The recent turmoil in global markets triggered by the reversal of yen carry trades serves as a reminder that volatility and risk are never far away. At the end of an economic cycle and the beginning of a rate-cutting cycle, it is a time when growth slows down and monetary policy experiences a "gap," making it prone to fluctuations. The recent resurgence of concerns about a U.S. recession has also increased market worries about the Federal Reserve's late response ("Basis for Recession Judgment and Historical Experience"), and when combined with sentiment and trading factors, it is even more likely to cause instability ("New Issues of Carry Trade and Liquidity Shock"). The "false alarms" of Silicon Valley Bank at the beginning of 2023 and the UK pension crisis at the end of 2022 are still fresh in our minds, and the pandemic in 2020 and the financial crisis in 2008 severely impacted the global economy and financial system. However, there were also "minor setbacks" such as the credit bond and market crash at the end of 2018, and the reserve shortage at the end of 2019.
As the most important monetary authority in the global financial system, the Federal Reserve's seemingly "formulaic" rate cuts and liquidity injections in response to each crisis actually have "a lot to say." The significance of discussing this issue lies in the fact that only by understanding the different problems at different stages can we determine which policies can truly be effective, such as whether it is a pure growth issue (income statement), a liquidity shock (cash flow statement), or a debt crisis (balance sheet); or whether the problem lies within the banking system, non-bank institutions, or non-financial corporations and residents, because the effectiveness of policies depends on being "timely" and "targeted."
In this article, we discuss the Federal Reserve's strategies and effectiveness in dealing with potential future fluctuations (such as recession risks, liquidity shocks, or credit issues) by analyzing the sources of risk, sorting out the ways the Federal Reserve has responded to crises in the past, different policy toolkits, and how to monitor risks.
Abstract
Sources of Problems: Growth Pressure (Income Statement), Liquidity Shock (Cash Flow Statement), Debt Crisis (Balance Sheet)
Downward growth, liquidity shocks, and debt crises are different "troubles" that may be encountered in an economic cycle, corresponding to the "three statements." The income statement depicts the strength of demand, the cash flow statement portrays the ease of obtaining funds, and the balance sheet shows the solvency and leverage level. In extreme cases, they correspond to recession, liquidity squeeze, and debt crisis, respectively.
Although the reality is not so clear-cut, the measures to deal with the above three types of problems are quite different: 1) Income statement issues: Whether it is high inflation caused by excessive demand or recession caused by weak demand, it is essentially a seesaw between financing costs and investment returns. Therefore, the Federal Reserve can influence financial institutions' costs by adjusting policy rates and then transmit it to the real sector to solve the problem, such as the conventional rate cuts in 1994 or 2019, which are somewhat similar to this time ("Interest Rate Cut Manual"); 2) Cash flow statement issues: Facing tight funds (financing liquidity issues) and asset sales引发的挤兑 (trading liquidity issues), the central bank needs to play the roles of the Lender of Last Resort and the Market Maker of Last Resort through unconventional operations of injecting liquidity (providing liquidity or direct asset purchases) to prevent liquidity shocks from evolving into larger-scale balance sheet crises. These operations generally work, such as the reserve shortage in 2019, the pandemic in 2020, the crisis of small and medium banks in 2023, and the recent yen carry trade; 3) Balance sheet issues: Facing debt problems caused by high leverage, monetary policy can provide liquidity but cannot resolve debt, requiring fiscal support and debt restructuring, such as the savings and loan crisis and the financial crisis in 2008.
How to solve different problems? Detailed explanation of the Federal Reserve's unconventional policy toolkit: how to operate and whom to operate on
In dealing with the above different problems, conventional operations (raising or lowering interest rates) go without saying. In this article, we will focus on unconventional policy tools, that is, how to operate and whom to operate on? How to operate, according to whether the Federal Reserve directly holds the underlying assets, can be divided into two major types: providing liquidity (such as the BTFP during the Silicon Valley Bank period) and direct purchases (QE or balance sheet expansion), corresponding to the Federal Reserve's roles as the Lender of Last Resort and the Market Maker of Last Resort.
Whom to operate on, the Federal Reserve needs to "directly take the field" and "prescribe the right medicine" to solve problems in abnormal situations where liquidity and credit transmission are not smooth. Specifically:► Primary Dealers: Counterparties to the Federal Reserve, influencing the liquidity of the financial system. Primary dealers (usually qualified commercial or investment banks) are the trading counterparts of the Federal Reserve's monetary policy and can participate in Treasury auctions, also acting as market makers. As the starting point of the transmission channel for the Federal Reserve's monetary policy, the liquidity condition of primary dealers affects all segments of the entire market. Therefore, unconventional operations are usually conducted when the entire financial system is under stress, with asset purchases (QE) and Primary Dealer Credit Facilities (PDCF) being implemented in 2008 and 2020. Additionally, in 2019, when reserves were tight, the Federal Reserve conducted large-scale overnight repos and Treasury purchases (balance sheet expansion) to address liquidity shocks caused by a lack of reserves.
► General Financial Institutions: The Federal Reserve directly participates in financing activities for small and medium-sized banks and shadow banks. Other financial institutions include deposit institutions that are not primary dealers and shadow banks. Even if the liquidity of primary dealers is guaranteed, a broad risk aversion sentiment may also prevent liquidity from being passed down. Other financial institutions, unable to obtain liquidity through normal channels, also require timely intervention by the Federal Reserve to prevent the spread, such as in 2020 and 2023. In 2020, the crisis caused by the pandemic did not directly impact large U.S. financial institutions as in 2008, but the risks to the real economy led to difficulties in the money market. The Federal Reserve introduced the Commercial Paper Funding Facility (CPFF) and the Money Market Investor Funding Facility (MMIFF) to reduce the default risk of short-term bills like commercial paper to stabilize the money market. In 2023, during the turmoil of small and medium-sized banks, the Federal Reserve introduced the Bank Term Funding Program (BTFP) to provide more lenient loan terms for small and medium-sized banks.
► Non-financial Corporate and Household Sectors: When liquidity cannot be transmitted from financial institutions to the real economy, the Federal Reserve directly intervenes. Unlike the 2008 financial crisis that impacted financial institutions, during the 2020 pandemic, businesses and households were the first to be affected, experiencing a shock to their cash flow statements. In the face of insufficient willingness from banks to lend and a significant expansion of bond credit spreads, the Federal Reserve expanded its traditional role as the lender of last resort, directly providing support to businesses and households. For example, during the 2020 pandemic, the Federal Reserve introduced the Primary and Secondary Market Corporate Credit Facilities (PMCCF & SMCCF), directly purchasing bonds and ETFs; as well as the Main Street Lending Program (MSLP), the Commercial Paper Funding Facility (CPFF), and the Term Asset-Backed Securities Loan Facility (TALF) to directly provide short-term financing liquidity support to small and medium-sized enterprises and consumers to alleviate the impact of the pandemic, stabilizing employment, consumption, and production.
