As we argued in our previous piece detailing the Fed’s 100bps cut and increased asset purchases, although the Fed had unloaded countless rounds of ammunition, additional firepower remained.

On the heels of the fiscal impasse in Congress over the weekend, the Fed once again showed that it is ready to do whatever it takes to keep the economy afloat during this unprecedented stop in the U.S economy. Indeed, with its latest moves, the Fed expanded its toolkit beyond its 2008 playbook with the goal of not only bolstering financial markets plumbing, but also deploying targeted measures to assist beleaguered “main street”.

We recap the Fed’s major policy announcements below:

  1. Removed cap on QE: As we speculated, the Fed moved away from previous guidance of $700 billion in asset purchases ($500bn treasuries, $200bn mortgages) to a pledge to buy whatever “amounts needed” for effective transmission of monetary policy and smooth market functioning. Agency CMBS is also now eligible for purchase.
  2. Set up two facilities aimed at supporting credit to large employers
    1. Primary Market Corporate Credit Facility (PMCCF)
      1. Allows corporations to issue directly to SPV (backed by Treasury’s exchange stabilization fund)
      2. Eligibility requirements: issuer must be investment grade-rated (“IG”), maturity of 4 years or less
    2. Secondary Market Corporate Credit Facility (SMCCF)
      1. Issuer must be IG-rated, maturity of 5 years or less
      2. U.S. listed corporate ETFs also eligible
  3. Dusted off the Term Asset-Backed Securities Loan Facility (TALF) to facilitate the flow of credit to consumers and businesses:
    1. Aims to promote the issuance of ABS backed by student loans, auto loans, loans guaranteed by the Small Business Administration (SBA) etc.
  4. Expanded the eligible securities in the Commercial Paper Funding Facility (CPFF) to include high quality, tax-exempt commercial paper, and making pricing terms more attractive
    1. Aims to help to ease the stress in the muni sector

Our View

Unique disruptions call for exceptional measures. Today, the FOMC dug deep yet again to buy more time for a fiscal cavalry that remains encumbered by political differences. While these actions should continue to chip away at pockets of market illiquidity, we view this move as particularly positive for investment grade credit and the initial market response (tighter IG spreads, rally in corporate bond ETFs while other spread sectors lagged) corroborates this view. Although there is certain to be a slew of negative headlines surrounding a surge in recorded infections and a temporary cratering in economic activity, the Fed has essentially provided a backstop to IG credit which should limit spread widening going forward.

Moreover, we also contend that these facilities provide strong incentives for companies on the borderline of investment grade to retain/achieve IG status. At the margin, BBB- and BB+ companies will likely be more inclined to take the necessary steps (de-lever, asset disposals etc.) to achieve an IG rating as the premium bifurcating IG/non-IG has increased due to the Fed’s provision for investment grade issuers.

Policymakers are acutely aware of the “priority to care for those afflicted” on main street. Resurrecting TALF should help transmit the benefits of monetary policy to small businesses facing bankruptcies because of mandated social distancing, and those that are set to be laid off/lose their income due to the associated disruption. However, we reiterate that it is imperative for Congress to generate a policy response commensurate with the scope of this unparalleled disturbance.

Finally, a quick review of the developing Coronavirus AID, Relief, and Economic Security (Cares) Act shows promise as it is poised to provide:

  • Employers with assistance to pay through forgivable bridge loans
  • Checks to citizens ($1200 put forth so far)
  • Suspension of payroll taxes for business
  • Relief for distressed companies in hard hit sectors such as air travel and hospitality
  • Funding for hospitals
  • Potential student debt relief

Our base case remains that an outsized fiscal package (likely over $1.5 trillion, with strict terms on funding assistance for larger corporations in the form of limits on executive compensation, stock buybacks etc.) is on the horizon, which will likely put pressure on the term structure of rates and lead to an outperformance of high quality credit vs treasuries over a 12 month horizon.

However, until then you can rest assured that the Fed will continue to run this race against the virus with sustained intensity (further steps may include loosening regulatory requirements on big banks and/or the Fed requesting Congress to amend the Federal Reserve Act to expand the asset class universe that the central bank is permitted to directly buy), or at least until it’s time to finally pass the baton to Congress and fiscal policy.