Municipal and corporate bonds rallied yesterday after the Fed unveiled major expansions of its fiscal stimulus policy. The new policies sent a clear message to investors: the Fed is willing to do whatever it takes to support the market.
After unleashing a wave of fiscal firepower on the market last week, the central bank launched a second salvo of initiatives to support liquidity in panicked markets, including more loans for businesses and an unlimited purchasing of government debt.
The COVID-19 bailout package hit an impasse in the Senate on Monday, and the market was ready to nosedive in response. Luckily, the Fed took drastic action to support the market while Washington was busy bickering over the fine print. The Fed announced the move roughly 90 minutes before the market opened on Monday, but it punctuated its announcement with an ominous warning to investors.
“It has become clear that our economy will face severe disruptions,” the Federal Reserve said in its official statement on Monday, “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.”
Translation: the U.S. needs to do whatever it takes to support the economy during this crisis.
Whatever It Takes
The Fed’s latest initiatives have officially gone further than the drastic action taken during the ’08 Financial Crisis. During the Crisis, Fed stimulus was mainly intended to keep the financial sector from going under. However, the central banks are focusing a lot more resources on the smaller businesses this time around. The Fed plans on offering extensive lending options for small and large businesses, and it will even begin supporting liquidity of corporate-backed debt.
Many experts believe the drastic action is warranted. Unlike 2008, the economy is at a virtual standstill, so the downturn could have even more long-reaching implications for the U.S. economy.
Thousands of U.S. businesses are having difficulty accessing working capital, so the Fed’s decision to intervene in the credit markets seems to be well-founded. The central bank will work with the Treasury Department to ensure liquidity by injecting cash into the marketplace.
The Fed can purchase private-sector assets directly, and it has restrictions on the types of municipal bonds it can buy. However, officials are bending the rules in order to support the fragile market. The central bank can offer emergency loans on a widespread basis under section 13(3) of its charter. So far, Fed officials have invoked section 13(3) on six separate occasions this week to combat the credit crunch.
Mortgage securities and Treasury bonds are also getting a lift from the Fed. The central bank said it will expand its purchasing program to include unlimited amounts of these assets. This week, the Fed will buy $375 billion worth of Treasury bonds and $250 in mortgage securities.
To support the capital markets, the central bank will open three new lending facilities to support the credit markets. The Treasury Department will support the effort with $30 billion, allowing the facilities to offer up to $300 billion in available financing. Officials also announced a plan to introduce a “Main Street Business Lending Program” that will support small and midsize businesses. However, that initiative would likely require support from the Treasury Department. The Fed didn’t detail any specifics behind the plan.
The Treasury Department wants to support the Fed efforts, but Congress has its hands tied. On Monday, the Senate failed to move forward with COVID-19 support legislation for the second-straight day. In typical DC fashion, politicians are holding back COVID-19 relief so they can push their agendas. Meanwhile, the Fed has to battle the credit crunch on its own.
The Traders Take
The Fed announcement led to a rally in corporate bonds. The iShares Investment Grade Corporate Bond ETF rallied 7.39% on the news. Municipal bonds also got a lift, albeit a modest one. The iShares National Muni Bond ETF jumped 1.90% after the Fed released its announcement. Unsurprisingly, the dollar suffered from a modest pullback, and gold inched higher.
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