► Offshore Markets: Addressing global dollar liquidity tensions. Due to the special status of the U.S. dollar in the global market, the Federal Reserve has established global dollar liquidity facilities to provide dollar liquidity support to other monetary authorities when offshore dollars are tight, preventing the spread of offshore dollar liquidity risks. For example, in 2008 and 2020, dollar liquidity swaps were established. On the basis of the five permanent major central banks (Canada, the United Kingdom, Japan, Switzerland, and the European Central Bank), the Federal Reserve added swap agreements with nine other central banks during the pandemic. At the same time, the Federal Reserve's newly established repurchase facility for foreign and international monetary authorities during the pandemic provided dollar liquidity to more countries and became a permanent facility on July 28, 2021.
Review of Past Crises: What Issues Arose in Different Crises and How Did the Federal Reserve Respond?
In this section, we review the main crises since the 1970s and the Federal Reserve's responses. It should be noted that before the 2008 financial crisis, the Federal Reserve's policy tools were mainly the discount window and were not abundant. However, after the financial crisis, the Federal Reserve became more adept at using unconventional policy tools. Specifically:
► Primary Dealers and Deposit Institutions: 1) 2008 Financial Crisis: After the real estate bubble burst, the banking industry, which held a large amount of subprime mortgages and mortgage loans, saw a significant reduction in assets, and interbank liquidity was clearly impacted. At the beginning of the financial crisis, the Federal Reserve introduced a series of unconventional policy tools for primary dealers and deposit institutions, such as the Primary Dealer Credit Facility (PDCF) and the Term Auction Facility (TAF), which effectively alleviated local pressures in the interbank market. 2) 2019 "Money Crunch": The combination of quarterly tax payments, increased bond issuance, and a shortage of reserves led to a liquidity shock in the money market, causing a surge in repo rates, and the effective federal funds rate also temporarily exceeded the Federal Reserve's target upper limit. The Federal Reserve conducted repo operations totaling $75 billion in liquidity and made technical adjustments to the interest rate corridor to alleviate liquidity tensions in the repo market, while also expanding its balance sheet (purchasing short-term debt) to replenish bank reserves.
► Other Financial Institutions: 1) 2008 Redemption Pressure: In 2008, as the risks in the banking system spread and Lehman Brothers went bankrupt, fluctuations in the commercial paper market led to significant panic and selling pressure on money market funds. The Federal Reserve introduced unconventional tools such as the Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility (AMLF) and the Money Market Investor Funding Facility (MMIFF) to stabilize market sentiment and alleviate redemption pressure. 2) 2020 Redemption Pressure: The outbreak of the pandemic led to a significant drop in the prices of risky assets, which in turn led to large-scale product redemptions and futures margin calls. The Federal Reserve introduced the Money Market Mutual Fund Liquidity Facility (MMLF) to alleviate the concentrated redemption pressure it faced. 3) 2023 Small and Medium-Sized Bank Crisis: After the Silicon Valley Bank crisis, the Federal Reserve introduced the Bank Term Funding Program (BTFP), allowing qualified financial institutions to obtain loans with a term of up to one year, secured by collateral at face value, to avoid liquidity tensions caused by runs and falling asset values.
► Corporate and Household Sectors: 1) 2008 Balance Sheet Recession Pressure. The bursting of the real estate bubble led to a significant reduction in private sector assets. The Federal Reserve introduced the Term Asset-Backed Securities Loan Facility (TALF) to support credit流向 consumers and businesses and stimulate consumption to promote recovery. 2) In 2020, the pandemic impacted the real economy, with non-financial corporate cash flows under pressure and financing conditions significantly rising. The Federal Reserve used a series of unconventional policy tools to directly purchase investment-grade bonds and related ETFs to help stabilize the market and provide short-term liquidity support to small and medium-sized enterprises to promote economic recovery.
How to Identify Problems? A Five-Dimensional Indicator System for Monitoring Liquidity at Different LevelsMeasuring the liquidity of the U.S. financial market can be approached from five dimensions: central bank injections, the financial system, capital markets, the corporate sector, and the offshore market. These dimensions depict the liquidity conditions at different levels within the monetary transmission path mentioned in the text. Specifically: 1) The central bank financial liquidity indicator (Federal Reserve liabilities - Treasury General Account - Reverse Repo, approximately equal to the scale of commercial bank reserves) measures the impact of the Federal Reserve and fiscal policy on the liquidity of the financial system from a "quantity" perspective. This indicator also has a good predictive effect on the medium-term trend of the U.S. stock market ("U.S. Liquidity May Be Facing an Inflection Point"); 2) The OIS-SOFR spread represents the liquidity tension between the U.S. banking system; 3) Investment-grade and high-yield credit spreads, as well as financial and non-financial commercial paper spreads, can measure the cost of corporate financing; 4) The U.S. stock market VIX and U.S. Treasury MOVE indicators measure asset price volatility; 5) Major currency cross-currency swaps with the U.S. dollar depict the tightness of offshore U.S. dollars. We have organized 13 indicators from the above five dimensions in Chart 26 for investors' reference.
Current situation? Slowing down but not a deep recession, controllable liquidity shock, and not much leverage pressure.
Firstly, looking at the cash flow statement, the recent reversal of the yen carry trade has more to do with localized liquidity shocks, and there has been no systemic U.S. dollar liquidity tension (which is often reflected in a strong dollar, rising OIS and commercial paper spreads, widening currency cross-currency swaps, leading to "indiscriminate" asset sales, including gold and U.S. Treasuries, as was the case during the 2020 pandemic). Secondly, from the balance sheet perspective, thanks to the government's leverage helping residents deleverage, the balance sheets of the U.S. private sector are also relatively healthy, significantly lower than the level during the 2008 financial crisis, which is the core reason why there is no systemic risk currently. Thirdly, from the income statement perspective, the U.S. growth is slowing down, but there is no pressure of a deep recession ("Basis for Recession Judgment and Historical Experience"), thanks to higher investment returns that can withstand higher interest rates, and the hedging effects provided by different segments, so the current problem can be solved by a small rate cut. Even if there is a shock similar to the 2023 Silicon Valley Bank, the Federal Reserve has ample means to quickly provide liquidity to weak links to calm market fluctuations and prevent the crisis from spreading further.
