Board of Governors of the Federal Reserve System

The Federal Reserve has acted with unprecedented speed and force to mitigate the economic and financial impacts of the pandemic. These actions can be generally grouped into three categories: (1) monetary policy measures, to bolster economic activity over the medium term and to support more immediate market functioning concerns, thereby fostering effective monetary policy transmission; (2) steps to stabilize short-term funding markets; and (3) actions to support more directly credit flows to households, businesses, and communities.¹

Monetary policy

On March 3, 2020, the Federal Open Market Committee (FOMC) reduced the target range of the federal funds rate and on March 15 reduced it further to near zero. The FOMC stated at its mid-March and late April meetings that it expects to maintain this target range until it is confident that the economy has weathered recent events and is on track to achieve its maximum employment and price stability goals. These measures will support a recovery in employment and a return of inflation to its 2 percent objective. The FOMC further emphasized it would use its tools to support the economy and assess the timing and size of adjustments to its policy stance in light of incoming information.

As a more adverse outlook for the economy associated with the COVID-19 pandemic prompted investors to move rapidly toward cash and shorter-term government securities, trading conditions in the markets for Treasury securities and agency mortgage-backed securities (MBS) started to experience strains. These markets are critical to the overall functioning of the financial system and to the transmission of monetary policy to the broader economy. In response, the FOMC undertook purchases of Treasury securities and agency MBS in the amounts needed to support smooth market functioning, and with these purchases market conditions improved substantially (figure A).²

Stabilizing short-term funding markets

Investors' rapid move into cash and the most liquid assets also caused strains in many other financial markets, reducing the flow of credit to businesses needed to fund critical operations. This liquidity squeeze—with short-term funding drying up even for companies in good financial standing—was particularly acute in mid-March and threatened to amplify the initial economic shock. Businesses and state and local governments with strong finances rely on short-term debt, or "commercial paper" (CP), to raise cash to pay for health care, employee salaries, and suppliers' invoices. These businesses and governments are generally able to roll over their CP every few weeks. As market strains rose, many investors were unwilling to advance funds for longer than a few days, so businesses were forced to issue CP on a near-daily basis, with no guarantee that investors would accept it.

At the same time—and contributing to the stress—investors started to pull away from some prime institutional money market mutual funds (MMF). These funds typically hold CP and other short-term debt instruments. However, the scale of investor redemptions threatened to exhaust these funds' holdings of their most liquid assets. Concerns that the funds would restrict or suspend daily redemptions grew, prompting even heavier outflows. The consequences of a failure in the CP market or of restricted redemptions from money funds could have been dire: Households and businesses might have missed payments to counterparties, forcing technical defaults by creditworthy entities, with potential consequences for the broader economy.

In response, the Federal Reserve, together with the Department of the Treasury, set up the Commercial Paper Funding Facility (CPFF) and Money Market Mutual Fund Liquidity Facility (MMLF). These emergency lending facilities were established under section 13(3) of the Federal Reserve Act. Each facility has $10 billion of equity (CPFF) or credit protection (MMLF) provided by the Treasury Department to protect the Federal Reserve from losses. The CPFF and MMLF function as backstops for these critical short-term funding markets by providing investors confidence that they can access their cash when they need it, relieving the pressure to sell amid fear that other investors are doing likewise. In turn, these backstops are critical to businesses, and thereby support employment and the broader economy.

A companion facility, the Primary Dealer Credit Facility (PDCF), was established to provide loans against good collateral to the primary dealers that are critical intermediaries in short-term funding markets. In March, constraints on dealers' intermediation capacity contributed to deteriorating liquidity in even usually liquid markets. The PDCF improves the ability of primary dealers to contribute to smooth market functioning and thereby supports the financial needs of businesses, households, and communities.

Indicators of market functioning improved after the announcement of the CPFF, the MMLF, and the PDCF (figures B, C, and D). Issuance of overnight CP dropped, and redemptions from money funds slowed and then reversed. In addition, after an initial wave of borrowing, market strains eased, and market participants have largely ceased initiating new draws at these facilities (figure E).

More direct support for credit across the economy

As it became clear that the pandemic would significantly disrupt economies around the world, markets for longer-term debt also faced severe strains, as the cost of borrowing rose sharply for those issuing corporate bonds, longer-term municipal debt, and asset-backed securities (ABS). Borrowing costs in these markets comprise the yield on a comparable-maturity risk-free bond and an additional difference, or "spread." These spreads widened notably, in some cases to post-crisis highs, and issuance of new debt in these markets slowed substantially or stopped altogether. Effectively, the ability of creditworthy households, businesses, and state and local governments to borrow, even at elevated rates, was threatened. In addition, small and medium-sized businesses that traditionally rely on bank lending faced large increases in their funding needs as COVID-19 and health policies implemented to minimize the spread of the virus forced them to close or substantially curtailed their revenues.

