Is FED Running Out of Bullets in Bringing Down The COVID-19 Impact? Oil Market Yet Under Duress

Crude oil prices are under duress in the wake of COVID-19 impact on the global economy and oil demand. The Brent crude oil futures slipped once again post a slight recovery to $53.90 (intraday high on 3 March 2020) to the present level of $32.87 a barrel (as on 16 March 2020 2:48 PM AEDT), which marked a price fall of ~ 39 per cent.

The previous slight recovery in the Brent crude oil futures was mainly due to the boost provided by the United States Federal Reserve in the form of an emergency rate cut in the benchmark interest rate, which was followed by rate cuts from other nations, in an effort to boost the global economic conditions.

To Know More, Do Read: Production Cut and Central Bank Actions Propel Crude; Weak Demand Across Refineries Persist

The series of rate cuts raised speculations among the market participants, and the crude oil prices recovered; however, the demand for OPEC crude remained oblique, and OPEC estimated a fall in demand for 2020.

While crude oil prices are plunging due to the lower economic activities, and in tandem, lower demand, the United States Federal Reserve is taking further actions to provide cushion to the beleaguered economic activities in the wake of the coronavirus impact.

FED to Support Credit Flow to Households and Businesses

The Federal Reserve recently announced that it would monitor the credit market, and would support the credit flow to households and businesses via utilising various tools in order to maximise the employment and price stability.

The actions taken by the FED to enhance the credit flow to households and businesses are as below:

Discount Window

FED is lending to depository institutes such as banks with an aim to support the liquidity and stability across the banking system and effective implementation of the monetary policy. The discount window is providing direct funds access to depository institutes, which could hedge their liquidity risks efficiently.

The better liquidity risk management by depositary institutes is anticipated by the FED to help depositary institutes in avoiding extreme measures such as withdrawing credit during the times of market stress, enhancing credit required by the households and businesses to revive from the economic slowdown; and,

• In support of discount window, the FED Board lowered the primary credit rate by 150 basis points to 0.25 per cent, which reflected both the 100 bps reduction in the target range for the federal funds rate and a 50 bps narrowing in the primary credit rate relative to the top of the target range.

Intraday Credit

The Federal Reserve extended the intraday credit on both collateralised and uncollateralised, which would further ensure a reliable support towards the functioning of payment systems along with the settlement and clearing of transactions across a range of credit markets.

Bank Capital and Liquidity Buffers

The Federal Reserve is also suggesting and encouraging banks or depository institutions to lend from their liquidity buffers and capital. As per the FED, since the financial crisis of 2007-2008, U.S. bank holding companies have built a substantial level of capital and liquidity, which exceeds the minimum and buffers suggested by the regulator, and could be now utilised to lend credits to the households and businesses.

Reserve Requirement

In January 2019, the Federal Reserve implemented monetary policy in an ample reserves regime, which as per the FED does not play a substantial role in the operating framework; thus,

• The Board decided to reduce the reserve requirement ratios to zero per cent effective on 26 March 2020, which marks the starting of the next reserve maintenance period.

Not just in enhancing the credit limit to households and businesses, the Federal Reserve seems to be working on the Provision of U.S. dollar liquidity enhancement.

Collaborative Actions of Central Banks to Increase Dollar Liquidity

The United States Federal Reserve and central banks such as the Bank of Canada, the Bank of England, the Bank of Japan, and many others announced a coordinated action in order to boost the dollar liquidity, i.e., the U.S. dollar liquidity swap line arrangements.

All those central banks on arrangement have decided upon lowering the standing U.S. dollar liquidity swap by 25 bps in order to set the new rate to the U.S. dollar overnight index swap plus a spread of 25 bps, which the Federal Reserve assesses would increase the swap lines' effectiveness in providing term liquidity.

In the wake of booster provided by the Federal Reserve, the dollar index is seeming to be recovering from its recent low of 94.65 (3 March 2020) to the recent high of 98.91 (as on 13 March 2020), up by 4.50 per cent. However, presently the index is trading slightly lower from its recent high of 98.91 at 98.00 (as on 16 March 2020 7:24 PM AEDT).

The recent actions and collaborative work between various central banks are an ongoing effort to stabilise the economy, which tumbled considerably due to the impact of the COVID-19 outbreak.

However, despite many such actions to spur economic activities, the commodity market is not showing any relief.

To Know More, Do Read: Central Banks Draw Rate Cut Card to Spur Demand as World Grapples COVID-19, Commodities to Shine?

Whilst the coronavirus outbreak is one thing, which is keeping the demand for oil in check, the rising supply from the non-OPEC countries cannot be ignored, and it is adding considerable pressure on the oil price.

In its recent 178^th Extraordinary meeting, some of the OPEC members decided and currently securing consent from other members to slash the production by another 1.5 million barrels per day till the end of the year 2020.

However, many independent analysts still anticipate that these short-term measures by OPEC such as production cut would not dictate the oil price, and the price would largely be derived by the demand factors, as the market is not concerned about the supply due to the rising production capacity of non-OPEC oil-producing countries such as the United States.

The United States recently reached a record high domestic production capacity of 13.00 million barrels per day, and many other non-OPEC countries are following the suit.

To Know More, Do Read: The Oil Spill: U.S. Refineries Pullback Production as Acquisition Cost Surmounts and Demand Tumbles

It should also be noticed by investors, that while this section of the energy market is relatively under pressure due to the COVID-19 outbreak, other sectors of the energy industry such as Solar Energy is relatively dodging the impact of the virus outbreak and marking record high installation across the continent.

To Know More, Do Read: Rooftop Solar PVs Dodge the COVID-19 Impact as New Installations Set Records

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