On Sunday afternoon, 15 March, the Federal Reserve announced aggressive policy responses to the crisis engulfing the United States stemming from the COVID-19 outbreak. The announcements were in response to economic forecasts that were marked down sharply and to further signs of potentially steep and longer-lasting disruptions. The two most noteworthy elements of Sunday's actions were an immediate cut in the federal funds rate to near zero (a target range of 0% to ¼%) and announcement of a program that will result in the expansion of the Fed's holdings of Treasury securities and Agency mortgage-backed securities over coming months by a total of approximately $700 billion.

What comes next

Sunday's aggressive rate cut could be the "final" adjustment to the federal funds rate, as there is little appetite now within the Federal Reserve for employing negative interest rates.

To be sure, if our economic forecast that includes a severe but brief recession is accurate, inflation is more likely to remain below 2% for several years and the unemployment rate will rise by approximately 3 percentage points and remain above its full employment level. In such conditions, the federal funds rate would be likely to remain near zero for several years.

Relatedly, the FOMC appears poised to announce within the next few months the results of its review of monetary policy and strategy. We anticipate that it will announce an adjustment to the inflation-targeting portion of its framework to incorporate elements of flexible average inflation targeting that would permit the Fed to announce that it would accept, or even promote, a moderate overshoot of 2% inflation as a tool to buttress long-run inflation expectations and possibly boost nominal interest rates. If credible, such a framework could result in more capacity to provide stimulus by lowering real interest rates.

While the Chairman refused to describe the asset purchase program as quantitative easing, that could change if the economic fall-out looks to persist beyond just one or two quarters. A longer-lasting downturn would likely result in the announcement of expanded asset purchases beyond those announced on Sunday, as a tool to further lower bond yields and mortgage spreads.

Finally, the Fed, with recent actions, signaled that it is prepared to move decisively and aggressively to mitigate negative economic impacts and create conditions that will help promote an eventual recovery, and that substantial fiscal and other policy interventions to help contain the spread of the disease and its economic repercussions are called for as soon as possible.

Posted 16 March 2020 by Ken Matheny, Executive Director, Research Advisory Specialty Solutions, S&P Global Market Intelligence