Fed backstops the economy with $2.3trn in measures
David Page, Head of Macro Research at AXA Investment Managers, comments on the recent developments at the US Federal Reserve:
- Fed announces $2.3trn worth of measures aimed at helping to get cash into the economy.
- The Fed announced a range of measures, backed by Federal government funds, to purchase loans, bonds and securities to ease credit provision to households, small and large businesses, municipal and state governments.
- In every instance the Fed is trying to expedite lending to agents across the full range of the economy as it is affected by coronavirus.
- Fed Chair Powell spoke in a separately organised webinar. He stated that the Fed would “shepherd the economy through difficult times”.
- He went on to discuss his hopes for a “robust recovery”, the Fed’s role in lending, but not spending in the economy, and that inflation was far from a concern for the Fed at present.
- Financial market reaction was muted, with yields broadly stable, equities firmer and the dollar weaker.
The Federal Reserve announced additional actions today amounting to $2.3trn (10.5% of GDP) of support to the economy. Fed Chair, Powell, stated that the “country’s highest priority must be to address the public health crisis” and that the Fed’s role is “to provide as much relief and stability” as possible. The Fed announced the following measures:
- Paycheck Protection Program Liquidity Facility (PPPLF). To provide term financing to eligible financial institutions backed by loans to small businesses in the government’s PPP scheme to bolster the effectiveness of this program. PPP is a key scheme to provide loans (and grants if employment is retained) to small business but was hindered by financial institutions liquidity. The Fed is now stepping in as the backstop to that liquidity.
- The Main Street Lending Program. Buying up to $600bn in loans to backstop credit to small and medium-sized business.
- Expansion of size and scope of Primary and Secondary Market Corporate Credit Facilities (PMCCF and SMCCF) and the Term Asset-backed Securities Loan Facility (TALF). All three scheme operate through Special Purpose Vehicles (SPVs) that allow the Fed to purchase up to $850bn in credit, backed by $85bn from the US Treasury.
- Municipal Liquidity Facility that will offer up to $500bn in lending to states and municipalities, with $35bn of credit protection from the Federal government.
While each of these individual programs addresses very different markets and has a range of different associated fees, spreads and costs, the principle is the same for each: getting cash into the economy. By offering to purchase the underlying loans and securities from eligible financial institutions the Fed aims to ensure the flow of funds to small and large businesses, households and municipal and state governments. This is designed to overcome the constraints that individual financial institutions face, arising from credit aversion, cost of capital and – even for the largest of US banks – balance sheet size, given the enormity of the lending required. This should allow individual financial institutions to undertake the necessary checks with regards to origination of loans, which the Fed has no capacity to undertake, but allow the Fed to employ its much larger balance sheet to hold the loans, while effectively being indemnified from loss by the Treasury’s equity contribution. This is done in a financially efficient way, through the creation of an SPV, to allow the Fed to make large scale purchases, backed by a relatively small amounts of capital provided from the Treasury. The Treasury has earmarked $450bn of such capital, with the Fed schemes announced to date using just under $200bn. This provides more capital to back further schemes if deemed necessary, extend current schemes further, or backstop greater than expected losses in any of the schemes if necessary. The scale of this scheme illustrates the enormous difficulty of getting the scale of loans and access to finance into the economy quickly enough to support the full range of agents in the economy.
Fed Chair Powell gave a separately arranged Webinar in coordination with the Brookings Institute. He spoke only in very broad terms about the Fed’s role in what he described as “very difficult times” and talked of the Fed “shepherding the economy through these difficult times”. However, he did address a number of broader issues. First, he described the Fed as part of an effort to provide a bridge from the pre-crisis economy to the other side. Second, he talked about the prospect of a “robust recovery”, which he said “many expected to start in H2 2020”, but whose precise timing will fundamentally depend on the path of the virus itself. Third, he emphasised that the Fed was not undertaking spending decisions but was enabled to lend to financially sound institutions on a secured basis, adding that many of the measures undertaken recently were done so on an emergency basis and only under the oversight of Treasury Secretary Mnuchin. Fourth, Powell reiterated our own much repeated observation that many of the concerns individual express about inflation from the Fed’s lending programs and security purchase schemes echo the 2008 concerns that QE would result in high levels of inflation. Powell emphasised that the evidence of the last decade had not seen high levels of inflation stating that “today too high inflation is not a first order concern – far from it”. Fifth, Powell stated that monetary policy was where they wanted it for now, with Fed focus being on these lending programs.
Financial markets have once again had much to digest today with the announcement of the Fed’s scheme, a second 6m plus (6.6m) weekly increase in jobless claims, the Fed Chairs comments and the sharpest recorded drop on record in consumer confidence. Yet market reaction has so far been modest. 2-year yields were unchanged at 0.24% after the Fed’s measures were announced, but dipped 2bps to 0.22% as Chair Powell spoke. 10-year government yields initially rose 4bps to 0.77% but have settled back to 0.75%. Meanwhile the S&P 500 equity index rose to over 1% before Powell spoke, but is currently is 0.7%. The dollar is more consistently lower, down 0.5% against a basket of currencies.