In reaction to the global financial crisis and the current pandemic, the Federal Reserve has developed new, more resilient frameworks to maintain strength in the U.S. economy. These new policy tools and their effectiveness will be discussed in the AFP 2020 session, Building Confidence in Liquidity Management: Understanding the Fed Toolkit.
Tom Hunt, CTP, AFP’s Director of Treasury Services, recently discussed the Fed’s toolkit with AFP 2020 speaker Laurie Brignac, Chief Investment Officer and Head of Invesco Global Liquidity for Invesco.
Tom Hunt: Given all of the events that transpired in March, what was your motivation in coming up for this topic for your session initially? And why is it even more important now, given what has occurred?
Laurie Brignac: It's always hard when you're trying to think of something that will be pertinent at all times. Because like you said, you come up with an idea, and markets change and evolve. And if you think about the end of last year, there had been the repo disruption back in September, which took markets by surprise.
At the time, the Fed started doing more temporary open market liquidity operations to add liquidity back into the market, and everybody acted like this was some new thing. Maybe I'm just really old, Tom, but the Fed used to be in the market every single day doing repos. They were either adding or draining reserves every single day.
And I thought it might help the audience to understand that the Fed does have quite a few tools in their tool chest, they just may not use them for a while. But this isn't anything new, it's kind of standard. I thought, let's take a look at what the Fed has in its toolkit. How do they use them?
Hunt: Yes. For some of us, the last financial crisis wasn’t all that long ago, and this feels very reminiscent of a lot of the backstops that were put in place then. But maybe to build on that, could you talk about your co-presenter and what experience and insight you see him contributing to the session?
Brignac: Like I said, I've been doing this for a long time, and for many years it was frustrating, because there really wasn't a lot of focus on the research that the brokers would put out on the front end of the curve. It's a lot longer-term corporate treasury information, and people really just didn't focus on the Fed.
We have Alex Roever, Managing Director for J.P. Morgan. He's a bit of a Fed geek, just like me. And he brings the banking perspective. Obviously, they're talking to even more clients than we are. And I thought Alex would do a great job in coming in and setting the stage, and talking about what we’ve observed, because he is on the research side.
And then I can also pipe in as a user of the research. All the stuff that Alex is observing, how do I manage it in my portfolios? I thought it would be really dynamic to be able to have back and forth, but also at the same time, put together some baseline slides that's almost like a cheat sheet—the alphabet soup of the facility. What's permanent? What's in their normal toolbox? What adds permanent reserves? What adds temporary reserves? Not to do a huge deep dive, but at least give them something they could refer to later. Because I know I keep some of these cheat sheets around.
Hunt: Absolutely. What are some of the important takeaways you hope attendees glean from your session?
Brignac: I think the most important thing, apart from having that cheat sheet, which I think they would find really helpful, is basically understanding the framework of how the Fed manages the liquidity in the front. It's one thing to say, ‘What's your outlook on interest rates? How is the Fed going to implement monetary policy?’ But I think just the day-to-day is so important—especially with corporate treasurers and the fact that they're holding onto more liquidity than they normally would. How does liquidity move through the market? And how does the Fed spur that?
Post-2008, regulators made a lot of structural changes to the banks and how they manage their liquidity, and how much capital they have to hold. And we even saw that have a negative connotation in March. Again, it might be helpful for the treasurers to understand that sometimes the Fed can add a ton of liquidity to the market, but if you can't get through to the end-user of the cash, it's really not effective. That might be helpful too, when you see some of these blips in the market, like we saw back in September. It wasn't a credit issue, it was a plumbing issue. And maybe understanding the difference between a real plumbing issue.
Hunt: We’ve seen companies building up the reserves at banks. And the capital ratio changes and things like that are in response to a lot of what happened in the last crisis. What's the effectiveness of that, and how does it play into the whole overall liquidity picture? Is it providing a gate in terms of repayment? It certainly plays into the liquidity coverage ratio; it plays into a lot of areas that banks are being measured. But from a corporate standpoint, what does that all mean?
Brignac: I think that's where Alex, with his banking hat on, could really focus on. Because again, we are hearing banks are like, ’Please, God, don't put in any more cash.’ They actually are getting to the point where they want to turn them away. There is just too much cash being held on balance sheet, and it is a drag for them.
Hunt: As we've been talking about, the Fed has been extremely active in addressing the impacts of the pandemic on the U.S. and global economy. What do you think is working well, and what might need a little bit of refinement?
Brignac: It's a slippery slope here, to be perfectly honest. What helped a lot, and what we were hearing from other market participants, especially back in March, is that they did not know how to price five-year, 10-year, or 30-year bonds because there wasn't a clearing level in the front end. When you get no bid on high-quality, two-week commercial paper from a bank like a J.P. Morgan, because their balance sheet was full, how do you price a 10-year bond?
And I think that what they did back in March with the money market liquidity facility, with the commercial paper facility, if you look and see how much it was used, it wasn't very much. It was helpful, but it provided a floor to rates. Now, all of a sudden, we knew we could put commercial paper back at a flat rate at the Fed, working through an intermediary. What that did was just allow the rest of the curve to price.
I think that was good. It wasn't so much the amount of liquidity that they put in the system, it was providing transparency on clearing levels. I think they've really done just about everything, in my mind, that they need to do.
For more insights, don’t miss Building Confidence in Liquidity Management: Understanding the Fed Toolkit. Register for AFP 2020 here.