But Wait, There’s More

Story Highlights

• After dropping big on the Fed's announcement of a rate cut, markets rebounded today on the announcement of the new "term auction facility."
• The Fed plans to lend at least $40 billion in the coming weeks through auctions at reduced rates.
• America's Fed coordinated with Europe's major central banks to help manage liquidity globally.
• We continue to view credit fears as overwrought as banks can tap a variety of sources globally for liquidity.

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There was an interesting development this week, beyond the Fed's announcement of a new tool in its arsenal. For the past few Fed cuts, the market rose that day but fell the next. This time, just the reverse. Why the trend reversal? Blame it on Ron Popeil.

If you've ever suffered insomnia, you know you don't get to hear about the really good stuff until after infomercial guru Ron Popeil says, "But wait . . . there's more." The Chop-o-matic slices and dices and juliennes! But wait, there's more! Order now, and get the Pocket Fisherman . . . free!

Today, the Fed said "But wait, there's more," the market got its free Pocket Fisherman, and investors fell for it hook, line and sinker. And . . . there's the end to our labored metaphor.

What a fickle bunch we are. Yesterday, the market fell big on the much-anticipated 25 bp cut to both the target and overnight rates. Today, US stocks greeted the Fed's follow-up with enthusiasm, surging 2.3% at one point before a couple head-spinning whipsaws and a late day surge to end up 0.6%. So what's behind the Fed's added bonus feature?

Fed, ECB, Central Banks Coordinate to Add Liquidity
By Scott Lanman, Bloomberg
https://www.bloomberg.com/apps/news?pid=20601087&sid=aGiX5k85vGVU&refer=home

The above article gives a good overview, but in summary, the Fed announced a new "Term Auction Facility." Over the coming weeks, the Fed will lend at least $40 billion through four auctions. Basically, these short-term loans offer additional liquidity to banks through direct lending at rates that should be below the discount rate—presumably without the associated stigma of going hat-in-hand to the discount window. And banks will have a bit more flexibility in what they can offer as collateral. Though the market clamored for a larger rate cut—this solution may be a more immediate and flexible option than a larger cut.

But it's not just America's Fed doing this—Canada and Europe's major central banks are doing something similar. And what's more, the Fed agreed to allow the participating central banks to make loans in dollars (and vice versa). Normally, central banks can only lend to banks in their home currency. This "currency swap" may help alleviate dollar logjams in Europe.

We think the Fed's action is just fine and appropriate, and we like seeing innovation from our central banks. But, we wouldn't get carried away into believing this is the silver bullet to fix the economy—simply because we don't think the economy is much imperiled.

What today's announcement highlights is the world's major banks have access to ample sources of liquidity not readily available 20 years ago. Just in recent days, we've had news of major US banks getting capital from overseas. Even 10 years ago, most folks simply couldn't fathom Citigroup receiving a capital infusion from an Abu Dhabi sovereign wealth fund. Banks turning to alternate sources for funding isn't a sign of systemic trouble—it's a sign that free markets and globalization will help sustain healthy businesses better than any government bailout.

Today's announcement underscores another point: Better technology and continuing innovation means the Fed has far more tools at its disposal than in decades past—not only for reacting to liquidity hiccups, but also for assessing monetary and credit conditions globally. That doesn't mean the world's central banks can't commit major policy errors, just that we're likely to see fewer than in the past—which is very positive. Central banks can react to turbulence more nimbly without drastically moving rates—which is largely what we saw today.

Now, whether this was the right nimble action, time will tell. It will also be interesting to see how many banks line up for the auctions. Recall: When the Fed had an emergency discount rate cut in August, few banks took them up on it—simply because they didn't need the capital infusion or had better offers elsewhere. If that's the case, the Fed was right not to make a major cut and allow just those institutions truly in need to step forward.

It all sounds nice, and the market responded in kind. But today's big positive push doesn't tell us any more about the market's future direction than yesterday's big drop. And, we won't be surprised to see continued grumbling over credit market woes. But we continue to view credit fears as overwrought—from where we sit, those concerns have been headlines news so long, there's not much surprise power left to drive markets down. The real surprise will be in just how resilient both our economy and markets remain.