Although no enhanced forward guidance was provided, the Fed reiterated its commitment to support the economy with tools from the GFC-era playbook as well as new programs.
The Fed’s balance sheet has spiked to $6.5 trillion, from less than $4 trillion at the end of 2019.
Combined with Congressional and Treasury Department actions, the relief/liquidity programs amount to nearly 25% of expected 2020 real U.S. GDP.
Following its April meeting, the Federal Open Market Committee (FOMC) restated its commitment to use its full range of tools to support the economy and to keep the fed funds rate near zero “until it is confident that the economy has weathered recent events and is on track to achieve its maximum employment and price stability goals.” The FOMC also announced that it will continue with its Treasury and agency securities purchases “in the amounts needed to support smooth market functioning, thereby fostering effective transmission of monetary policy to broader financial conditions.” From a peak of $75 billion per day in the third week of March, the Federal Reserve (Fed) has already slowed its Treasury purchases to $10 billion per day this week; with more easing back expected as market functionality continues to improve.
Considerable risks bring back GFC playbook … and then some
The FOMC believes that the COVID-19 pandemic “poses considerable risks to the economic outlook over the medium term” and that it “will use its tools and act as appropriate to support the economy.” Earlier today, the initial read on first quarter real gross domestic product (GDP) was released, which contracted at a -4.8% annualized quarter/quarter rate, the largest since the Global Financial Crisis (GFC) in 2008. Consensus estimates are significantly more dire for the second quarter; with an approximate range of -10% to -50% by Wall Street economists. Given this heightened uncertainty, the FOMC left unchanged its vague guidance on the future path of interest rates.
The Fed has not only used its playbook from the GFC, but significantly added to it during the COVID-19 crisis. Using International Monetary Fund (IMF) data, since March, in addition to the aforementioned rate cuts and Treasury/agency securities purchases, the Fed has:
- Expanded overnight and term repurchase agreements (repos).
- Lowered the cost of discount window lending.
- Reduced the existing cost of swap lines with major central banks and extended the maturity of foreign exchange operations.
- Broadened U.S. dollar swap lines to more central banks
- Offered temporary repo facilities for foreign and international monetary authorities
- Introduced facilities to support the flow of credit, in some cases backed by the U.S. Treasury department, using funds appropriated under the CARES Act, including:
- Commercial Paper Funding Facility to facilitate the issuance of commercial paper by companies and municipal issuers.
- Primary Dealer Credit Facility to provide financing to the Fed’s 24 primary dealers collateralized by a wide range of investment grade securities.
- Money Market Mutual Fund Liquidity Facility (MMLF) to provide loans to depository institutions to purchase assets from prime money market funds (covering highly-rated asset backed commercial paper and municipal debt.
- Primary Market Corporate Credit Facility to purchase new bonds and loans from companies.
- Secondary Market Corporate Credit Facility to provide liquidity for outstanding corporate bonds.
- Term Asset-Backed Securities Loan Facility to enable the issuance of asset-backed securities backed by student loans, auto loans, credit card loans, loans guaranteed by the Small Business Administration (SBA), and certain other assets.
- Paycheck Protection Program Liquidity Facility (PPPLF) to provide liquidity to financial institutions that originate loans under the SBA’s Paycheck Protection Program (PPP) which provides a direct incentive to small businesses to keep their workers on the payroll.
- Main Street Lending Program to purchase new or expanded loans to small and mid-sized businesses.
- Municipal Liquidity Facility to purchase short-term notes directly from state and eligible local governments.
So far, most of the ~$2.3 trillion that’s been pumped into the U.S. economy has come from the Fed’s purchases of U.S. Treasuries and mortgage-backed securities (MBS)—taking a page from its 2008 Global Financial Crisis (GFC) playbook. This has led to a rapid and significant increase in the Fed’s balance sheet, as you can see below.
Fed’s Balance Sheet Goes Parabolic
Source: Charles Schwab, Bloomberg, as of 4/22/2020.
Of course, what the Fed has done is in conjunction with what’s been announced on the fiscal side by Congress, including these key policy responses:
- $484 billion Paycheck Protection Program and Health Care Enhancement Act
- $2.3 trillion Coronavirus Aid, Relief and Economy Security Act (“CARES Act”)
- $8.3 billion Coronavirus Preparedness and Response Supplemental Appropriates Act
- $192 billion Families First Coronavirus Response Act
Adding everything up to date, it’s a combined relief package more than 26% of current Congressional Budget Office (CBO) estimates for 2020 real GDP, as you can see below.
Combined Monetary/Fiscal Relief
Source: Charles Schwab, as of 4/29/2020. *Real GDP based on CBO (Congressional Budget Office) economic projections for 2020. Phase 1 provides funding for vaccine, therapeutic, and diagnostic development; Phase 2 provides grants for unemployment insurance, a 6.2% increase in Federal Medical Assistance Percentage (FMAP) for Medicaid, and refundable tax credits for paid medical and sick leave; Phase 3 establishes the Paycheck Protection Program (PPP); Phase 3.5 provides enhancements for the PPP and additional health care enhancements.
As is customary, Fed Chair Jerome Powell conducted a press conference following the FOMC’s announcement—done virtually today for obvious reasons. He began by acknowledging the “tremendous loss and hardship” people around the world are facing and expressing gratitude for health care workers and other first responders; while also reiterating the Fed’s willingness to use its “full range of tools” to combat the crisis. Powell also noted that the crisis’ health and economic burdens are falling most heavily on those least able to carry them; and that “lack of access to credit” could cause households to lose their homes, or businesses to shut down—hence the extreme steps the Fed has taken to date.
Powell said the next payroll report will likely show a double-digit unemployment rate and second quarter growth will decline at an “unprecedented rate.” On the lending side, Powell noted that “by serving as a backstop to key credit markets, it makes private capital more willing to engage in them now.” He also noted that the bond buying program was put in place to restore proper functioning in bond markets; but that it also helps promote more accommodative financial conditions.
We’re often asked the question whether the Fed is reaching the limits of what it can do—to which our consistent answer is “there really is no defined limit.” When Powell was asked during the presser whether the Fed will likely need to do more, his answer was, “yes.” This could potentially be represented by “enhanced forward guidance”—possibly as soon as the next FOMC meeting in June. Tying the Fed’s commitment to the market’s expectations, a key comment from Powell was that “the market expects us to be there for a good while, and that’s appropriate.”
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