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Sources of risk and problems: growth pressure, liquidity shock, and debt crisis
Looking back at historical experience, growth pressure, liquidity shock, and debt crisis are different "troubles" that may be encountered in an economic cycle ("Troubles" and Asset Performance Characteristics in the Later Stage of Interest Rate Hikes), which correspond to the problems in the three familiar financial statements of enterprises: the income statement, the cash flow statement (financing cash flow and investment cash flow), and the balance sheet; the income statement reflects the strength of demand, the cash flow statement depicts the ease of obtaining funds, and the balance sheet shows the solvency and leverage level. In extreme cases, they correspond to recession, liquidity squeeze, and debt crisis, respectively:
► Problems with the income statement: the seesaw between financing costs and investment returns; interest rate cuts are the main policy response. Under the background of Federal Reserve tightening, the rise in financing costs is a common problem faced by various segments such as commercial banks, non-bank financial institutions, enterprises, and residents ("Detailed Explanation of Financing Costs and Burdens of Various Departments in China and the United States"). Tightening financial conditions will lead to an overall economic contraction, weakening growth momentum, and may even trigger different degrees of recession, reflected in the decline of enterprise income statement revenue and profits. Faced with the growth downturn caused by high financing costs, the Federal Reserve can adjust policy interest rates to affect the financing costs of financial institutions, and then transmit to the real economy, such as ordinary interest rate cuts or hikes. For example, the interest rate cuts in 1994 or 2019 were quite similar to this time ("Interest Rate Cut Trading Manual"). However, the problems faced during high inflation periods may be more difficult. At that time, even if growth faces downward pressure, central banks will find it hard to turn around quickly, and overly tight monetary policies will drag the economy into a deep recession. For example, the U.S. stagflation at the end of the 1970s and the beginning of the 1980s ("Reviewing the Historical Experience of U.S. Recessions").
► Problems with the cash flow statement: liquidity tension (financing liquidity problem) and asset sales引发的挤兑 (trading liquidity problem); the central bank needs to play the role of the ultimate lender (Lender of Last Resort) and the ultimate market maker (Market Maker of Last Resort). In an environment where overall financing costs are rising, if there is an excessive exposure to risks or external risk events, financial institutions or enterprises may face increased liquidity demand and financing difficulties, reflected in a shortage of financing cash flow on the cash flow statement. At that time, the Federal Reserve may need to play its traditional role as the ultimate lender to inject liquidity to avoid further spread of liquidity shocks. Generally, policy interventions are effective, such as the lack of reserves in 2019, the pandemic in 2020, the crisis of small and medium banks in 2023, and the recent yen carry trade.
In addition, the term "liquidity" can also be interpreted from the perspective of market transactions, reflecting that the concentrated sale of assets by participants in a specific market triggers a liquidity squeeze in that market. An increase in market selling pressure can even turn into a one-way market, leading to a significant drop in asset prices, manifested as pressure on investment cash flow in the cash flow statement, such as the significant sale of commercial paper assets by money market funds in 2008, which led to a surge in commercial paper spreads. At that time, the Federal Reserve needed to play the role of the ultimate market maker, stabilize market sentiment to restore liquidity, and prevent liquidity shocks from evolving into a broader asset-liability crisis. At the same time, the above-mentioned financing liquidity and trading liquidity are interconnected. Financial institutions and enterprises facing financing difficulties may need to sell assets in exchange for short-term funds, further increasing market liquidity pressure. The significant drop in asset prices caused by trading liquidity may lead to an increase in demand for financing funds, triggering a spiraling increase in pressure.
► Problems with the balance sheet: liquidity tension combined with high leverage leads to solvency problems; monetary and fiscal "dual approaches" are needed. Under the influence of liquidity shocks, if the balance sheet is relatively healthy, it may only face asset sales in exchange for liquidity, or it may lead to profit or cash flow statement problems after obtaining short-term financing at punitive interest rates. However, if there is a severe leverage pressure on the basis of liquidity tension, it will trigger a debt crisis, such as the savings and loan crisis in 1990 and the financial crisis in 2008. Faced with debt problems caused by high leverage, monetary policy can reduce the cost of repayment but only treats the symptoms, not the root cause. It needs to be combined with fiscal support and debt restructuring to achieve the final settlement, such as the savings and loan crisis and the financial crisis in 2008.The differences in risk exposure also lead to liquidity issues occurring in different localized segments, such as the commercial paper market in 1970, the stock market in 1987, the banking system and money market funds in 2008, the repurchase market in 2019, and the corporate and household sectors in 2020. Therefore, relying solely on fixed "moves" is difficult to quickly and effectively address liquidity issues in different segments, requiring the Federal Reserve, as the monetary authority, to "prescribe the right remedy" through unconventional monetary policy tools.
How to solve different problems? How does the Federal Reserve operate and on whom does it operate?
Under the traditional credit transmission channel, the Federal Reserve, as the main body of liquidity adjustment, regulates market interest rates and money supply through open market operations, thereby affecting the ability of commercial banks and other intermediaries to expand credit to the real economy. However, after the occurrence of risk events, the lack of liquidity in localized segments requires the Federal Reserve to "prescribe the right remedy" and inject liquidity in a targeted manner. Conventional operations (raising or lowering interest rates) go without saying, and in this article, we will focus on unconventional policy tools, that is, how to operate and on whom to operate?
How to operate: Providing liquidity vs. direct purchase
The essence of the Federal Reserve's series of unconventional rescue methods is the supplementation of liquidity. According to whether the Federal Reserve directly holds the underlying assets, it can be divided into two major types: providing liquidity (such as the BTFP during the Silicon Valley Bank period) and direct purchase (QE or balance sheet expansion), corresponding to the Federal Reserve's ultimate lender and ultimate market maker functions. Specifically:
► Providing liquidity: The Federal Reserve, as the ultimate lender, provides additional liquidity to the market. There are various manifestations of financing liquidity issues, including a significant increase in reverse repurchase rates for specific assets, or not accepting a certain type of asset as collateral. Under the conventional monetary policy mechanism, only depository institutions and primary dealers can get loan support from the Federal Reserve, which can provide financing loans to them through discount windows and repurchase agreements, with collateral quality requirements usually being relatively strict (such as Treasury bonds, government-guaranteed bonds, etc.). In unconventional situations, the Federal Reserve will expand conventional loans, with two specific methods: 1) Expanding the scope of subjects: When liquidity transmission is not smooth and other segments have a surge in liquidity demand, the Federal Reserve will bypass primary dealers and depository institutions and directly provide liquidity to other financial institutions or non-financial enterprises, such as the Bank Term Funding Program (BTFP) introduced in 2023 to deal with the crisis of small and medium banks; 2) Relaxing collateral quality requirements: In traditional policy tools, such as discount windows and repos, collateral requirements are usually relatively strict (such as Treasury bonds, agency MBS, etc.), but during crises, the shortage of collateral or the devaluation of collateral itself can lead to financing difficulties, so in unconventional policy tools, the Federal Reserve usually relaxes collateral quality requirements to meet more financing needs. For example, the Federal Reserve expanded the scope of collateral to corporate bonds, MBS, ABS during the 2008 crisis, and further expanded to small and medium enterprise loans during the pandemic.
