Explained: The extraordinary rate cut by the US Federal Reserve

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Brandishing an array of financial weapons, the Federal Reserve announced extraordinary action Sunday to try to blunt the heavy damage the coronavirus outbreak has begun to inflict on the US economy.

It’s slashing its benchmark interest rate to near zero. It’s buying $700 billion in bonds. It’s moving aggressively to smooth disruptions in the Treasury market.

And it’s prepared to do more.

The surprise intervention was an acknowledgement by the Fed that the economy seems suddenly on the brink of recession and a signal that it will do all it can to minimize the blow to households, companies and the economy.

Collectively, its actions are intended to keep markets functioning and lending flowing to businesses and consumers. Otherwise, as revenue dries up for countless small businesses that have suddenly lost customers, these employers could be forced to lay off workers or even seek bankruptcy protection.

By slashing its benchmark short-term rate and pumping hundreds of billions of dollars into the financial system, the Fed’s moves recalled the emergency action it took at the height of the financial crisis. Starting in 2008, the Fed cut its key rate to near zero and kept it there for seven years. The central bank has now returned that rate – which influences many consumer and business loans – to its record-low level.

And yet Chairman Jerome Powell acknowledged in a conference call with reporters that the Fed’s action isn’t likely to prevent the recession. The main reason: The economy is coming to a standstill because of the necessary behavioral changes being made across the country to stem the viral outbreak – an avoidance of travel, shopping and mass gatherings.

Rather, the economic outlook, the Fed recognizes, depends mainly on how quickly the United States can arrest the spread of the virus.

So what, exactly, did the Fed announce Sunday? And why?

THE FED SLASHED ITS BENCHMARK RATE TO NEARLY ZERO:

The Fed cut its short-term rate by a full percentage point, its steepest cut since the financial crisis in 2008, to a range of zero to 0.25%. That is the lowest level since December 2015, when the Fed raised rates for the first time after leaving them at nearly zero for seven years.

Over time, this move should lower a broad range of borrowing costs for things like homes, credit cards and autos. Powell said that while the move is intended to lower borrowing costs now, it would become even more important once the outbreak passes and consumers and businesses are confident enough to ramp up spending again.

President Donald Trump has urged the Fed to consider cutting rates below zero, but Powell said the Fed isn’t considering that now.

“We do not see negative rates as an appropriate policy in the United States,” he said on the conference call Sunday.

IT WILL BUY AT LEAST $700 BILLION IN BONDS

On Monday, the Fed will start buying at least $500 billion in Treasury securities and at least $200 billion of mortgage-backed securities issued by Fannie Mae and Freddie Mac. Those purchases are intended to smooth the functioning of the Treasury bond market and mortgage lending and to keep long-term borrowing rates down.

The Treasury market is the largest and most important such market in the world, because yields on Treasuries influence interest rates on many other loans and are used to price other global financial assets. Last week, banks and other large investors were unable to sell all the 10-year Treasuries they wanted to unload – pressure that inflated rates in that market. The Fed’s buying is intended to plug that gap and keep rates low.

“When stresses arise in the Treasury market, they can reverberate throughout financial markets and the entire economy,” Powell said.

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