Monday morning, March 23, the Federal Reserve (Fed)
announced one of the most aggressive monetary easing programs in the history of
central banking. The set of measures announced includes open-ended purchases of
Treasury securities and agency mortgage-backed securities (quantitative easing
or QE), and programs to support the flow of credit to consumers and employers.
In the new QE program, the Fed “will buy Treasuries and agency mortgage-backed securities in the amounts needed to support smooth market functioning and effective transmission of monetary policy to broader financial conditions and the economy…”.1 The size, duration and speed of purchases has been left open to ensure maximum flexibility, nimbly address market functioning across market segments, and proceed rapidly. This week alone, the Fed will buy $375 billion of Treasury securities and $250 billion of mortgage-backed securities. The total amount for one weak is greater than the Fed’s so-called “QE2” program in 2012. This is the Fed’s “whatever it takes” moment.
Additional measures seek to support the flow of credit
The Fed also announced several measures to support the flow
of credit to the economy:
- The Primary Market Corporate Credit Facility
(PMCCF) would support new bond and loan issuance, and the Secondary Market
Corporate Credit Facility (SMCCF) would provide liquidity for outstanding
corporate bonds in the secondary market, including US-listed exchange-traded
funds (ETF) in the investment grade corporate bond space.
- The Fed revived the Term Asset-Backed Securities
Loan Facility (TALF), which enables the Fed to provide loans to investors to
buy asset-backed securities backed by student loans, auto loans, credit card
loans, and loans guaranteed by the Small Business Administration.
- The Fed also extended its support to the
municipal bond and commercial paper markets by extending the securities it can
buy and improving pricing.
- Finally, the Fed announced the Main Street
Business Lending Program to support lending to small and medium-sized
businesses with details still to come.
While Fed measures in the government markets (Treasuries and
mortgage-backed securities) are open-ended, in private sector markets, new
loans are limited to $300 billion, with the Treasury to cover up to $30 billion
in losses. But it is highly likely that there is more to come. In the current draft Senate bill, there is a proposal to
allocate $425 billion to the Treasury’s Exchange Stabilization Fund (ESF).
While the exact amount is currently being negotiated and may be smaller,
Congress may agree on an allocation that would expand the ESF. In that case the
Fed, just as it is doing now, can lever the guaranteed amount to significantly
expand its current credit support programs.
Market reaction was mixed
The market’s reaction to these extraordinary measures was
mixed. Investment grade corporates performed
strongly on the news that the Fed would be entering that market. Treasuries and mortgage-backed securities
also reacted positively. The US dollar
rallied against emerging market and developed market currencies. However, other risky assets, such as high
yield bonds and equities, did not rally on the news. Investors in higher-risk securities may need
to see more clarity on the path of economic growth before these assets improve.
Fed’s measures are bold and fast. We believe such a large amount of support to
the economy should support market functioning and limit tensions in the financial
sector, which arose from an exogenous shock to the economy. While a deep
economic contraction in the economy is unavoidable at this stage, we believe the
Fed’s proactive and aggressive policies are limiting risks to the financial
system and providing fertile ground for an economic recovery after the peak in
the COVID-19 shock.
Source: Federal Reserve, March 23, 2020
Blog header image: pabradyphoto / Getty
Quantitative easing (QE) is a monetary policy used by
central banks to stimulate the economy when standard monetary policy has become
referenced above are those of the authors as of March 23, 2020. These comments should not
be construed as recommendations, but as an illustration of broader themes.
Forward-looking statements are not guarantees of future results. They involve
risks, uncertainties and assumptions; there can be no assurance that actual
results will not differ materially from expectations.