on market sentiment, bolstering hopes that policy effort will help the economy find a bottom in the coming months, setting the stage for a recovery by year-end. This should help equities extend their positive performance and support some further recovery in risk appetite—which in turn could take us one step closer to normalization—admittedly on a still very long road.
After a major PR offensive that included an unprecedented TV interview by the Fed’s Chairman, the FOMC dropped three bombshells on a market that was poised for a relatively uneventful press release. Both the Fed and the Administration have been intensely engaged in a coordinated effort to boost confidence on both Wall Street and Main Street. But they knew very well that upbeat talk alone would not do the trick unless it was backed up by a significant stepping up of the policy effort, which the Fed has quickly delivered.
The FOMC has quickly overcome its internal divisions on whether or not to purchase government bonds. The need to engineer a decline in the cost of credit, notably in the mortgage market, has tilted the balance: the press release noted that direct purchases of USTs are meant “…to help improve conditions in private credit markets”. Longer term bond yields had moved up significantly since the December lows, pushing up the cost of mortgage financing and thereby potentially undermining efforts to stabilize the housing market. The Fed therefore decided it was time to step in to counterbalance concerns raised by the massive increase in the government’s borrowing requirement. The Fed was probably also encouraged by the strong impact of a similar announcement by the Bank of England last week, which quickly lobbed 70bp off Gilt yields.
