How Much Tariff Turmoil Until the Fed Intervenes? Five Market Crises Provide Clues

In the wake of President Donald Trump’s tariff rollout last week, trillions of dollars have been erased from stock markets, Wall Street deal-making has seized up, hedge funds have liquidated some of their riskier trades, a large swath of corporate lending has ground to a halt and questions are even being asked about just how safe US Treasuries really are.

The turmoil is stoking concern that a shock of this magnitude could expose latent risks in the financial system.

This, in turn, is sparking the same question again and again in financial circles: What would it take for the Federal Reserve to step in and provide a calming influence?

The Fed tends to intervene only when it sees clear indications of market dysfunction — the most obvious being a freeze in the flow of capital, according to David Wilcox, director of US economic research at Bloomberg Economics and a former Fed official.

Policymakers are on the lookout for situations where “there’s no meaningful price at which things can clear” and that prevents market intermediaries from trading, he said.

US financial conditions have already deteriorated to the worst since May 2020, according to a Bloomberg index, which uses various indicators to track the overall level of financial stress in the country’s money, bond and equity markets.

At Deutsche Bank AG, strategist George Sarevelos told clients on Wednesday that “if recent disruption in the US Treasury market continues we see no other option for the Fed but to step in with emergency purchases of US Treasuries to stabilize the bond market.”

The central bank’s decision-making would be complicated by two factors: Firstly, the labor market has remained resilient and inflation is proving sticky. The latter could be reignited by the tariffs even if growth slows, limiting the Fed’s ability to cut interest rates or do anything that might boost prices further. Secondly, any injection of cash into US markets or coordinating with international peers to ensure dollars keep flowing risks running into more criticism from the White House than witnessed in past interventions.

It’s also the case that history doesn’t always repeat and that the next blow-up in markets may be different than what’s been seen in the past, requiring a different medicine. One only needs to look at the US interest rates market for potentially worrisome signs there. Fears are reigniting that a popular strategy among hedge funds known as the basis trade — wagering on the gap between prices of Treasuries and futures tied to the bonds — will be forced to unwind as the market becomes increasingly roiled by the trade war.

Below are five instances when the Fed stepped in, and a tipping point indicator that demanded its attention.

Read More: Tracking Every Trump Tariff and Its Economic Effect

1998: The Imminent Collapse of a Hedge Fund

In September 1998, the Fed oversaw the rescue of Long-Term Capital Management, or LTCM, by a group of fourteen banks and brokerage firms. The fund suffered massive losses amid the Asia financial crisis in 1997 and after Russia devalued its currency the following year. That triggered a flight to safety by investors and raised the risk of a fire sale in already illiquid markets.

In the run-up to LTCM’s failure, a key lending benchmark, the three-month London interbank offered rate surged, making it increasingly expensive to borrow US dollars and signaling increasing concern over Wall Street’s exposure to the firm. That is, until the New York Fed orchestrated a bailout in late September. The central bank subsequently cut rates at its gathering a week later and then again in the middle of October.

2001: A Shaky Economy and a Massive Shock

After the dot-com bubble burst in the US stock market in early 2000, worries about the economic fallout began to appear in the market for US Treasuries. Between May and November 2000, the short end of the curve inverted, prompting an emergency rate cut in January 2001.

Just nine months later, the Sept. 11 terrorist attacks created risks that investors struggled to quantify, roiling the market again.

“The attack took not only 3,000 lives, but also an enormous amount of literal infrastructure that allowed financial markets to function,” said Wilcox. “Without that, for a time, it was impossible for transactions to occur. The extent was mind-boggling.”

Banks and institutions tapped the Fed’s discount window and utilized the New York Fed’s daily open market operations in order to shore up their cash. While balances at the lending facility were generally under $1 billion in the period prior to the attacks, usage spiked to about $46 billion on Sept. 12, Fed data show.

2007-08: Global Financial Crisis

During the summer of 2007, prices on subprime mortgage bonds began to crater. Fears of losses spread throughout the financial system, finding their way into a part of money markets known as asset-backed commercial paper. The spread between 90-day AA-rated asset-backed CP and a benchmark known as the overnight index swap began to signal trouble. That August, the Fed cut the primary discount rate it charges commercial banks and other institutions to boost liquidity.

By the next year, those worries had spread to the world’s largest banks, driving up the cost to hedge against losses on the firms using credit-default swaps. In the runup to the failures of Bear Stearns and Lehman Brothers, and the rescue of Merrill Lynch, prices for CDS tied to those banks had surged to levels signaling panic.

After Lehman’s bankruptcy in September 2008, the Fed slashed interest rates to zero and opened up lending facilities that backstopped the financial system.

“When liquidity becomes a concern, the Fed moves in a big way in rates and credit facilities to provide it to parts of the market that aren’t functioning,” said Mark Zandi, chief economist at Moody’s Analytics. “If it’s the macroeconomy, they move slowly and deliberately. If both those things conflate, such as in the Global Financial Crisis, they’re on DEFCON 1.”

2020: A Global Pandemic

At the onset of the Covid-19 pandemic, a vicious unwinding in an estimated $500 billion hedge fund arbitrage trade — known as the basis trade — rattled everything from US Treasuries to corporate debt. Fears that another such unwind is lurking have emerged again as yields on government bonds have surged while swaps spreads have tanked.

Panicked investors yanked billions of dollars from one segment of money-market funds in less than two months, helping upend the commercial-paper market that companies rely on for short-term liquidity. All of this coincided with a massive hoarding of cash by companies looking to weather an impending collapse in economic activity.

As a result, the Fed cut interest rates back to zero and ramped up programs to facilitate lending in the credit markets. They engaged in outright purchases of Treasury securities to the tune of about $1.6 trillion over several weeks.

Altogether, the asset purchases would swell the central bank’s balance sheet to nearly $9 trillion over the next two years from over $4 trillion before the pandemic.

“If we saw market functioning breaking down like we saw in early 2020, that would also be of concern to the Fed,” said Andrzej Skiba, managing director and head of US fixed income at RBC Global Asset Management.

2023: Regional Banking Crisis

In the run up to the collapse of Silicon Valley Bank in March 2023, an exodus of deposits was already well underway. When the Fed began raising interest rates in 2022, a perfect storm emerged for America’s regional banks.

Savers, lured by higher money-market fund rates, pulled cash from low-yielding bank accounts. At the same time, the rapid rise in rates was leaving the banks with huge unrealized losses on holdings of Treasuries and mortgage-backed securities.

That forced banks to turn to other sources of funding in order to shore up their reserve balances. Enter the Federal Home Loan Banks, which provide funding to members via short-term loans. In just three months, FHLB advances outstanding surged to more than $1 trillion by the end of March 2023 from $819.1 billion at the end of 2022.

Faced with a cascade of bank failures, the Fed launched the Bank Term Funding Program to bolster liquidity. More than 1,600 firms tapped the facility, which ran for one year. Once the BTFP was introduced, concern about evaporating bank deposits and unrealized losses on securities eased.