In light of these unusual and exigent circumstances, the Federal Reserve, with approval of the Secretary of the Treasury and associated equity to absorb potential losses from the Treasury Department, took a series of steps to support the flow of credit to households, businesses, and communities using authorities under section 13(3) of the Federal Reserve Act. Ultimately, a set of 13(3) facilities were announced to support the flow of up to $2.6 trillion of credit to large employers, small and medium-sized businesses, households, and state and local governments. The Treasury's equity investments in many of these facilities were authorized by the Cares Act (Coronavirus Aid, Recovery, and Economic Security Act).

The Term Asset-Backed Securities Loan Facility (TALF) was established on March 23 (and revised on April 9) to facilitate the issuance of auto loans, equipment leases, credit card loans, and other lending that is bundled into securities that are sold to investors. By facilitating issuance and instilling confidence that these markets will function effectively, the TALF contributes to the flow of credit to consumers and businesses. A TALF program was also operated in 2009–10 and was effective in supporting consumers and businesses.

The Paycheck Protection Program Liquidity Facility (PPPLF) was established on April 9 (and revised on April 30) to extend credit to lenders that participate in the Small Business Administration's Paycheck Protection Program (PPP), which provides forgivable loans to small businesses so that they can keep their workers on the payroll. The PPPLF bolsters the effectiveness of the PPP by supplying liquidity to lenders focused on servicing small businesses.

The Primary Market Corporate Credit Facility (PMCCF) and the Secondary Market Corporate Credit Facility (SMCCF) were established on March 23, with revised terms issued on April 9. These facilities are designed to work together to support the flow of credit to large investment-grade U.S. corporations so that they can maintain business operations and capacity during the period of dislocation related to COVID-19. The PMCCF will stand ready to purchase new bonds and loans issued by such corporations, while the SMCCF will support trading in bonds that these corporations had previously issued. High secondary market yields increase borrowing costs for businesses because seasoned bonds compete with newly issued bonds for investors' funds. In addition to purchasing individual bonds, the SMCCF will also purchase shares in exchange-traded funds (ETFs), which are commonly used vehicles that allow investors to purchase a share in all of the bonds forming an index, as a way to quickly and broadly support the functioning of bond markets and thus credit access by investment-grade firms. The PMCCF and SMCCF are open to firms that were investment grade but downgraded to the upper end of the speculative-grade range following the pandemic shock. In order to prevent an unusually large gap from opening up between borrowing costs faced by investment-grade and high-yield businesses, the SMCCF may also purchase a limited amount of shares in ETFs that target high-yield bonds. Since the announcement of the PMCCF and the SMCCF, spreads of both investment-grade and speculative-grade corporate bonds declined notably (figure F). In addition, issuance of investment-grade corporate bonds strengthened.

The Municipal Liquidity Facility (MLF) was established on April 9 (and revised on April 27) to help state and local governments better manage cash flow pressures in order to continue to serve households and businesses in their communities. The facility will purchase short-term debt from U.S. states, counties, and cities. These purchases directly improve access to credit and indirectly buoy access to market finance through improved market conditions and investor sentiment. Conditions in municipal bond markets improved after the announcement that the CPFF and the MMLF would be broadened to accept securities issued by state and local governments, and they improved further after the subsequent announcement of the MLF. In April, spreads on municipal securities continued to decline, and primary-market issuance continued to pick up (figure G).

The Main Street Lending Program was established on April 9 (and revised on April 30) to support the flow of credit to small and medium-sized businesses. The program includes three facilities, each of which will purchase participations in loans originated by insured depository institutions to borrowers with 15,000 or fewer employees or $5 billion or less in annual revenue. The Main Street program complements the PMCCF and SMCCF by supporting lending to businesses that are too small to benefit directly from those facilities. Purchases of loan participations both directly enhance access to credit for small and medium-sized businesses and indirectly support lending outside the program by expanding the lending capacity of depository institutions.

Figure A shows an example of how bid-ask spreads, a measure of transaction costs, jumped in the first half of March for U.S. Treasury securities, particularly for seasoned off-the-run vintages.³ As Federal Reserve purchases gradually increased, market functioning improved, though bid-ask spreads for off-the-run vintages remain somewhat elevated.

A. Indicative U.S. Treasury Bid-Ask Spreads

Figure B shows that during the COVID-19 outbreak, institutional prime MMFs experienced heavy redemptions. The announcement and implementation of the MMLF helped stem such outflows.

B. Prime Money Market Mutual Fund Net Flows

Figure C illustrates the transmission of strains to the CP market during the COVID-19 outbreak. Issuance of CP with overnight maturities rose sharply as investors pulled back to only the shortest-maturity assets. The announcement by the Federal Reserve and the Treasury Department of an emergency facility to backstop CP issuance (the CPFF), a liquidity facility for primary dealers (the PDCF), and a facility for MMFs (the MMLF) greatly eased pressures in funding markets.

