• Market Update
• Newsletter
• Research
• News
• Resources
• Primers
• Treasury Yield Curve
• Contact Us
• Site Map

Market Update -- Economic Comment

Written by Jane Caron, CFA, Chief Economic Strategist

March 12, 2008

Some economists believe that the Fed's latest liquidity program announced on Tuesday, the Term Securities Lending Facility (TSLF), has reduced the likelihood that the Fed will aggressively ease monetary policy at next week's FOMC meeting. We disagree. While the Fed's liquidity programs should reduce pressure in the financial markets, they are unlikely to lead lending rates down to levels that can help restore economic growth by themselves. Thus, we expect the FOMC to lower the federal funds rate when they meet next week from 3% to at least 2.50% and possibly 2.25%. In our opinion, the Fed's effort to restore liquidity opens a window that should allow additional rate cuts to have an impact on the economy. The Fed should take advantage of this opportunity by further easing monetary policy.

The TSLF will allow the 20 primary dealers who routinely trade U.S. government securities with the Fed to pledge bonds they hold (Treasury, Agency, agency MBS and AAA-rated private label residential MBS that are not on review for a downgrade) for loans of Treasury securities held in the System Open Market Account (SOMA). The term of these loans will be 28-days. The dealers will have to bid at auctions held every week for these loans. The size of the program is expected to eventually reach $200 billion. The Fed has also announced that they are increasing the size of the auctions in the Term Auction Facility (TAF), which serves the same function for depository institutions. These bi-weekly auctions will increase to $50 billion from $20 billion. In addition, the Fed and central banks around the world have taken some other, lower profile, steps to restore liquidity in the financial system.

We are pleased that the Fed has taken these necessary steps, but we are concerned that the financial system will remain impaired. As we wrote about in our February 27 commentary, until market participants have clarity about the likely performance of the collateral backing bonds, and they have confidence about the level of counterparty risk embedded in over-the-counter transactions, it is unlikely that the financial markets will channel credit smoothly. Until that happens, economic growth will remain constrained.