The liquidity crisis is the main factor that disrupts financial markets around the world. In order to cope with the global recession, central banks do their best to support stock markets.
Due to panic in the markets, many investors feel uncertainty and sell out all their assets including U.S. Treasury bonds which had previously been seen as reliable. For now, there is a lack of money in the financial markets. Low prices for safety assets make this situation much worse. The currency which investors viewed as the only reliable asset in this turbulence is also in deficit. As a result, the value of securities and market indexes severely declined.
To rescue markets, many central banks reduce rates and pour more money into the economy. Some promising effects can already be registered.
On March 3, the Federal Reserve took extraordinary measures due to coronavirus and market downfall. For the first time since 2008, it reduced interest rates to 1-1.25%. In addition, the Federal Reserve decided to conduct overnight reverse repurchase operations (repo) at an offering rate of 1.00 percent, and by a per-counterparty limit of $30 billion per day.
The regulator was able to increase liquidity by purchasing Treasury and mortgage securities and selling them back in order to keep short-term rates flat. Because all these measures were taken in a very short period of time, it was clear that the Federal Reserve is awaiting more serious consequences of the pandemic.
On March 15, the regulator took the decision to further decline targeted diapason rates to 0-0.25%.
To protect the market, the Federal Reserve used $500 billion to purchase Treasury bonds and $200 billion to buy mortgage securities. The rate for repo was reduced to 0% with a per-counterparty limit of $30 billion per day.
The next day, the volume of repo was increased by $500 billion.
Moreover, for the first time since 2012, the Federal Reserve announced cooperation with the Bank of Canada, the Bank of England, the Bank of Japan, the European Central Bank, the Federal Reserve, and the Swiss National Bank on coordinated action to enhance the provision of liquidity via the standing US dollar liquidity swap line arrangements.
The Federal Reserve also announced that it will actively purchase and refinance sub-investment-quality debts under partial guarantees from the Treasury of the United States. The recovery of the emergency loan facility will be secured by purchasing asset-backed securities (TALF): car loans, student loans or loans for small businesses.
These measures will be valid until September 30, 2020. In total, the U.S. Treasury will provide the economy with $300 billion of additional finance or $10 billion for each program.
Nevertheless, the market is still in decline while the number of COVID-19 cases increases. On March 23, the Federal Reserve announced that it would acquire securities without any restrictions to guarantee smooth functioning of the markets. Aside from $2 trillion that the US pours into the economy, the Federal Reserve will also receive about $4 trillion.
Under this program, the Federal Reserve will buy mortgage loans from government-sponsored enterprises including Fannie Mae. In addition, a secondary market corporate credit facility (SMCCF) was created to purchase bonds and ETFs and provide liquidity for the corporate bond market.
The regulator expanded the range of bonds that might be acquired by the primary market corporate credit facility (PMCCF) and the secondary market corporate credit facility (SMCCF).
Now PMCCF and SMCCF can purchase bonds worth up to $750 billion against $200 billion before. This step was taken when the US Treasury increased its initial equity investment from $20 billion to $75 billion.
According to Larry Kudlow, advisor to the U.S. President, the total amount of support is about $6 billion, which is the highest in the country’s history.
On February 20, 2020, the main index of the Japanese stock market Nikkei 225 was trading at 23,479.15 points. On March 19, the indicator crashed to 16,552.83, having lost 29.5% from February.
On March 2, Haruhiko Kuroda, the head of the Bank of Japan, made an emergency statement and promised to ensure sufficient liquidity and stability in the financial markets.
On March 16, after the U.S. Federal Reserve announced its plan to save stock markets, Japan also revealed a stimulus package. Unlike the American central bank, the Bank of Japan did not change the key interest rate, which was already at minus 0.1% per annum. A further rate reduction may negatively affect the profits of banks, which in turn would affect the volume of loans to businesses provided by financial institutions, experts said. The target yield of ten-year government bonds was left at about zero (plus or minus 0.2 percentage points).
Instead, amid the pandemic, the country’s central bank announced that it will expand its incentives. The Japanese regulator doubled the annual repurchase program of exchange-traded index funds (EFT) to 12 trillion yen ($112 billion). It also raised the target for the repurchase of corporate bonds from 3.2 trillion yen to 4.2 trillion, and short-term bills from 2.2 trillion yen to 3.2 trillion.
The annual benchmark for the repurchase of Japanese government bonds was confirmed at 80 trillion yen ($747 billion). For comparison, in the previous 12 months, the volume of government securities repurchased by the central bank was about 14 trillion yen.
