Unorthodox Monetary Policy: Fed Takes The Next Step

from BCA research


The Fed will now target lower private sector borrowing rates, which is a critical step in mitigating the economic downturn and the credit crunch.

The Fed announced earlier this week the creation of the Term Asset-Backed Securities Loan Facility (TALF), which will lend up to $200 billion to holders of AAA-rated ABS backed by newly and recently originated consumer and small business loans. The Fed also will purchase up to $100 billion in GSE debt, and up to $500 billion in GSE-backed MBS, steps similar to those we indicated were imminent in BCA's fixed-income bulletins. There is little hope of an economic recovery when the cost of borrowing to the private sector is prohibitively high, so these Fed measures are crucial. In particular, the authorities must target lower mortgage rates to support the housing market. The Fed's purchase program may need to grow, but is an important step. No doubt, banks will remain under pressure to deleverage for some time and lending standards will remain tight. However, risk aversion should moderate and the severe credit crunch should ease if investors see lower private sector borrowing rates and some improvement in final demand via fiscal stimulus. Bottom line: Investors should be positioned for a tightening in high-quality spreads, especially U.S. agencies and MBS.