The U.S. economy is currently facing heightened uncertainty, stemming from the COVID-19 pandemic. State leaders effectively shut off all but the most essential economic activities overnight, and although the reopening of most states continues, many businesses remain fully or partially closed.
To alleviate the financial impact being felt across the nation, the federal government passed the Coronavirus Aid, Relief, and Economic Securities (CARES) Act in March to provide companies and individuals with financial relief. At the same time, the Federal Reserve dug into its policy toolbox to support asset prices and prevent a financial market meltdown – and it continues to dig deeper even today.
In particular, the Fed has committed to purchase an unlimited amount of Treasury securities, mortgage-backed securities, loans and corporate bonds – essentially printing dollars to finance debt – to ensure liquidity in the credit markets and aid businesses, consumers, states and cities. It also drove down interest rates to stimulate investment.
These are largely the same tools the Fed employed during and after the Great Recession, and the performance of these lifelines is critical to the health of the commercial real estate industry. But many believe that more needed to be done to prevent further economic deterioration due to the pandemic.
The Fed effectively added another tool in August, by adopting changes to its policy framework to seek periods of higher inflation, according to numerous reports. The Fed will no longer tie interest rate increases to an unemployment goal or the 2 percent target inflation rate it established in 2012. The aim is to prolong the period of low interest rates – and to reassure market participants that they will remain low – to provide further economic support. However, this policy may only provide modest help if history is any indication. Interest rates were held at very low levels after the Great Recession, which did lead to an expansion of the U.S. economy, but at a slow pace.
After years of keeping interest rates at historically low levels and its balance sheet at historically high levels coming out of the Great Recession, from 2017 to 2019 the Fed increased the benchmark federal funds rate 175 basis points to a level of about 2.5 percent. It also shrank its balance sheet to $3.8 trillion by August 2019 from a high of $4.5 trillion in 2015. But the Fed reversed course in the second half of 2019 when liquidity in the short-term repurchase agreement (“repo”) market started drying up. At that time, it cut the federal funds rate by 75 basis points and added roughly $200 billion to its balance sheet.
In March, as fear and uncertainty over the pandemic ushered in the lockdowns, the Fed responded by cutting the federal funds rate by 125 basis points to institute a zero-interest-rate policy. It also introduced several new emergency funding facilities that to date have pushed its balance sheet to roughly $7 trillion and expanded to a variety of asset types beyond Treasuries and mortgage securities.
As an example, as part of its new Term Asset-Backed Loan Facility (TALF), the central bank has purchased approximately $11.1 billion in student, auto, credit card and Small Business Administration loans, among other asset-backed securities. This is a tool that it first rolled out during the financial crisis a dozen years ago.
Other programs include the Main Street Lending Program, which is providing loans to businesses of up to 15,000 employees or up to $5 billion in annual revenue, and a medley of initiatives that are enabling the Fed to buy certain debt securities for the first time ever, such as municipal bonds, corporate debt and commercial paper. As part of the plan, the Fed announced early in the summer that it would buy up to $750 billion in corporate bonds, including corporate bond exchange-traded funds.
The Fed’s flurry of initiatives to support asset prices and stimulate investment mirror central bank efforts in other parts of the world, but it takes modern U.S. monetary policy into uncharted territory. Its balance sheet has expanded 70 percent, making more than 34 percent of U.S. gross domestic product, the highest level ever. Additionally, when the Fed enacted a zero-interest-rate policy for seven years beginning in 2008 to combat the Great Recession, the 10-Year Treasury yield didn’t drop below 1 percent. However, this time around it did, and it remains under 1 percent as of the writing of this article.
Low interest rates and strong credit markets are good news for real estate investors, but the maneuvers to generate them are not without consequence. Most noticeable has been the depreciation of the dollar versus other currencies and the rise in gold, silver and commodity prices. Some analysts worry that the combination of zero interest rates and money printing could potentially lead to prolonged economic stagnation similar to what Japan has experienced over the last couple of decades.
Every financial crisis requires a unique set of solutions and this pandemic-driven crisis is no different. The Fed is taking whatever steps necessary to support the economy, and its swift reaction in March prevented the seizing of credit markets. But the Fed’s job will not be over even after the pandemic ends. While every action taken can have adverse consequences whether predictable or not, the Fed has proven to be resourceful in employing known methods and constructing new tools to prop up and stabilize the economy. Until the economy is back on sound footing, hopefully the Fed’s tools will continue to keep it churning.