► Direct purchase: The Federal Reserve, as the ultimate market maker, provides liquidity to the market by directly purchasing assets. When market selling pressure increases or even becomes a one-way market, asset prices face significant downward pressure, which may reduce the financing and market-making capabilities of financial intermediaries, affecting credit flow. At this time, the Federal Reserve usually assumes the function of the ultimate market maker, taking over the assets sold by the market, such as QE initiated during the 2008 financial crisis and the 2020 pandemic, and purchasing Treasury bonds (balance sheet expansion) in 2019 to deal with the "money shortage."
On whom to operate: In unconventional situations, "directly entering the field" to "prescribe the right remedy"
The rescue targets of the Federal Reserve's unconventional monetary policy correspond to different segments of the credit transmission mechanism. After the 2008 financial crisis, the Federal Reserve was no longer limited to the traditional ultimate lender framework of injecting liquidity into primary dealers and depository institutions, but instead took steps to find the segments that were truly problematic. The liquidity rescue for different segments also shows certain differences, specifically:
► Primary dealers and depository institutions: The Federal Reserve's trading counterparts affect the liquidity of the financial system. Primary dealers (usually some qualified commercial banks or investment banks) are the Federal Reserve's monetary policy trading counterparts, can participate in Treasury auctions, and also act as market makers. Under the traditional lender of last resort framework, primary dealers and depository institutions are the main targets of the Federal Reserve's liquidity injection. On the basis of having conventional repurchase tools and discount windows (primary dealers cannot participate in discount windows) and other conventional operations, more innovative monetary policy tools mainly provide additional liquidity beyond conventional financing liquidity by relaxing collateral requirements and extending loan terms. As the starting point of the Federal Reserve's monetary policy transmission channel, the liquidity status of primary dealers affects all segments of the market, so unconventional operations are usually carried out when the entire financial system is under pressure. Both in 2008 and 2020, operations such as asset purchases (QE) and Primary Dealer Credit Facilities (PDCF) for primary dealers were implemented. In addition, during the 2019 money market crisis, the Federal Reserve conducted large-scale overnight repurchase and Treasury bond purchases (balance sheet expansion) to deal with the liquidity shock caused by insufficient reserves.► General Financial Institutions: The Federal Reserve directly participates in financing activities for small and medium-sized banks and shadow banks. Other financial institutions include deposit institutions that are not primary dealers and shadow banks. Even if the liquidity of primary dealers is still guaranteed, a broad risk aversion sentiment may also prevent liquidity from flowing downwards. Other financial institutions cannot obtain liquidity through normal channels and also need the Federal Reserve to intervene in a timely manner to block the spread, such as in 2020 and 2023. In 2020, the crisis caused by the pandemic did not directly impact large U.S. financial institutions as in 2008, but the risks in the real economy led to difficulties in the money market. The Federal Reserve introduced the Commercial Paper Funding Facility (CPFF) and the Money Market Mutual Fund Liquidity Facility (MMMFs) to reduce the default risk of short-term bills such as commercial paper and stabilize the money market. In 2023, during the turmoil of small and medium-sized banks, the Federal Reserve introduced the Bank Term Funding Program (BTFP) tool to provide more relaxed borrowing conditions for small and medium-sized banks.
► Non-financial Enterprises and Household Sectors: When liquidity cannot be transmitted from financial institutions to the real economy, the Federal Reserve directly intervenes. Unlike the 2008 financial crisis that impacted financial institutions, 2020 was a typical cash flow shock, with enterprises and residents becoming the first "victims". In the face of insufficient bank lending willingness and a significant expansion of bond credit spreads, the Federal Reserve expanded its traditional role as a lender of last resort, directly providing support to businesses, residents, and others. For example, during the 2020 pandemic, the Federal Reserve introduced the Primary and Secondary Market Corporate Credit Facilities (PMCCF & SMCCF), directly purchasing bonds and ETFs; as well as the Main Street Lending Program (MSLP), the Commercial Paper Funding Facility (CPFF), and the Term Asset-Backed Securities Loan Facility (TALF) to directly provide short-term financing liquidity support to small and medium-sized enterprises and consumers to alleviate the impact of the pandemic, stabilize employment, consumption, and production.
► Offshore Market: Responding to global dollar liquidity tensions. Due to the special status of the U.S. dollar in the global market, the Federal Reserve also has central bank liquidity swaps and the Foreign and International Monetary Authorities Repo Facility (FIMA) global dollar liquidity tools to provide dollar liquidity support to other monetary authorities when offshore dollar liquidity is tight, preventing the spread of offshore dollar liquidity risks. For example, both in 2008 and 2020, dollar liquidity swaps were established. On the basis of the five permanent major central banks (Canada, the United Kingdom, Japan, Switzerland, the European Central Bank), the Federal Reserve added swap agreements with nine other central banks during the pandemic. At the same time, the Foreign and International Monetary Authorities Repo Facility newly established by the Federal Reserve during the pandemic provided dollar liquidity to more countries and has become a permanent facility as of July 28, 2021.
It is also worth noting that the counterparty of the Federal Reserve's unconventional monetary policy is not necessarily the actual rescue object of the Federal Reserve. For example, in 2008, the Federal Reserve introduced the Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility (AMLF) to alleviate the redemption pressure of money market funds and help stabilize the selling pressure of the commercial paper market. However, it was actually achieved by providing loans to deposit institutions to purchase asset-backed commercial paper, so when analyzing the Federal Reserve's monetary policy, it is more important to discover the essence of liquidity injection.
Crisis experience review: What went wrong in which links? How did the Federal Reserve respond?