C. Total Commercial Paper Issuance, by Maturity

Figure D depicts the sharp increase in short-term funding costs for investment-grade nonfinancial firms with double-A ratings and for such firms with A2/P2 ratings prior to the announcements of the CPFF and the MMLF. Funding costs decreased markedly shortly after these announcements, though costs also remain somewhat elevated.

D. 1-Month Funding Market Spreads for Investment-Grade Nonfinancial Firms

Figure E shows the evolution of balances outstanding in selected Federal Reserve facilities. In general, balances grew rapidly during the first few weeks after a facility was established; balances subsequently declined as market strains eased.

E. Emergency Lending Facilities

Figure F shows a COVID-19-induced spike in the cost of credit for firms in both the investment- and speculative-grade portions of the corporate bond market. Following the initial announcements of the PMCCF and the SMCCF, and the subsequent expansions of the size and scope of the facilities, spreads of both investment-grade and speculative-grade corporate bonds declined notably, and issuance of investment-grade corporate bonds strengthened.

F. Corporate Bond Spreads to 10-Year Treasury

Figure G shows a similar pattern for general obligation (GO) municipal bond spreads, with borrowing costs shooting up due to the pandemic but coming down by more than 1 percentage point following both the expansion of the MMLF to include some municipal bonds and the subsequent announcement of the MLF. The GO spread still remains fairly elevated relative to earlier in the year.

G. Spreads to Treasuries

In mid-March, offshore dollar funding markets came under stress, as manifested by sharp increases in foreign exchange (FX) swap basis spreads, which widened to levels last seen in the Global Financial Crisis (GFC) (top panel of figure A).¹ In response, the Federal Reserve and several other central banks announced the expansion and enhancement of dollar liquidity swap lines. In addition, the Federal Reserve introduced a new temporary repurchase agreement (repo) facility for foreign monetary authorities. The expanded swap lines were met with strong demand (figure B). Subsequently, swap basis spreads have moved back down toward their levels before the COVID-19 shock (bottom panel of figure A).

A. Three-Month FX Swap Basis Spreads

B. Central Bank Dollar Liquidity Swaps Outstanding

The U.S. dollar is the leading currency for trade and other international transactions and is used extensively as a funding and investment currency worldwide. In general, foreign financial institutions lack ready access to U.S. retail deposits or other stable sources of dollar funding and thus rely more heavily on wholesale funding markets than do U.S. institutions. As a result, when dollar funding markets seize up, as occurred during the GFC and recently as COVID-19 emerged, foreign financial institutions may be disproportionately affected. They not only may cut back on lending to foreign borrowers, thereby exacerbating disruptions in global markets, but also may reduce lending to U.S. residents and liquidate holdings of U.S. assets in order to obtain dollars, harming U.S. households and businesses. The Federal Reserve's dollar liquidity programs aim to mitigate these strains, supporting the flow of credit to U.S. households and businesses.

Recent usage of the Federal Reserve dollar swap lines

In response to the COVID-19 pandemic and accompanying stresses in dollar funding markets, the Federal Reserve coordinated with several other central banks to expand and enhance its central bank liquidity swap lines during the week of March 15, 2020.² The swap fee was reduced from 50 basis points to 25 basis points over the U.S. dollar overnight index swap rate. To better target stresses in funding markets for longer-term dollar borrowing, swap operations with a maturity of 84 days were added to the usual 7-day operations by the four central banks that traditionally hold regular auctions—the Bank of England (BOE), the Bank of Japan (BOJ), the European Central Bank (ECB), and the Swiss National Bank (SNB). In addition, temporary swap lines were reopened with the nine central banks that had temporary agreements during the GFC. Finally, the four foreign central banks with standing swap agreements announced that they would begin daily auctions.

The auctions initially conducted by the BOE, BOJ, ECB, and SNB were met with strong demand. Swaps outstanding as of April 30 stood at $446 billion, the highest level recorded since the GFC, with participation dominated by the BOJ ($220 billion) and the ECB ($143 billion); participation by central banks with temporary arrangements was lower but still sizable at $44 billion (figure B).

The Federal Reserve's temporary FIMA Repo Facility

In addition to the swap line enhancements, on March 31, the Federal Reserve announced a new program to support dollar funding markets, the temporary FIMA (Foreign and International Monetary Authorities) Repo Facility. This facility is designed to provide a reliable source of dollar liquidity to a broad range of countries, many of which do not have swap line arrangements with the Federal Reserve. Under this facility, FIMA account holders (which include central banks and other monetary authorities) can enter into overnight repos with the Federal Reserve, temporarily exchanging U.S. Treasury securities they hold with the Federal Reserve for U.S. dollars, which can then be provided to institutions in their respective jurisdictions. This facility is intended as a backstop, with the rate set at the primary credit rate plus 25 basis points.

The FIMA Repo Facility allows central banks to obtain dollars for liquidity purposes without selling their Treasury securities outright, which should help prevent Treasury market disruptions. Usage of this facility has been minimal thus far.