If the market continues to collapse, what options does the Federal Reserve have if it cannot urgently cut interest rates?

Federal Reserve Chairman Jerome Powell and his colleagues have made it clear that they will resist the urge to cut interest rates prematurely in the face of persistent inflation above target, which undoubtedly dampens market expectations for rate cuts.

However, investors are betting that the rise in U.S. Treasury yields will trigger market volatility, ultimately forcing the Federal Reserve to take intervention measures, including relaxing bank leverage rules and injecting cash through the repurchase market, among other potential actions.

The Federal Reserve's "Patience Game"

Federal Reserve officials have recently indicated that they are moving away from a preventive rate-cutting path and adopting a more cautious stance. This shift in position has gradually taken shape against the backdrop of economic data showing persistent inflation and a still-strong labor market.

In his latest statement, Federal Reserve Chairman Powell emphasized: "We need to see more compelling evidence that inflation is indeed steadily moving toward the 2% target." He warned: "Cutting rates too early or too much could reverse the progress we have made in controlling inflation."

This stance has gained broad support within the Federal Reserve. According to Bloomberg, Federal Reserve Governor Christopher Waller recently stated, "If inflation indicators do not improve, we may need to remain patient in our policy." Meanwhile, Atlanta Fed President Raphael Bostic further delayed his rate-cut expectations, predicting only one rate cut this year, possibly extending to the fourth quarter.

Supporting the Federal Reserve's hawkish stance are recent economic data. Data from the U.S. Department of Labor showed that non-farm payrolls increased by 228,000 in March, far exceeding expectations. The unemployment rate rose slightly, while wage growth remained stable. This indicates that the U.S. labor market remains healthy despite widespread tariff shocks facing the global economy.

In terms of inflation, although the March CPI rose 2.4% year-on-year, marking the lowest level in seven months, the market generally expects this positive trend may be difficult to sustain, especially after Trump implemented comprehensive tariff policies, currently seen as "just the calm before the inflation storm."

Bloomberg quoted economists as saying, these data combinations send a clear signal to the Federal Reserve: the economy does not need immediate policy support, while inflation risks still exist.

What Other Cards Does the Federal Reserve Have to Play?

Despite the increasingly clear tough stance of Federal Reserve officials, the market is still betting on multiple rate cuts this year.

Currently, traders expect the Federal Reserve to cut rates for the first time in September and to lower rates by a total of 50 basis points by the end of the year. This is a significant reduction from the six rate cuts that the market anticipated earlier this year, but still higher than the latest dot plot expectations from Federal Reserve officials.

This expectation gap has led to increased market volatility. The yield on the U.S. 10-year Treasury bond recently surged, even briefly breaking 4.5%, reaching a recent high. The stock market also experienced a significant pullback, especially in technology stocks and other interest rate-sensitive sectors.

As U.S. Treasury yields soar, speculation is increasing that the Federal Reserve may have to take measures to stabilize the market.

The Federal Reserve still has various tools available to address market turmoil, and Barron's believes that these include relaxing bank leverage rules, injecting cash into the market through repurchase agreements, and purchasing specific types of U.S. Treasury bonds.

Relaxing SLR Rule Requirements

In terms of relaxing bank leverage rules, one solution is to temporarily modify the "Supplementary Leverage Ratio (SLR)" rules. This rule limits the risks that large banks can take on, including the amount of U.S. Treasury bonds they can hold.

The SLR requires banks' core capital (such as common equity) to cover at least 3% of their total on-balance-sheet and off-balance-sheet assets (with higher requirements for systemically important banks), regardless of the risk level of the assets. If the SLR strictly limits their asset size, dealers may reduce market-making activities (such as being unwilling to hold bond inventories) due to insufficient capital, leading to a lack of "intermediaries" in the market and exacerbating supply-demand imbalances.

During the pandemic in 2020, the Federal Reserve relaxed this regulation by temporarily excluding Treasury bonds and banks' reserves at the Federal Reserve from SLR calculations, effectively releasing banks' capital "capacity" to allow them to expand their Treasury holdings without consuming additional capital, thus creating space for banks to absorb a large amount of new government debt.

If bond dealers face a lack of balance sheet space again, the Federal Reserve may take similar measures once more. This will not affect interest rates or send any confusing economic signals; it will simply release space in the banking pipeline system.

Purchasing Specific Types of U.S. Treasury Bonds

The Federal Reserve may also begin purchasing specific types of U.S. Treasury bonds to calm particularly unstable parts of the market. However, unlike past bond purchase programs (i.e., quantitative easing), this would be a short-term, targeted initiative, a "precise fix" rather than "aggregate easing."

This is what the Bank of England did in 2022. During the pension crisis in 2022, the Bank of England stabilized the gilt market through temporary bond purchases (Targeted Long-Term Repo Operations) while continuing to raise interest rates to curb inflation, demonstrating that liquidity management tools and interest rate policies can operate independently.

The Federal Reserve could adopt a similar approach, known as a market functioning purchase programThe Federal Reserve outlined in its 2024 Financial Stability Report the specific indicators it looks for before intervening: widening bid-ask spreads (where buyers and sellers are far apart), price increases during low trading volumes, and evidence that matching buyers and sellers is becoming increasingly difficult.

Injecting Cash Through the Repo Market

Another option is for the Federal Reserve to provide loans to banks and bond dealers overnight through so-called repurchase agreements. In exchange, banks provide U.S. Treasury securities as collateral to the Federal Reserve.

A "repurchase agreement (Repo)" is an operation where the Federal Reserve provides short-term (usually overnight) loans to banks and bond dealers while accepting high-quality assets such as U.S. Treasury securities as collateral. Essentially, it is a form of collateralized financing. This measure is quick, clean, and does not affect interest rates.

The Federal Reserve also has swap lines with other central banks, allowing it to lend dollars overseas during global market funding shortages. If the pressures in the U.S. Treasury market are related to broader financing issues, these tools may quickly increase.

When Silicon Valley Bank collapsed and triggered a regional banking crisis, the Federal Reserve established a mechanism to provide additional liquidity at a lower punitive measure than the discount window. While the Federal Reserve is still dealing with inflation, buyers were able to successfully expand their balance sheets by hundreds of billions of dollars. In other words, the Federal Reserve was able to increase liquidity without sending mixed signals regarding inflation.