We reviewed the ins and outs of liquidity shock events experienced by the United States since the second half of the last century, including the 1970 Pennsylvania Central Railroad bankruptcy, the 1987 "Black Monday," the 1998 LTCM event, the 2008 financial crisis, the 2019 repurchase market, and the 2020 pandemic, focusing on the use and effectiveness of the Federal Reserve's monetary policy. Before the 2008 financial crisis, the Federal Reserve's tools for dealing with risk events and liquidity shocks were not abundant, mainly relying on the discount window. However, after the financial crisis, the Federal Reserve became more "proficient" in the use of unconventional policy tools. Specifically:
► Primary Dealers and Deposit Institutions: 1) 2008 Financial Crisis: After the real estate bubble burst, the banking industry, which held a large amount of subprime mortgages and mortgage loans, saw a significant reduction in assets, and interbank liquidity was obviously impacted. At the beginning of the financial crisis, the Federal Reserve introduced a series of unconventional policy tools for primary dealers and deposit institutions, such as the Primary Dealer Credit Facility (PDCF) and the Term Auction Facility (TAF), which effectively alleviated local pressure in the interbank market. 2) 2019 "Money Crunch": The triple factors of quarterly tax payments, increased bond issuance scale, and reserve shortages together led to a liquidity shock in the money market, causing a surge in repurchase rates, and the effective federal funds rate also broke through the Federal Reserve's target upper limit at one time. The Federal Reserve conducted a total of $75 billion in repurchase injections to alleviate liquidity tension in the repurchase market and started asset purchases to supplement bank reserves.
► Other Financial Institutions: 1) 2008 Redemption Pressure: In 2008, as the risks in the banking system spread and Lehman Brothers went bankrupt, fluctuations in the commercial paper market led to a significant degree of panic and selling pressure on money market funds. The Federal Reserve introduced unconventional tools such as the Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility (AMLF) and the Money Market Investor Funding Facility (MMIFF) to stabilize market sentiment and alleviate redemption pressure. 2) 2020 Redemption Pressure: The outbreak of the pandemic led to a sharp drop in the prices of risky assets, which in turn led to large-scale product redemptions and futures margin calls. The Federal Reserve introduced the Money Market Mutual Fund Liquidity Facility (MMLF) to alleviate the concentrated redemption pressure it faced. 3) 2023 Small and Medium-sized Bank Crisis: After the Silicon Valley Bank crisis, the Federal Reserve introduced the Bank Term Funding Program (BTFP), allowing qualified financial institutions to obtain loans up to one year with collateral face value as a guarantee, thereby avoiding liquidity tension caused by runs and asset value declines.
► Enterprises and Household Sectors: 1) 2008 Balance Sheet Recession Pressure. The bursting of the real estate bubble led to a significant reduction in private sector assets. The Federal Reserve introduced the Term Asset-Backed Securities Loan Facility (TALF) to support credit流向 consumers and businesses, stimulating consumption and promoting recovery. 2) The 2020 pandemic impacted the real economy, with non-financial enterprises facing tight cash flows and a significant increase in financing conditions. The Federal Reserve used a series of unconventional policy tools to directly purchase investment-grade bonds and related ETFs to help the market stabilize and provide short-term liquidity support to small and medium-sized enterprises to promote economic recovery.
Three liquidity shocks in the second half of the 20th century: 1970, 1987, and 1998The liquidity shock in the commercial paper market triggered by the bankruptcy of the Pennsylvania Central Railroad in 1970 led to difficulties in short-term corporate financing, and the Federal Reserve released liquidity through the discount window. The Pennsylvania Central Transportation Company was the largest railway company in the United States at the time, controlling over 20,000 miles of railway network and about one-eighth of the national freight volume. The Pennsylvania Central Railroad was formed in February 1968 by the merger of the New York Central Railroad and the Pennsylvania Railroad, with assets exceeding $6.5 billion. However, due to poor management and operation, the company suffered consecutive losses, forcing it to rely on high-interest commercial paper issuance. Ultimately, it filed for bankruptcy due to insufficient cash flow, and the default of $87 million in commercial paper caused a significant shock to the market at that time, significantly impacting market confidence and creating difficulties for corporate short-term financing. Eventually, the Federal Reserve provided funds to banks through the discount window, which in turn provided loans to companies unable to obtain financing in the commercial paper market, thus alleviating the corporate financing difficulties.
The "Black Monday" stock market crash in 1987 led to significant asset price fluctuations and liquidity tension, prompting the Federal Reserve to intervene to prevent an economic recession. On October 19, 1987, the Dow Jones Industrial Average plummeted by 22.6%. The reasons for this event included programmed trading, portfolio insurance, and panic sentiment. In response, the Federal Reserve injected $17 billion in liquidity into the market through open market operations, encouraged commercial banks to release liquidity for financial market participants, and provided loans to commercial banks through the discount window.
The 1997-1998 Asian financial crisis led to huge losses for LTCM, and the high exposure of other financial institutions to it led to the spread of risks. The Asian financial crisis broke out in 1997, with some economies in the region experiencing a sharp decline in growth. The following year, the Russian ruble devalued and stopped repaying debts, causing huge losses to the investment strategies of the U.S. Long-Term Capital Management (LTCM). Since many large Wall Street banks and investment institutions had related businesses with LTCM, and LTCM had accumulated a large number of positions through leverage, the LTCM issue quickly triggered market liquidity risks. To prevent a broader financial crisis, the Federal Reserve announced an emergency reduction of 25 basis points in the federal funds rate in September of that year. Before the financial crisis, the Federal Reserve did not have a systematic framework for dealing with financial risks, but to alleviate the potential risk spread caused by the LTCM incident, the Federal Reserve led a consortium of 14 banks to acquire LTCM for $3.6 billion to prevent possible systemic financial risks.
Looking at the three liquidity events that occurred in the second half of the 20th century, the Federal Reserve's response to crises was relatively "naive," heavily relying on conventional discount window tools. For example, during the 1970s, when the bankruptcy of the Pennsylvania Central Railroad caused fluctuations in the commercial paper market, the Federal Reserve still provided liquidity to banks through the traditional credit transmission channel of the discount window, without directly addressing the root of the problem, which to some extent "complicated" the issue.
