MIKE TOWNSEND: Hi, everyone, and welcome to another episode of WashingtonWise Investor, an original podcast from Charles Schwab. I’m your host, Mike Townsend, and our mission is to help you cut through the noise and the nonsense of the nation’s capital and figure out what really matters to the markets and to investors.
We are living in exceedingly strange times, to say the least, so I’m adapting the usual format of this podcast to focus on key things for investors to know as we move through extraordinary volatility in the markets and dramatic changes to everyday life. In just a few minutes, I’ll be joined by one of Schwab’s experts for an in-depth discussion of the many steps the Federal Reserve has taken over the past week to address the economic and market uncertainty brought on by the coronavirus and their implications for bond investors.
But I want to begin today with a look at what else is going on in Washington in response to this crisis. Before I get too far along, let me be clear that things in Washington are moving with astounding speed—as with so many aspects of life in the United States right now, the news changes literally by the hour. I’m recording this on the afternoon of Wednesday, March 18, so the information I’m sharing is accurate as of that time. But I acknowledge that there is the possibility, even a likelihood, that some of what I say here will be overtaken by events. You can keep up with the very latest by following me on Twitter: @MikeTownsendCS, where I’ll do my very best to make sure I’m sharing the latest information.
So here are three things to know.
First off, the Senate is in session right now in the Capitol, but the House of Representatives is on an indefinite recess. Before leaving town, House members easily approved the second package of coronavirus aid. This follows on the first bill that included $8.3 billion in emergency spending, which was approved by Congress and signed by the president on March 6. The second package is a $100 billion bill that increases the availability of paid sick leave for many companies that employ between 50 and 500 people; expands family and medical leave; expands unemployment benefits; allocates more than $1 billion in support for safety-net programs like food stamps and the reduced or free school lunch program; and provides for free coronavirus testing for all who need it, including the uninsured. The Senate passed that bill on March 18.
At the same time, Congressional leaders from both parties are deep into negotiations with the administration on a third bill—a massive economic stimulus package that is expected to be in the $1-to-$1.3 trillion range, and it could grow even larger. Details on that economic stimulus bill are still very much in flux, but the White House and some key Senators are pushing hard for the immediate sending of checks to individual taxpayers, perhaps $1,000, in either one or two rounds of payments. The scope of who would receive those checks is still under negotiation, though it is expected that they will be based on things like income and family size.
There are dozens of other ideas floating around Capitol Hill right now for what else should be in that bill—candidates include a lending program for the airline industry, which has asked for $50 billion in aid, as well as aid for other industries that have been particularly hard hit by the crash in consumer spending and travel; a huge amount of aid for small businesses, perhaps on the order of $250 billion or more, possibly through an enhanced loan program at the Small Business Administration; some sort of payroll-tax cut or payroll-tax holiday, though momentum on Capitol Hill appears to be trending against that idea; a guarantee program to ensure the stability of money market funds; and additional aid for safety-net programs, unemployment insurance, and perhaps student-loan-debt relief. And these are just a few of the ideas being tossed around.
Senate Majority Leader Mitch McConnell said earlier this week that the Senate would stay in session until this third bill is done. Now this isn’t as simple as it might seem. There are 100 senators, and the president recently recommended limiting gatherings to no more than 10 people. Further complicating matters, there are 66 senators who are over the age of 60, including 14 who are older than 75, so this is the population most at risk from the coronavirus. So far, no senator has shown signs of the illness, though several have self-quarantined or continue to self-quarantine after coming into contact with someone with the virus.
The House of Representatives, however, is on recess this week—part of the regular schedule of “district work periods,” in which lawmakers spend time in their home districts. House members are supposed to return on Monday, March 23, but have postponed that return date until the Senate has passed the economic stimulus bill, that third piece of aid legislation, and House members need to return to Washington to vote on it. Right now, that looks like it could be sometime next week.
The second thing to know is that on March 17, Treasury Secretary Steven Mnuchin announced that the IRS would postpone the April 15 deadline for individual income tax payments. Americans will have an additional 90 days to pay their taxes—interest and penalties for late payment will be waived. The relief is available to individual taxpayers who owe $1 million or less and to businesses that owe $10 million or less.
Importantly, individuals still have to file their tax returns by April 15—you just don’t need to pay your taxes when you file. So the sensible action is to file your return as soon as you can if you are expecting a refund, as the IRS is prioritizing refunds right now. And if you owe taxes, file by the April 15 deadline, but consider whether you want to take the option of delaying your payment by 90 days.
The third thing I want to address is the growing rumors that the markets may close for a period of time. In interviews on March 17, Secretary Mnuchin said that he believes it is very important that the markets continue to operate, saying, “I want to be very clear—we intend to keep the markets open.” This echoes comments made the day before by SEC Chairman Jay Clayton, as well as the heads of the major exchanges, including the New York Stock Exchange and the Nasdaq. Mnuchin did say on March 17 that it was possible that the exchanges could shorten their trading hours if that became necessary—he was the first official to raise that possibility. For now, however, there has been no serious discussion of reducing trading hours.
While the president could order a shutdown of the nation’s markets, right now, we think that is unlikely.
The New York Stock Exchange and other exchanges have closed temporarily for a variety of world events, from a four-month closure in 1914 during World War I to a two-day closure in 2012 when Hurricane Sandy came through the New York area. There have also been closures for things like a day of mourning when President Kennedy was assassinated in 1963 and a day of celebration for the moon landing in 1969.
We will of course continue to monitor any developments in this area, and there will be plenty of communication if any changes to the markets or market hours are under consideration.
