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.
Download PDF Reprint
Amar Reganti, Fixed Income Investment Director
Caroline Casavant, Investment Analyst
1Including the District of Columbia
IMPORTANT DISCLOSURE
Wellington Management Company LLP (WMC) is an independently owned investment adviser registered with the US Securities and Exchange Commission (SEC). WMC is also registered with the US Commodity Futures Trading Commission (CFTC) as a commodity trading advisor (CTA) and serves as a CTA to certain clients including registered commodity pools and their operators. WMC provides commodity trading advice to all other clients in reliance on exemptions from CTA registration. WMC, along with its affiliates (collectively, Wellington Management), provides investment management and investment advisory services to institutions around the world. Located in Boston, Massachusetts, Wellington Management also has offices in Chicago, Illinois; Radnor, Pennsylvania; San Francisco, California; Beijing; Frankfurt; Hong Kong; London; Luxembourg; Singapore; Sydney; Tokyo; Toronto; and Zurich. • This material is prepared for, and authorized for internal use by, designated institutional and professional investors and their consultants or for such other use as may be authorized by Wellington Management. This material and/or its contents are current at the time of writing and may not be reproduced or distributed in whole or in part, for any purpose, without the express written consent of Wellington Management. This material is not intended to constitute investment advice or an offer to sell, or the solicitation of an offer to purchase shares or other securities. Investors should always obtain and read an up-to-date investment services description or prospectus before deciding whether to appoint an investment manager or to invest in a fund. Any views expressed herein are those of the author(s), are based on available information, and are subject to change without notice. Individual portfolio management teams may hold different views and may make different investment decisions for different clients.
In Canada, this material is provided by Wellington Management Canada ulc, a British Columbia unlimited liability company registered in the provinces of Alberta, British Columbia, Manitoba, New Brunswick, Newfoundland and Labrador, Nova Scotia, Ontario, Prince Edward Island, Quebec, and Saskatchewan in the categories of Portfolio Manager and Exempt Market Dealer. • In Europe (ex. Austria, Germany and Switzerland), this material is provided by Wellington Management International Limited (WMIL), a firm authorized and regulated by the Financial Conduct Authority (FCA) in the UK. This material is directed only at persons (Relevant Persons) who are classified as eligible counterparties or professional clients under the rules of the FCA. This material must not be acted on or relied on by persons who are not Relevant Persons. Any investment or investment service to which this material relates is available only to Relevant Persons and will be engaged in only with Relevant Persons. • In Austria and Germany, this material is provided by Wellington Management Europe GmbH, which is authorized and regulated by the German Federal Financial Supervisory Authority (Bundesanstalt für Finanzdienstleistungsaufsicht – BaFin). This material is directed only at persons (Relevant Persons) who are classified as eligible counterparties or professional clients under the German Securities Trading Act. This material does not constitute investment advice, a solicitation to invest in financial instruments or information recommending or suggesting an investment strategy within the meaning of Section 85 of the German Securities Trading Act (Wertpapierhandelsgesetz). • In Hong Kong, this material is provided to you by Wellington Management Hong Kong Limited (WM Hong Kong), a corporation licensed by the Securities and Futures Commission to conduct Type 1 (dealing in securities), Type 2 (dealing in futures contracts), Type 4 (advising on securities), and Type 9 (asset management) regulated activities, on the basis that you are a Professional Investor as defined in the Securities and Futures Ordinance. By accepting this material you acknowledge and agree that this material is provided for your use only and that you will not distribute or otherwise make this material available to any person. • In Singapore, this material is provided for your use only by Wellington Management Singapore Pte Ltd (WM Singapore) (Registration Number 201415544E). WM Singapore is regulated by the Monetary Authority of Singapore under a Capital Markets Services Licence to conduct fund management activities and is an exempt financial adviser. By accepting this material you represent that you are a non-retail investor and that you will not copy, distribute or otherwise make this material available to any person. • In Australia, Wellington Management Australia Pty Ltd (WM Australia) (ABN 19 167 091 090) has authorized the issue of this material for use solely by wholesale clients (as defined in the Corporations Act 2001). By accepting this material, you acknowledge and agree that this material is provided for your use only and that you will not distribute or otherwise make this material available to any person. Wellington Management Company LLP is exempt from the requirement to hold an Australian financial services licence (AFSL) under the Corporations Act 2001 in respect of financial services provided to wholesale clients in Australia, subject to certain conditions. Financial services provided by Wellington Management Company LLP are regulated by the SEC under the laws and regulatory requirements of the United States, which are different from the laws applying in Australia. • In Japan, Wellington Management Japan Pte Ltd (WM Japan) (Registration Number 199504987R) has been registered as a Financial Instruments Firm with registered number: Director General of Kanto Local Finance Bureau (Kin-Sho) Number 428. WM Japan is a member of the Japan Investment Advisers Association (JIAA), the Investment Trusts Association, Japan (ITA) and the Type II Financial Instruments Firms Association (T2FIFA). • WMIL, WM Hong Kong, WM Japan, and WM Singapore are also registered as investment advisers with the SEC; however, they will comply with the substantive provisions of the US Investment Advisers Act only with respect to their US clients.
