The Calming of Short-Term Market Fears and Its Long-Term Consequences: The Federal Reserve's Reaction to COVID-19

Abstract

We study the impact of five key Fed policy responses to the Covid-19 crisis on the stock market's fear of loss and fear of variability. Using a unique global dataset of option prices to construct the term structures of fear, up to ten years into the future, we find that FX swap lines have the most decisive impact on market fear, but only on the US and countries with access to the swaps. Liquidity support and macroprudential policies had a smaller but still significant impact, while policies aimed to support the wider economy did not affect fear. These results raise important questions on the trade-off between short-term market calming and long-term moral hazard, as well as the relative importance of central banks, and the importance of the Federal Reserve as a global liquidity provider.