The regulator also promised to introduce a new corporate loan scheme, under which commercial banks will be able to borrow money from the Bank of Japan for almost a year at a zero interest rate to loan companies hit by a pandemic.
On April 7, a state of emergency was introduced in Japan. Against this background, the Bank of Japan has reduced its number of operations. However, the regulator will continue to support social infrastructure by issuing banknotes, making decisions in the field of monetary policy and ensuring unhindered settlement of funds.
The European Central Bank (ECB) has decided to provide support for monetary policy through the purchase of assets for 120 billion euros until the end of 2020. Between June 24, 2020 and June 23, 2021, the interest rate on all loans issued under the program of targeted long-term financing will be 25 basis points below the average interest rate on ECB loans.
Later, the ECB announced a program of additional repurchase of securities of private and public sector for 750 billion euros in countries that were hit by the pandemic. All these companies will be nationalized and will re-commercialize later.
However, markets were not impressed by the ECB statement. For example, the British FTSE 100 and the German DAX indexes began to decline even faster. According to Reuters, the ECB has no more tools in its arsenal of measures. For instance, the rates are already negative at historically lower level, so their further decline, according to analysts, can be counterproductive.
In turn, the Bank of England reduced its basic interest rate to 0.1%. Like other central banks around the globe, the British regulator activated the urgent repo mechanism. An additional £200 billion was allocated for the repurchase of government bonds and non-financial corporate bonds.
The country’s authorities also allocated £330 billion ($410.5 billion) to the loan guarantee system (15% of GDP). This will help small and medium-sized enterprises take loans of up to £5 million under state guarantee. If loans provided by banks to private companies are not repaid, the state will have to compensate these losses to banks.
The People’s Bank of China has taken a set of measures to support the economy amid the coronavirus. In particular, the central bank allocated three trillion yuan ($422 billion) to support the banking system in the first half of February and 170 billion yuan at the end of March.
The People’s Bank of China is among the central banks easing their monetary policy. In February, the base rate on one-year loans for first-class borrowers (loan prime rate or LPR) decreased from 4.15% to 4.05%. The five-year LPR was reduced by 5 basis points – from 4.80% to 4.75%. The Chinese central bank also reduced its five-year LPR by five basis points to 4.75% from 4.80%. Rates will likely continue to decline.
Moreover, the regulator reduced the seven-day reverse repo rate, a key benchmark for its other base rates, by 20 points, to the lowest level in history at2.2%.
The target level of required reserves for banks specializing in lending to small- and medium-sized businesses has been reduced to 0%, which should release about 400 billion yuan ($56.38 billion) of liquidity to support an economy that has been hit by the coronavirus.
The support of the authorities is yielding results – the total amount of financing, including bank loans, off-balance loans, as well as the placement of shares and bonds, jumped to 5.15 trillion yuan ($732 billion) in March, in comparison with 860 billion yuan a month earlier.
On March 20, when local markets and the currency collapsed, the Central Bank of Russia did nothing and kept its key rate at the same level (6%). However, the regulator announced new large-scale measures to support banks, borrowers and other financial institutions.
Thus, the Central Bank allows assets management companies to not revaluate securities that were purchased before March 1, as well as debt securities purchased from March 1 to September 30, 2020. The measure covers assets of more than 1.3 trillion rubles.
Concerning huge banks that play significant roles in the country’s financial system (11 banks), the central bank agreed to provide short-term liquidity support. According to the package of banking regulation «Basel III», the highly liquid assets of commercial banks should cover all expected outflow of funds over the next 30 days. For banks in trouble, the Central Bank has provided an irrevocable credit line tool, which is a monetary tool to cover the outflow of customer deposits. In light of the situation, the Central Bank can print as much cash as needed. Since April, the Central Bank has expanded its total limit of 1.5 to 5 trillion rubles and reduced the cost from 0.5% to 0.15%. In early April, according to the Bank of Russia, «one important credit institution opened an irrevocable credit line with the maximum possible limit of 500 billion rubles.»
On March 13, the Board of the National Bank of Ukraine (NBU) decided to reduce the base rate from 11% to 10% per annum. Despite the risks associated with coronavirus, a falling inflation allows NBU to lower the cost of money in the economy.
To maintain interest rates on the interbank market at an acceptable level, the regulator decided to provide liquidity in hryvnias at a rate of 12% (base rate + 2%) via repos secured by bonds of internal government loans (OVDPs) for 14-90 days and currency swap for 28-31 days.
