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The Federal Reserve (Fed) today raised its response to the coronavirus crisis to a whole new level, announcing open-ended quantitative easing (QE) as well as purchases of short-dated investment- grade (IG) corporate debt and exchange-traded funds (ETFs), measures that had not been adopted even at the height of the global financial crisis just over a decade ago.
The decision to buy corporate debt takes a page from the European Central Bank’s playbook, and disproves market concerns that this step might be beyond the Fed’s institutional reach; the fact that purchases will target the whole investment-grade spectrum and not be limited to AAA issuers is bold.
The decision to purchase ETFs follows the Bank of Japan’s example, and expands the purchase of IG debt to longer maturities. Together, these measures show that the Fed understands the need for a creative, decisive and adaptive strategy to fight the current crisis.
The Fed announced a raft of new measures and facilities aimed at: (i) providing targeted relief to affected households and businesses; (ii) giving broad support to economic activity; and (iii) ensuring the smooth functioning of money and credit markets. These include:
- Open-ended QE. On March 15, the Fed had launched US$700 billion in asset purchases. Today, it announced it will purchase Treasuries and agency mortgage-backed securities (MBS) “in the amounts needed” to keep markets functioning smoothly and ensuring monetary policy can do its job. The sky is the limit, in other words.
- The scope of purchases is now broadened to encompass agency commercial.
- New facilities to support credit to households and businesses with up to US$300 billion in new financing, seeded with US$30 billion in equity by the Treasury:
- A Primary Market Corporate Credit Facility (PMCCF) for new bond and loan issuance; this will provide four-year financing to investment-grade companies, and borrowers will be able to defer interest and principal payments for the first six months (extendable at the Fed’s discretion). The PMCCF will extend loans through a Special Purpose Vehicle (SPV) seeded by the Treasury.
- A Secondary Market Corporate Credit Facility (SMCCF) for outstanding corporate bonds across the investment-grade spectrum as well as ETFs; this will also work via a Treasury-seeded SPV.
- A Term Asset-Backed Securities Loan Facility (TALF) to support the issuance of asset-backed securities (ABS) based on student, auto, credit card loans and loans guaranteed by the Small Business Administration.
- Expansion of the Money Market Mutual Fund Liquidity Facility (MMLF) and the Commercial Paper Funding Facility (CPFF) to a wider range of securities.
- Planned launch of a Main Street Business Lending Programme to support lending to small- and medium-sized businesses.
Three crucial things to note, in my view, to assess the likely impact on the economy and markets.
First: The Fed has essentially pledged unlimited firepower to support the broad economy and stabilise markets; it has launched a decisive, creative and adaptive strategy which suggests it stands ready to do whatever it takes to fight the current crisis. I would expect a flexible approach both in terms of the size of the programmes and potentially the eligible securities.
Second: The Fed will provide targeted support so that businesses and households can get the credit they need to survive through the crisis.
Third: The Fed now needs to quickly follow through to provide clarity on how the new facilities can be accessed by the relevant private institutions. Preliminary indications from the markets are that liquidity is improving on the margin, but anything more needs much more clarity on the operational aspects of the new facilities. This is understandable; the new facilities have just been announced and there is a lot of new information to process—but the focus now must quickly switch to the operational aspects.
Surviving the Shock
Will it work? I think the Fed’s support can help the US economy survive the shock and set the stage for a strong recovery in the second half of the year, on two conditions:
One: that the draconian government-mandated shutdown of large parts of the economy is sufficiently short-lived. We are entering the second of extreme social distancing and business closures in a number of US states. If containment measures prove effective, in the coming weeks the data should provide reassuring evidence that contagion is being contained, that we are “flattening the curve;” this should allow for a gradual relaxation of the preventive measures, outside of the worst-affected areas. With the right monetary and fiscal support, the majority of affected businesses should be able to survive and then ramp-up operations as the situation normalises.
Two: that Congress gets its act together and launches a package of fiscal measures in the next few days. US fiscal policy needs to step in to provide direct cash payments to individuals, extended unemployment benefits and emergency paid leave, as well as some form of rent/mortgage payments forbearance for impacted small- and medium-sized businesses and financial assistance to corporates in the hardest hit sectors.
The bill currently in Congress would also boost the reach of the newly announced Fed lending facilities: it would allow Treasury to allocate an additional US$425 billion in equity to the Fed’s SPV, which would translate in an additional US$4 trillion of potential lending.
The fiscal support package currently in Congress amounts to about US$2 trillion, or 10% of US gross domestic product. In synergy with the Fed’s array of measures, it would allow a large share of businesses and households to weather the storm. The damage to the economy—and to the livelihood of countless individuals—will still be substantial, but this combination of fiscal and monetary policy would allow the majority of businesses to avoid bankruptcy and to rehire/pay their workers as the emergency ends.
A combined “shock and awe” fiscal and monetary support is also needed to reassure financial markets while we still face significant uncertainty on the duration of the crisis. Without the fiscal component, monetary policy cannot do it on its own—and investors clearly realise this.
It’s time for Congress to set aside partisan disputes and provide the support that US households and businesses urgently need. Concerns about bailouts and moral hazard should also be set aside, in my view. Airlines, carmakers and retailers are not in trouble because they did anything wrong; they are not guilty of any reckless behaviour that would be condoned and incentivised by a bailout; no viable business strategy could have insured them against a shock of this magnitude. Financial assistance to households and small- and medium-sized businesses should be time-bound, limited to bridge them through the crisis—but it should start as soon as possible.
The Fed has made its move; it’s still the biggest and quickest player in town—but it can no longer be the only game in town. Congress must stop squabbling and act now.
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