The Fed on Monday morning announced open-ended QE, effectively promising to buy unlimited amounts of assets in an effort to assuage markets.
Although there will be plenty of finger-pointing when this crisis is finally over, nobody will be able to accuse Jerome Powell of not taking the most drastic measures imaginable, even if there will be a veritable chorus of folks accusing the Fed of ignoring the moral hazard inherent in limitless asset buying.
“The Federal Open Market Committee is taking further actions to support the flow of credit to households and businesses by addressing strains in the markets for Treasury securities and agency mortgage-backed securities”, the Fed said, in a statement released Monday morning prior to the cash open on Wall Street. Here’s open-ended QE (plus commercial MBS, for good measure):
The Federal Reserve will continue to purchase Treasury securities and agency mortgage-backed securities in the amounts needed to support smooth market functioning and effective transmission of monetary policy to broader financial conditions. The Committee will include purchases of agency commercial mortgage-backed securities in its agency mortgage-backed security purchases. In addition, the Open Market Desk will continue to offer large-scale overnight and term repurchase agreement operations.
In a separate statement, the Fed goes into considerably more detail and it becomes clear that this new package is, in fact, quite extensive.
In addition to noting the inclusion of commercial mortgage-backed securities in asset purchases, the Fed announced $300 billion in new financing aimed at getting credit to “employers, consumers, and businesses”. The programs through which that credit will be extended will be backstopped by $30 billion in guarantees from the Treasury (via the ESF).
Next, the Fed announced it’s going to buy corporate bonds via a pair of vehicles – the Primary Market Corporate Credit Facility (PMCCF) for new bond and loan issuance and the Secondary Market Corporate Credit Facility (SMCCF) to provide liquidity for outstanding corporate bonds.
The primary facility will provide four-year bridge loans to IG corporates via an SPV in order to ensure large companies “are better able to maintain business operations and capacity during the period of dislocations related to the pandemic”. Companies tapping that facility can defer interest and principal payments during the first six months, a grace period that may be extended, the Fed says. Treasury will have an equity stake in the SPV which, effectively, gives Steve Mnuchin a stake in the companies, albeit of the arm’s-length, temporary variety.
The secondary facility will buy IG corporate bonds and credit ETFs. And, yes, you read that correctly. Here’s the statement:
The SMCCF will purchase in the secondary market corporate bonds issued by investment grade U.S. companies and U.S.-listed exchange-traded funds whose investment objective is to provide broad exposure to the market for U.S. investment grade corporate bonds. Treasury, using the ESF, will make an equity investment in the SPV established by the Federal Reserve for this facility.
Since mid-February, dislocations not seen since the depths of the financial crisis have shown up across a number of credit ETFs which, unlike mutual funds, promise instantaneous (almost literally) liquidity to investors.
As noted on Saturday, you might be inclined to suggest the disconnects between popular ETFs (e.g., the iShares iBoxx $ Investment Grade Corporate Bond ETF) and NAV is just “price discovery”. In other words, you could argue that the ETF is providing a way for an illiquid market to be priced in real-time, just as some country-specific equity ETFs allow US investors to price foreign equities even when those markets are closed (e.g., for a non-US holiday).
While that may be some semblance of true for debt issued by corporate titans with fortress balance sheets (i.e., for companies who will have little trouble surviving the severe economic downturn that’s coming over the next several months, and whose debt might drop now, but will easily recover), I would suggest that in many cases, the disconnects can’t properly be described as “price discovery”.
Rather, what you’re seeing in charts like the one shown above is probably people tapping the ETFs for liquidity (e.g., to fund redemptions or raise cash). The underlying market for a lot of this stuff is probably no-bid.
Remember, the onerous post-crisis regulatory regime means that even if the environment were more favorable, the street likely wouldn’t be willing to lend its balance sheet in a pinch. The explosion of corporate debt in the post-GFC world and the shrinkage of dealer inventories has created a wide disparity.
That is potentially perilous, and the Fed is now set to help fill the void, a somewhat ironic development considering it was post-crisis monetary policy which helped encourage corporates to issue mountains of new debt.
Corporate bond spreads have ballooned wider in recent days. Junk is now officially in “distressed” territory for the first time since 2009.
“At this point, we estimate US corporate revenue across public and private businesses will decline by roughly $4 trillion”, Bridgewater said Friday, calling it “a very dangerous decline” which, if not mitigated by fiscal and monetary policy, “will lead to a long-lasting ripple”.
The last two weeks have seen guidance withdrawn virtually across the board, while many management teams draw down credit lines and hoard cash in preparation for the inevitable.
Outflows from bond ETFs last week were off the charts. Lipper, for example, said IG funds witnessed an exodus that was four times as large as the previous record, set just a week prior.
The Fed says it “will avoid purchasing shares of eligible ETFs when they trade at prices that materially exceed the estimated net asset value of the underlying portfolio”. So, they’re not going to be paying a premium – the whole idea here is to close the discounts to NAV that have been the talk of the proverbial town over the past two weeks.
The Fed also rolled out new TALF, under which Powell “will lend on a non-recourse basis to holders of certain AAA-rated ABS backed by newly and recently originated consumer and small business loans”. Here’s what’s eligible:
Eligible collateral must be ABS where the underlying credit exposures are one of the following: 1) Auto loans and leases; 2) Student loans; 3) Credit card receivables (both consumer and corporate); 4) Equipment loans; 5) Floorplan loans; 6) Insurance premium finance loans; 7) Certain small business loans that are guaranteed by the Small Business Administration; or 8) Eligible servicing advance receivables.
There you go. The Fed is now a buyer of auto loan and lease ABS, student loan ABS, credit card receivables and small business loans, too.
The amount of those loans will be equal to the market value of the ABS minus a haircut. Treasury will also have an equity stake in the SPV established to execute this lending.
And there’s more. Late last week, the Fed announced a mini-muni bailout, and that’s being expanded. In addition to what was announced for municipal securities on Friday, “a wider range of securities, including municipal variable rate demand notes (VRDNs) and bank certificates of deposit” are now eligible for the money market liquidity facility. On top that, the commercial paper funding facility now includes high-quality, tax-exempt commercial paper as eligible securities and more favorable pricing terms.
All of this comes on the heels of last week, when the Fed resurrected the commercial paper facility, expanded swap lines beyond the G7, backstopped prime money market funds, and stepped into the muni market. You’re reminded that the Fed bought $272 billion of Treasurys last week and $68 billion of MBS, meaning that going into this week they were nearly halfway to the $700 billion in new QE announced just a week ago. As I noted on Sunday evening, that certainly seemed to suggest the $700 billion figure will go up at some point. Now, it’s open-ended.
The new measures are, in many cases, extensions and expansions of the facilities announced last week, but the purchases of corporate bonds and securities are a bold step, even as analysts and market watchers generally agreed that it was just a matter of time before the Fed started buying investment grade credit.
“The Federal Reserve is committed to using its full range of tools to support households, businesses, and the US economy overall in this challenging time”, one of the statements reads. “The coronavirus pandemic is causing tremendous hardship across the United States and around the world”, the Fed continues, adding that “while great uncertainty remains, it has become clear that our economy will face severe disruptions [and] aggressive efforts must be taken across the public and private sectors to limit the losses to jobs and incomes and to promote a swift recovery once the disruptions abate”.
There is no sense in which Donald Trump can accuse Jerome Powell of being a “do-nothing”, to use one of the president’s favorite derisive nicknames for rivals real and imagined. Now, it’s up to politicians to augment this extraordinary set of central bank actions with fiscal stimulus.
Perhaps Powell should open a verified Twitter account and spend his days prodding lawmakers into action.