Are we witnessing a paradigm shift in how market participants should view US monetary and fiscal policy? Fixed Income Investment Director Amar Reganti and Investment Analyst Caroline Casavant look at the Fed’s latest actions in the context of that critical question.
In the latest example of the Federal Reserve (Fed)’s unprecedented intervention in financial markets, the central bank directed an additional US$2.3 trillion of support toward:
- Support of fiscal programs;
- Extension of existing special-purpose vehicles (SPVs) to help the corporate and ABS markets; and
- Backstopping the municipal debt market.
It is difficult to overstate the importance of these developments. A month ago, it was unthinkable that the Fed would purchase ETFs, much less high-yield corporate debt. The line between the private and the public sector has continued to blur, as has the distinction between the Fed and the Treasury. What’s more, the conflation of monetary and fiscal policy has not been confined to the US, as the Bank of England (BoE) recently announced that it would explicitly fund government spending in the UK. This move, while considered temporary and reminiscent of actions taking during the global financial crisis, is likely to provide a tailwind to US proponents of monetary financing via “minting the coin.”
The details of these programs and their potential implications are outlined below.
Extension of PMCCF, SMCCF, and TALF
The Fed provided updated term sheets for the Primary Market Corporate Credit Facility (PMCCF), the Secondary Market Corporate Credit Facility (SMCCF), and the Term Asset Lending Facility (TALF). As in the case of the Commercial Paper Funding Facility (CPFF), the updated term sheets provide more support for markets than the initial iterations did and allow the Fed to purchase lower-quality debt than it ever has before. The aggregate size of the three facilities was expanded to US$850 billion, while the equity investment of the Treasury also increased to US$85 billion in credit protection.
The Fed expanded the universe of eligible bonds that the PMCCF and the SMCCF can purchase. Most notably, the Fed can now purchase BB- or better subinvestment-grade corporate credit that was recently downgraded (bonds otherwise known as “fallen angels”). The Fed extended the collateral eligible for TALF, including AAA commercial mortgage-backed securities (CMBS) and AAA collateralized loan obligations (CLOs).
Support for fiscal programs: PPP
The Fed announced that it will support a fiscal initiative called the Paycheck Protection Program (PPP) through the Paycheck Protection Program Liquidity Facility (PPPLF). The PPPLF will extend credit to all depository institutions that originate PPP loans on a nonrecourse basis, taking Paycheck Protection Loans (PPLs) as collateral. The PPL is a loan facility created by the federal government intended to incentivize small businesses to avoid layoffs during the COVID-19 crisis. The facility provides loans to small businesses and then forgives those loans if the companies keep employees on the payroll for eight weeks.
Support for fiscal Programs: MSLP
In addition to supporting the PPP, the Fed created an SPV to purchase the loans issued by eligible lenders associated with the Main Street Lending Program (MSLP). The Fed’s role in this facility is largely operational. The SPV was created with a US$75 billion equity investment from the Treasury and can issue up to US$600 billion in credit. The MSLP allows depository institutions, bank holding companies, and savings and loan holding companies to make loans to companies that employ at least 10,000 people and have revenues of less than US$2.5 billion. As participants in the program, eligible loan issuers retain a 5% share in the loans they issue, with the Fed’s SPV purchasing the other 95%.
A municipal securities backstop
The Fed created the Municipal Liquidity Facility (MLF), an SPV intended to provide US$500 billion to municipalities. The facility was created with a US$35 billion equity investment from the Treasury. The MLF exists to purchase debt directly from US states,1 counties with a population of at least two million, and cities with a population of at least one million. The Fed also opened the door to further intervention by suggesting it will monitor developments in the secondary markets.
A step back: The big picture
It’s easy to get lost in the details of what’s occurred over the past few weeks. The Fed has:
- Created at least nine legally distinct SPVs using its emergency powers outlined by Section 13(3) of the Federal Reserve Act: the CPFF, MLF, MMLF, MSELF, PDCF, PMCCF, PPPLF, SMCCF, and TALF;
- Published multiple term sheets for the new facilities created, each of which has different pricing and terms;
- Extended existing dollar swap lines;
- Created a new repo facility accessible to foreign monetary authorities;
- Cut the target range for the federal funds rate to the zero lower bound (ZLB); and
- Committed to unlimited purchases of Treasuries, agency MBS, and agency CMBS.
Put simply, the Fed has surpassed even the limits sent on March 23 for its direct support of financial markets. And the coordination between the Fed and the Treasury has reached its highest level since World War II. In the short term, these actions will support market functioning and help to avoid the worst economic outcomes that might have occurred amid COVID-19. They reflect a core function of the Fed: It’s essentially “a bank for the Treasury.” The Fed is serving an important operational role on behalf of the US government, similar to its role as the auction manager of Treasury debt.
It’s increasingly difficult to argue that monetary and fiscal policy exist separately. The evolving needs of the economy have necessitated a holistic approach to the nation’s management of assets. This evolution has been occurring for years and will only continue. The market barely moved when the BoE agreed to monetary financing. That’s because direct monetarization of debt is not much different from quantitative easing, which has already been going on for years.
In short, we are witnessing a paradigm shift in how market participants should view monetary and fiscal policy.
Amar Reganti, Fixed Income Investment Director
Caroline Casavant, Investment Analyst