Ukrainian experts fear that if the NBU begins to buy government bonds from non-residents, it will be a shock to the financial system. Experts believe that foreign companies may use the tool to buy foreign currency and repatriate their capital abroad. The country’s foreign exchange reserves may eventually be depleted, and the money supply in national currency will increase excessively.
While the world central banks moved to a policy of easing, the National Bank of Kazakhstan (NBK) raised the base rate from 9.25% to 12% on March 10. On the same day, the Kazakhstan Deposit Guarantee Fund raised the maximum recommended deposit rate. The central bank raised rates in an attempt to support the national currency due to a sharp drop in oil prices. Thus, the financial regulator tried to prevent speculation by major market players.
However, on April 3, when the pandemic reached Kazakhstan, the National Bank decided to reduce the base rate to 9.5% and expand the interest rate band to +/- 2 percentage points. So, the rate of permanent access operations to provide liquidity will be 11.5%, and the rate to withdraw liquidity will be 7.5%. The NBK explained that the current level of base rate may limit economic activity in the future.
To prevent speculative overvaluation by exchange points, the National Bank decided to establish limits for deviations of the purchase rate from the foreign currency sale rate. There is no shortage of foreign currency in Kazakhstan, the Central Bank said. From March 10 to March 31, the NBK conducted foreign exchange interventions for $1.49 billion in total. Moreover, liquidity in Kazakhstan is supported by the quasi-public sector, which, according to the decision of the government, is obliged to sell part of the foreign exchange earnings in the domestic market during the emergency.
In addition to participating in the foreign exchange market, the regulator continues to provide liquidity in the national currency secured by securities (REPO). A month ago, against the backdrop of the anti-crisis actions of the Kazakhstan regulator, stock market players talked about the need for long liquidity in existing REPO instruments in the country’s money market.
Kazakhstan has been experiencing a deficit in the money market since the start of 2020. At the end of February, professional participants told Kursiv that in a situation of imbalance, the regulator could provide additional liquidity because «the situation with liquidity in the repo market reduces the attractiveness of tenge instruments.»
When asked by Kursiv what unconventional monetary policy measures would help the Kazakhstani stock market, market players suggested several options for broader incentives. For example, according to experts, repurchase transactions for shares of national companies or redemption of bonds of national companies could be incentives. This “will not accelerate inflation and has a logic of buyback.” Stock market participants believe that such measures «will not allow a repetition of the tenge famine of 2014-2016, will not allow the domestic capital market to close and release liquidity, and will squeeze money into the corporate sector.»
Kazakhstan drew attention to global trends in the practice of anti-crisis measures of foreign central banks. According to investment bankers, by mid-April, a proposal for 2 billion tenge at 11% appeared in a REPO glass under GS overnight. Market experts suggest that the proposal be put forward to UAPF. Market participants took the news positively and explained to Kursiv that «money can only be placed on the security of a basket of securities, which is already in the UAPF portfolio. These are papers of the quasi-public sector. The state itself provides for repayment for them, but the profitability is higher.»
Experts are sure that the cautious step of the National Bank of the Republic of Kazakhstan will positively affect the development of the stock market, and in general, it is designed for higher income for pensioners than government securities or, especially, deposits in STBs. Money in the repo instrument under government securities is given on strict conditions: if the bidder does not fulfill the obligations, the UAPF will buy quasi-debts with a discount of 10-15% of the current amount of debt (income in the fund’s basket).
Serious support to the Kazakhstan stock market is likely to be provided by the decision of the authorities of Kazakhstan on the payment of dividends by quasi-state companies to the state in the amount of 100% of net income. Kazakhstani financiers are unanimous in their opinion that the plan voiced by President Kassym-Zhomart Tokaev regarding the payment of dividends by national companies is «the first real measure to support the stock market of Kazakhstan since the People’s IPO.» Professional stock market participants in the country say that increasing returns on publicly traded state-owned companies will make their stocks attractive; the further effect is positively multiplied on the financial indicators of institutional investors of these securities – UAPF, banks and insurance companies, as well as individuals and foreign investors.
Against the background of the revaluation dynamics of the national currency, the situation in the money market stabilized, the Association of Financiers of Kazakhstan noted. Rates by April 9 fell near the lower level of the base rate corridor: the yield on one-day repo transactions fell to 7.73% per annum (-105 bp), while the attraction/placement of liquidity through currency swap transactions cost market participants 7.99% per annum (-102 bp). The open position on NBK operations has not changed in recent days and is close to 3.8 trillion tenge of debt to the market.
Stimulus measures by central banks around the world can improve sentiment and raise asset prices. However, experts fear that as economic activity indexes are published (data for the first quarter of 2020 should appear soon) stock markets will go down again.