The 2008 financial crisis: high leverage and a crisis dominated by financial institutions
Bank liquidity shortage, with the Federal Reserve providing additional liquidity supplementation
Subprime products defaulted on a large scale, and market panic sentiment fermented; the Federal Reserve provided liquidity support to primary dealers and the banking system. In July 2007, Bear Stearns announced the liquidation of two hedge funds invested in mortgage-backed securities, causing widespread concern in the market. As the main channel for deposit institutions to seek liquidity support from the Federal Reserve, ten days after the Federal Reserve announced that the federal funds target rate would remain unchanged on August 17, the Federal Reserve reduced the financing rate of the discount window (main discount window rate, Primary Credit Discount Window Facility) by 50 basis points to 5.75%, and introduced the Term Discount Window Program (TDWP) in September, extending the loan term of the discount window and further reducing the rate by 50 basis points; However, the liquidity problem was not completely resolved, and the liquidity problem in the financial system gradually affected the real economy. The liquidity tension between banks tightened financial conditions, and the economy quickly contracted within a few months. In January 2008, the Federal Reserve reduced the federal funds rate by 75 basis points at one time. In March, the liquidity problem further escalated, and Bear Stearns encountered significant liquidity problems. Since the traditional discount window could only be used by deposit institutions, and Bear Stearns, as an investment bank, was not included, the Federal Reserve urgently introduced two liquidity support tools for primary dealers, including the Primary Dealer Credit Facility (PDCF) and the Term Securities Lending Facility (TSLF), allowing the Federal Reserve to provide loans to primary dealers and expand the scope of available loan collateral. At the same time, to address the inactive volume of the discount window for deposit institutions, the Federal Reserve introduced the Term Auction Facility (TAF), providing liquidity loans to deposit institutions at the best interest rates through auction methods, which temporarily eased market tensions.
Commercial paper defaults triggered a wave of redemptions in money market funds, stabilizing the money market to alleviate corporate short-term financing pressure
Lehman Brothers went bankrupt, and the risk in the financial system further spread. The Federal Reserve's policy tools were no longer limited to the traditional ultimate lender framework and began to provide direct support to other segments of the financial system. With the U.S. government announcing in September that it would take over the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac), the risk of the financial crisis was exposed to its peak, and the Libor spread soared rapidly; Lehman Brothers also faced a solvency crisis. The U.S. Treasury and the Federal Reserve, worried about the "moral hazard" that might arise from bailing out Lehman Brothers, did not bail it out like they did with "the two houses." Lehman Brothers went bankrupt on September 15, 2008, its commercial paper was significantly devalued, the money market fluctuated strongly, and the $6.26 billion Reserve Primary Money Fund's net asset value fell below $1 (Broke the buck). The Federal Reserve urgently introduced the Asset-Backed Commercial Paper Money Market Mutual Fund Liquidity Facility (AMLF), allowing deposit institutions to obtain loans with ABCP as collateral, thereby increasing the liquidity of the commercial paper market to indirectly assist money market funds in meeting investors' potential redemption needs. The U.S. Treasury also announced a temporary guarantee plan at the same time, providing $50 billion from the Exchange Stabilization Fund to guarantee investment funds in money market funds. In October, the Federal Reserve added the Money Market Investor Funding Facility (MMIFF) to directly purchase qualified assets (such as commercial paper) from qualified market investors (such as money market funds) through the establishment of SPVs, further improving the market's tradable liquidity problems and easing market tensions.
Supporting the repair of household and corporate balance sheetsThe liquidity crisis continues to ferment, with the economy falling into a balance sheet recession, prompting active rescue efforts from the Federal Reserve, the Treasury Department, and international organizations. The momentum for economic growth is being depleted amidst ongoing issues in the financial system. In October 2008, then-President Bush signed the Emergency Economic Stabilization Act of 2008, officially establishing the Troubled Asset Relief Program (TARP). To stimulate economic recovery, the Federal Reserve embarked on the path of quantitative easing (QE) in November, aggressively purchasing long-term Treasury bonds and other assets to lower long-term interest rates and facilitate the repair of economic activity. Additionally, the Federal Reserve reintroduced the Term Asset-Backed Securities Loan Facility (TALF) to alleviate liquidity issues for businesses and households, effectively boosting commercial banks' willingness to lend to households.
In the 2019 repurchase market: a temporary liquidity shock due to insufficient reserve assets
Quarterly tax payments, an increase in bond issuance, and a shortage of reserves contributed to a liquidity shock in the money market. On September 16, 2019, the federal funds market and the overnight secured financing rates (EFFR and SOFR) rose by 13 and 11 basis points, respectively, compared to the previous trading day, and further widened on the 17th. The EFFR breached the upper limit of the federal funds target rate (2.25%), and SOFR even temporarily exceeded 9% (closing at 5.25% that day). The main reasons were threefold: 1) Corporate quarterly tax payments: September 16 was the deadline for corporate quarterly tax payments, with businesses withdrawing liquid funds from money market funds and the banking system to pay taxes to the Treasury, which stored the funds in the TGA account at the Federal Reserve, leading to outflow pressure on money market funds; 2) An increase in bond issuance, leading to increased financing needs for primary dealers purchasing Treasury bonds: On the same day, the settlement of $54 billion in long-term Treasury bonds in the United States led to a significant increase in financing needs for primary dealers who purchased these bonds through the repurchase market; 3) The normalization of the Federal Reserve's balance sheet led to a reduction in reserves: As the Federal Reserve began the process of normalizing its balance sheet in October 2017, combined with a large issuance of Treasury bonds, banks held an increasing amount of Treasury bonds, while reserves within the banking system continued to decrease. In mid-September 2019, reserves in the banking system fell to their lowest point since 2011, reflecting a shortage of short-term liquidity.
The Federal Reserve alleviated money market liquidity pressure through repurchase agreements, asset purchases, and technical adjustments to interest rates. Given the importance of the money market to the U.S. financial system and liquidity transmission, the Federal Reserve responded quickly to this liquidity shock, starting on September 17 by providing $75 billion per trading day to the overnight repurchase market. Concurrently, following a 25 basis point rate cut in July, the Federal Reserve cut rates by another 25 basis points to a range of 1.5% to 1.75% at the September 18 FOMC meeting. The day after the FOMC meeting, the Federal Reserve made technical adjustments to the interest on excess reserves (IOER) and the overnight reverse repurchase rate (ONRRP), lowering both by 5 basis points, reducing the risk of the federal funds rate exceeding the upper limit of the range. Subsequently, the repurchase market gradually stabilized. On October 11, to alleviate the shortage of reserves in the banking system, the Federal Reserve announced it would purchase Treasury bonds at a rate of about $60 billion per month until the second quarter of 2020.
