March 23, 2020
This morning, the Fed Reserve (the”Fed”) announced extensive new steps to support financial markets and the real economy.
Fiscal and monetary policy coordination
Their quantitative easing (QE) program announced last Sunday will now be unlimited instead of the previously stated $700bn. In fact, the Fed is set to purchase as much as $250bn of mortgage-backed securities (MBS) this week alone.
The likely intended result will be to ensure yields remain low even as the Treasury readies its expansionary fiscal program (which will likely result in greater Treasury bond issuance).
Two brand new programs for financing corporates
The Fed will purchase up to $100bn of corporate bonds with at least one investment grade rating and a maturity of less than five years through the Secondary Market Corporate Credit Facility (SMCCF). The Fed will also lend $100bn for up to 4-year terms by directly lending to investment grade corporations through the Primary Market Corporate Credit Facility (PMCFF).
The Fed will look to avoid lending to companies who are receiving direct aid from the Treasury (such as the airline industry). Each of these programs will be supported by $10bn equity commitments from the US Treasury’s Exchange Stabilization Fund (ESF).
Elsewhere, in a return to its 2008-era playbook, the Fed will re-introduce the Term Asset-Backed Securities Loan Facility (TALF), a facility in which the Fed will purchase up to $100bn of consumer, equipment, and auto asset backed securities (ABS).
At $100bn each, both programs are small given the size of the corporate and ABS markets. If necessary, we believe they can be easily expanded. We anticipate an improvement in the functioning of the market and a return to normalcy over time as these types of policy actions are implemented.
The Fed will likely need Congress to pass the third coronavirus response bill before it can execute its corporate programs. This is because the latest version of the bill permits the Fed to create vehicles to purchase corporate and municipal debt, and it injects $500bn into the Exchange Stabilization Fund (ESF); which can be used to make direct corporate loans or to provide the equity credit enhancement necessary for the facilities to work.
While it is unclear how much in direct aid the Treasury plans to provide, the size of the ESF injection provides ample capacity for the Fed to expand its own programs further if necessary. We expect the bill is likely to be passed and signed into law shortly.
We take this as a signal that the Fed will do whatever it takes to provide adequate support to the economy through the coronavirus crisis.
Check out Perspectives on our website for our latest views on the economic impact of COVID-19
We are analyzing the effects of the coronavirus on the US and global economy. You can check here for an up-to-date summary of fiscal and monetary policy responses. In addition, we have recently published analysis of the Gross Domestic Product (GDP) impact on China and will be sharing global GDP scenarios.
This is an unprecedented time for the global economy and the pace and magnitude of the coordinated policy response is going to go well beyond even that we saw during the 2008 crisis. Despite the fact that a near-term reduction in GDP is likely to be in double digit territory, in time, we expect the unprecedented monetary and fiscal policy response to lay the groundwork for an eventual rebound. This should help to limit the extent of any long-term damage to the economy.
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