Stocks recovered some of their heavy losses Thursday after the U.S. Federal Reserve announced a new plan to pump $1 trillion in additional liquidity into the financial system.
“These changes are being made to address highly unusual disruptions in Treasury financing markets associated with the coronavirus outbreak,” the Fed said in a statement on Thursday afternoon.
Part of the stimulus plan involves increasing the scale of the Federal Reserve’s $60 billion in Treasury bond purchases and expanding from T-bills to purchases of bills, notes, TIPS and other instruments.
Another part of the plan involves a $500-billion, three-month and one-month repo operation that will take place on a weekly basis.
The final part of the package includes at least $175 billion in liquidity for the overnight repo market and $45 billion in stimulus for two-week operations.
Why It Matters
The term “repo” is short for repurchase agreement. Repo loans are loans taken out by small banks and hedge funds that are repaid in the short-term. These banks and hedge funds use low-risk securities, such as U.S. Treasury bonds, as collateral for the loans.
Liquidity in the U.S. repo market dropped back in September, and the Fed was forced to step in for the first time since the financial crisis in 2008.
Thursday’s stimulus package will ultimately provide up to $1.5 trillion in liquidity to the financial system in an effort to prevent the kind of credit market freeze that occurred during the financial crisis in 2008 and 2009.
The SPDR S&P 500 ETF Trust (NYSE: SPY) initially bounced following the Fed announcement, but it seems as though traders saw the bounce as a selling opportunity, as the rally was short-lived.
After rallying from 2,515 prior to the announcement to as high as 2,642, the S&P 500 was back down to 2,556 within an hour of the Fed release.
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Federal Reserve of New York photo by Beyond My Ken via Wikimedia.