In 2020, the economic impact of the pandemic led to a cash flow crisis for businesses as economic activities were frozen. Panic spread rapidly after the outbreak of COVID-19, and the Federal Reserve made emergency rate cuts and introduced various liquidity tools for depository institutions, but the effects were not significant. On February 29, 2020, Federal Reserve Chairman Powell stated that he was closely monitoring the potential economic impact of the pandemic and considering the use of policy tools to support the economy. A few days later, the Federal Reserve held an emergency meeting and announced a 50 basis point cut in the federal funds rate. However, market panic was not effectively alleviated, and on March 9, 12, and 16, the U.S. stock market triggered a first-level circuit breaker and trading was suspended three times. At the same time, as the pandemic's impact and policy restrictions on outdoor activities and consumption took effect, economic activities came to a standstill. On March 15, the Federal Reserve's FOMC meeting announced a one-time cut of 100 basis points in the federal funds rate and reduced the reserve rate to 0%. On March 17, the Federal Reserve restarted the Primary Dealer Credit Facility to inject liquidity into financial institutions, but this did not directly address the core issue. As mentioned earlier, even if financial institutions have liquidity, they have no incentive to provide credit and liquidity support to non-financial businesses in distress, known as "liquidity tiering."
Stabilizing the short-term money market to prevent technical bankruptcy of businesses
The U.S. money market faced significant risks as investors began to redeem money market funds to obtain the most liquid cash. The underlying assets of these funds are usually commercial paper and other short-term bonds. Commercial paper is a primary short-term financing tool for non-financial businesses to pay employee salaries, health insurance, and suppliers. The spread on commercial paper rose rapidly, even exceeding levels seen during the financial crisis, increasing the pressure on corporate financing and the selling of commercial paper. A failure in the commercial paper market could lead to even high-quality businesses facing technical defaults and bankruptcy, impacting the real economy. On March 17 and 18, 2020, the Federal Reserve introduced the Commercial Paper Funding Facility (CPFF) and the Money Market Mutual Fund Liquidity Facility (MMLF). On March 17, the Primary Dealer Credit Facility (PDCF) was established to provide fully collateralized loans to primary dealers. After the policies were announced, risks in the money market eased, and the usage of the aforementioned tools also declined from their peaks.
Direct support for households, businesses, and local government credit
The Federal Reserve announced its commitment to support the economy by directly providing liquidity support to the business sector, leading to a rebound in market confidence. Credit risks soared, and liquidity in the money market was difficult to transmit to the real economy, with businesses, especially small and medium-sized enterprises, facing a credit crisis. To support credit in the real economy, with the approval of the U.S. Treasury Secretary (the Treasury's CAREs Act provided nearly $200 billion in funding), the Federal Reserve directly provided support to businesses, residents, and others. On March 23, the Federal Reserve announced the use of its full range of tools to support the economy, launching four major measures that day, including unlimited QE, establishing two tools to support large corporate credit, restarting TALF, and expanding the scope of MMLF and CPFF. The Primary and Secondary Market Corporate Credit Facilities (PMCCF & SMCCF) established by the Federal Reserve were used to purchase new bonds or loans issued in the primary market and to provide liquidity for the repayment of corporate bonds in the secondary market, supporting businesses affected by the pandemic and under credit pressure. These tools effectively addressed the crux of the liquidity issues in the United States at the time. Although the actual usage of these policies was limited, they played a significant role in boosting market confidence.During the pandemic, the Federal Reserve expanded its liquidity support to states, cities, and counties for the first time. The impact of the pandemic led to a significant increase in public health and social service expenditures at the municipal level, while tax revenues plummeted, putting local governments under severe financial pressure during the COVID-19 crisis. The Federal Reserve introduced the Municipal Liquidity Facility (MLF) to purchase short-term notes, enhancing the liquidity of municipal bonds and ensuring that local governments have sufficient funds to maintain basic public services and avoid large-scale systemic risks.
Regulating international dollar liquidity to prevent the spread of peripheral risks
After the outbreak of the pandemic, the tension in the offshore dollar market increased. On March 15, 2020, the Federal Reserve, along with the central banks of Canada, the United Kingdom, Japan, the European Union, and the Swiss National Bank, announced that they would strengthen liquidity supply through standing dollar liquidity swap lines; on March 19, they announced the reopening of temporary swap lines with nine central banks that had reached temporary agreements during the financial crisis (Australia, Brazil, Denmark, South Korea, Mexico, Norway, New Zealand, the Monetary Authority of Singapore, and the central bank of Sweden), with the temporary lines expiring at the end of December 2021. On March 31, the Federal Reserve established a temporary foreign and international monetary authorities repurchase facility to provide dollar liquidity to more countries, which became a standing facility on July 28, 2021.
Silicon Valley Bank in 2023: Run risk exacerbates the balance sheet pressure of small and medium banks
Silicon Valley Bank announced the sale of some of its bonds and large-scale refinancing, triggering liquidity concerns. In the early morning of March 10, 2023, Beijing time, Silicon Valley Bank (SVB) announced a series of strategic updates: 1) The sale of $21 billion in bond investments and the immediate reconfiguration to shorter-duration bonds to enhance its asset sensitivity, with this sale expected to result in an after-tax loss of $1.8 billion; 2) The increase in the scale of term borrowing from $15 billion at the end of 2022 to $30 billion, in order to lock in financing costs and provide more stable liquidity support for the company; 3) Refinancing of $2.25 billion to address losses and provide liquidity support, including $1.75 billion in common stock and $500 million in preferred stock. Although the sale of AFS bonds by Silicon Valley Bank was a positive adjustment to cope with the high-interest-rate environment, the capital market focused more on SVB's investment losses and refinancing needs, leading to a significant drop in stock prices and panic accelerating the run, resulting in the bankruptcy of Silicon Valley Bank.
The Federal Reserve established the Bank Term Funding Program (BTFP) to provide short-term liquidity support. The core of the Silicon Valley Bank risk exposure lies in the liquidity issues of small and medium banks, on the one hand, there is the possible run by depositors, and on the other hand, a large amount of unrealized investment losses lead to a liquidity gap. In response to the former, the Treasury and FDIC provided deposit protection. In response to the latter, the Federal Reserve's BTFP program provided relatively ample support in terms of term and collateral conditions, with collateral applied for a one-year loan at par value (par value) rather than market value, with a rate of 1-year OIS + 10bp (currently 4.69%). Unlike direct purchases of long-end Treasury bonds and MBS in QE or "balance sheet expansion" focused on short-term debt purchases, BTFP is a short-term loan with a term to provide liquidity for financial institutions. The establishment of this tool effectively alleviated market panic, avoiding the need for banks to sell off assets in large amounts to meet withdrawal demands, and ceased issuance in March 2024.
