The Federal Reserve or “The Fed”, the central bank of the United States, is taking dramatic action in an attempt to stabilize the financial markets.  Actions taken by the Fed have not been seen since the 2008 financial crisis and they have several tools to assist them in stabilizing markets.  The two they’ve implemented recently are:

• Raise or lower the fed funds rate
• Purchase securities in the repo marketplace

On March 3, 2020 the Fed cut the Federal Funds rate by 50 basis points (0.5%).  What is the Fed Funds rate?

• It is the overnight interest rate that banks charge each other for lending excess cash.
• For consumers it’s important because banks can subsequently pass that lower interest rate on to consumers, i.e. mortgage, auto, credit card and other loans.
• The goal is to encourage consumers to borrow at lower rates and spend. This helps stimulate the economy.

Then, on March 15, the Fed made another surprise decision and cut the Fed Funds rate by an additional 100 basis points (1.0%) to, effectively, zero.  The chart below illustrates recent Fed Funds levels.*

In addition to Fed Funds rate cuts, the Fed can use short term repurchase agreements (repos) to provide liquidity into the financial markets. This means the Fed uses cash to purchase securities/assets from banks who agree to repurchase those securities at a specific date plus an interest charge.  The importance of these Fed repo actions is that it:

• Provides liquidity to banks when they need it
• Banks in turn then provide liquidity to corporations to pay for expenses such as salaries, etc.
• For consumers, this allows them to withdraw cash from their banks when needed (prevents a run on the bank)

Below is a chart of overnight repo purchases by the Fed. When repos increase, it means the Fed is more active in buying securities providing liquidity.* 

Lastly, the Fed has agreed to purchase short term debt (commercial paper) from investment grade companies, which provides cash to companies without having to go through a commercial bank.

The Fed implements these tools in times of economic stress or when the normal operations of the financial markets temporarily seize up. To put it simply, these actions provide financial liquidity so individuals and companies have access to credit/cash allowing them to maintain normal business operations and lifestyles. The latest stock market correction (brought on by the coronavirus pandemic) is one of these periods where the Fed should, and has, used these tools to ensure financial markets continue to operate for the benefit of both individuals and corporations.

*https://fred.stlouisfed.org/