How to identify problems? Monitoring the five major indicator systems of liquidity at different levels
Due to the large number of participants in the U.S. financial system and the complex transmission mechanisms, liquidity conditions are also multi-level (macro total and micro market), multi-market (repurchase, money fund, commercial paper, stocks, and bonds), and multi-dimensional (quantity and price). We have organized several mainstream indicators currently used to measure the liquidity or financial conditions of the U.S. market. Local Federal Reserve Banks such as the Federal Reserve Bank of St. Louis, the Federal Reserve Bank of Chicago, and the Federal Reserve Bank of Kansas City, as well as the Office of Financial Research (OFR) of the U.S. Department of the Treasury and institutions like Goldman Sachs, also have corresponding overall liquidity indicators. We have integrated their construction methods and sorted out directly observable liquidity indicators. We found that there is a strong commonality in the composition of these indicators. At the same time, based on the sorting of the liquidity transmission level, we divide the indicators into the following categories: central bank liquidity supply indicators, financial system liquidity indicators, asset price volatility indicators, corporate liquidity indicators, and offshore dollar liquidity indicators.
► Central Bank Liquidity Supply Indicators: The transmission of liquidity has a very clear logical chain. The central bank (Federal Reserve) affects the lending behavior of the financial system through price (interest rate level) and quantity (balance sheet) operations, thereby regulating non-financial enterprises and the resident sector. Therefore, judging the central bank's liquidity supply is the starting point for analyzing and monitoring liquidity. 1) Price, Federal Funds Rate: The interest rate level of the Federal Reserve's series of monetary policy tools is the most direct liquidity indicator. The focus can be on the Federal Reserve's federal funds rate, discount rate, reverse repo rate, etc. 2) Quantity, Federal Reserve Balance Sheet: After the 2008 financial crisis, the Federal Reserve started large-scale asset purchases, and the Federal Reserve's balance sheet size grew rapidly, injecting a large amount of liquidity into the market. However, it is worth noting that the changes in the Treasury General Account (TGA) and Overnight Reverse Repo (ONRRP) on the liability side of the Federal Reserve's balance sheet can play a "reverse balance sheet," affecting the liquidity effect. Therefore, a more accurate way to measure overall liquidity should be: Federal Reserve holdings of assets - TGA - reverse repo.
► Financial System Liquidity Indicators: Financial system liquidity, this link is more concerned by the market, with specific indicators including: 1) OIS-SOFR spread: The OIS rate (Overnight Interest Swap, OIS) refers to the fixed interest rate in the overnight interest rate swap contract, and the SOFR rate (Secured Overnight Financing Rate) is a widely used indicator to measure the overnight cash cost of borrowing in the repurchase agreement (repo) market with U.S. Treasury bonds as collateral, used as an alternative to LIBOR (London Interbank Offered Rate). In the OIS-SOFR swap, one party agrees to pay cash flows at a fixed interest rate, while the other party pays cash flows at the floating interest rate of SOFR. An increase in the spread usually indicates an increase in credit risk between banks and a tightening of liquidity, with the market's concerns about future liquidity increasing; 2) Repurchase market: It is the main market where fund lenders such as money market funds and banks provide liquidity and achieve short-term financing to fund borrowers such as hedge funds. Especially hedge funds usually use the repurchase market to achieve leverage purposes. For example, during the pandemic, due to the sharp drop in some financial assets and tight financial market liquidity, the repurchase market was significantly disturbed, and the willingness to lend funds decreased sharply. 3) Commercial paper spread: Commercial paper is usually issued by financial or non-financial enterprises with good credit, usually with a short term. Since money market funds are the main investors in commercial paper, changes in the commercial paper spread also reflect the liquidity of the short-term money market to a certain extent.► Asset Price Volatility Indicator: Asset price volatility is closely related to liquidity. When the market experiences tight trading liquidity, assets face selling pressure. The lenders of funds (buyers of assets) decrease, and the borrowers of funds (sellers of assets) avoid further increases in capital costs by financing at high prices (selling at low prices), leading to increased market volatility. Conversely, significant asset price fluctuations can also be a major cause of localized liquidity tension. Exposures that have not been adequately hedged against risks incur losses or require additional margin calls to avoid forced liquidation, both of which require additional liquidity, thereby increasing the cost of funds.
► Corporate Borrowing Rate Indicator: The credit spread essentially includes a portion of the liquidity premium. When overall market liquidity tightens, the credit spread for relatively high-risk assets naturally increases, reflecting investors' demand for higher returns on high-risk assets. The credit spread also reflects the financing costs of the corporate sector, indicating the liquidity situation at this stage. Commonly used indicators to measure credit spreads include the U.S. high-yield bond - 10-year U.S. Treasury bond rate and the U.S. investment-grade bond - 10-year U.S. Treasury bond rate.
► Offshore U.S. Dollar Liquidity Indicator: The cross-currency basis swap spread between major market exchange rates and the U.S. dollar is a commonly used indicator to measure offshore U.S. dollar liquidity. A widening basis spread indicates a scarcity of liquidity in the offshore U.S. dollar market.
Current Situation? Slowing but not a deep recession, controllable liquidity shock, and not much leverage pressure.
Firstly, looking at the cash flow statement, the recent reversal of the yen carry trade has more to do with localized liquidity shocks, and there has been no global dollar liquidity tightening. A global dollar liquidity shock is often manifested by a strong U.S. dollar, an increase in OIS and commercial paper spreads, and a widening of exchange rate cross-currency swaps, leading to an "indiscriminate" sell-off of assets, including gold and U.S. Treasuries, as was typical during the 2020 pandemic. However, this situation has not occurred ("New Issues of Carry Trade and Liquidity Shock").
Secondly, from the balance sheet perspective, thanks to the government's leverage helping residents deleverage, the balance sheets of the U.S. private sector are also relatively healthy, significantly lower than the level during the 2008 financial crisis, which is the core reason why there is no systemic risk currently.
Thirdly, from the income statement perspective, the U.S. growth is slowing down, but there is no pressure of a deep recession ("Basis for Recession Judgment and Historical Experience"). Thanks to higher investment returns that can withstand higher interest rates, and the hedging effects provided by different segments, the current problems can be solved by a slight rate cut. Even if there is a shock similar to the 2023 Silicon Valley Bank incident, the Federal Reserve has ample means to respond quickly, providing liquidity to weak links to calm market fluctuations and prevent the crisis from spreading further.