In my Deeper Dive segment this week, we’re going to focus on the recent actions of the Federal Reserve in response to the economic and market impacts of the coronavirus pandemic. Joining me to explain the Fed’s moves is Kathy Jones, senior vice president and chief fixed income strategist with the Schwab Center for Financial Research and our resident Fed expert. Thanks for joining me, Kathy.
KATHY JONES: It’s great to be here with you, Mike.
MIKE: Well, let’s begin with what happened last Sunday, March 15, one of the most dramatic days in the Fed’s history. The Fed announced that it was taking the benchmark interest rate to near zero. What were the Fed’s intentions with this move?
KATHY: I think the main objective for the Fed was to make sure that there’s enough liquidity in the financial system to keep it functioning properly. Now, liquidity is one of those words that’s used a lot and people don’t often understand, but it really means that transactions in the financial markets can take place at a reasonable frequency, at reasonable prices. And there have been signs of strain, as companies and households were paying more and more to obtain loans and finding it more difficult to get access to the credit that they needed. So the Fed lowered the fed funds rate—that’s their base lending rate—and took a few more steps to make sure that banks had plenty of access to funds in order to lend out to businesses and individuals.
MIKE: Kathy, we’ll come back to some of the other moves the Fed did in just a moment, but I want to focus first on this rate move. How do we know if it’s working? How long does it take to know if it’s working, and what will be the signs that it’s working?
KATHY: Well, you can typically see pretty quickly, because the markets adjust their expectations very fast. And so what we saw initially in response to that is, you know, the stock market went up, and the cost of credit, meaning the rates on loans, say, to corporations started to come down a bit relative to, say, the rates on Treasuries. Now, that’s the immediate response. It does take a while to see if it’s actually having the economic outcome that they want to see, and that is keeping the funds flowing in the system. I think the jury is still out, but at least it alleviated the near-term strains in the system.
MIKE: Well, Kathy, one of the questions that I’ve been getting a lot at my live events in the last couple of months is whether interest rates could go negative in this country. Could that happen here, and what would be the implications if it did happen?
KATHY: Well, and I’ve certainly had this question a number of times, too, over the last couple of years, it’s not what we expect to be, you know, sort of our base case scenario. The Fed has made it quite clear that they are not particularly inclined to use that as one of their tools. And in fact, Fed Chair Powell reiterated that at the press conference on Sunday—when they did lower the rate back to close to zero—he indicated he didn’t think that was appropriate policy. There’s a number of reasons for that, mainly because it hasn’t seemed to work particularly well in Europe or Japan. It puts a strain on the banking system, and so the Fed has really been very reluctant to go there.
Now, having said that, it isn’t just the fed funds rate you have to worry about. You have to worry about the other rates—so the Treasury auctions, you know, T-bills and T-notes and bonds all the time. If the economy were really to go into a tailspin, and investors were desperately seeking a place to put their money that they thought was safe, it is possible that short-term interest rates in the Treasury market, like one-year notes or two-year notes, could go into negative territory. It wouldn’t be because the Fed intended it to happen. It would be because the demand for that safety was so strong.
MIKE: Well, Kathy, what would be the impact of the Fed’s interest rate move on things like mortgage rates and credit card rates, things that everyday investors, everyday consumers are more familiar with?
KATHY: Well, it should lower the rates on those. Now, that being said, there’s also another component to setting those rates, and that’s supply and demand. So for mortgage rates, they typically are priced off of, say, 10-year Treasury yields, and those will follow when the Fed lowers short-term rates most of the time, so we’ll start to see those come down. But if the banks or the lenders have a really strong demand for refinancing or new mortgages, they may be slow to lower those rates, because right now they have enough demand at a higher rate. So it trails, but it usually trails kind of slowly behind where the Fed is going or where the market’s going in terms of interest rates.
Credit card rates behave similarly. They tend to be much higher, depending on your credit score, and again, they should come down, but it is a case of supply and demand. If people are continuing to use their credit cards and paying high rates of interest, the banks that issue them have less and less incentive to bring it down substantially.
MIKE: What about the impact on corporate and municipal bonds?
KATHY: Again, it should lower rates for corporate and municipal bonds, and again, just like mortgage rates and credit cards, the supply and demand for any particular bond is what really determines the price. So it will matter to some extent, because usually corporate bonds and municipal bonds are priced relative to Treasuries of similar maturity. But those differences between corporate bonds and Treasuries, say, can expand or contract depending on market conditions. And it will really depend on the credit-worthiness of the issuer of the bond, so if it’s a AAA-rated municipal bond, its yield will typically move in line with Treasury yields pretty closely. But if it’s a junk bond in the corporate market—meaning below investment-grade, or high-yield bond—its credit-worthiness is much more important than where Treasury yields are in determining, you know, where it’s going to be priced. So again, they’ll fluctuate relative to Treasuries, but those fluctuations can mean expanding that difference or contracting that difference, depending on the economic outlook and the supply and demand for that particular bond.
MIKE: Well, the Fed also made some other important moves on Sunday. Walk us through those other steps.
KATHY: In addition to lowering the fed funds rate, they announced that they will be increasing their balance sheet. They’ll be buying $500 billion in Treasuries of various maturities and $200 billion in mortgage-backed securities. And so the reason they’re doing this—this is similar to the quantitative easing programs that they did in the past during the financial crisis—the idea is to remove, you know, some of the supply, so that the prices go up and the yields go down. So what they really want to do is reassure the market that they’re going to keep yields down—and use all their tools to do that, because lower rates tend to help the economy.
Similar story in the mortgage market. The yield on mortgage-backed securities has not really been coming down as quickly as Treasury yields. So by buying mortgage-backed securities, they’re removing some of the supply from the market, and that should bolster the housing market by holding down mortgage rates.
Another thing that they did is they lowered the discount rate, and that’s the rate that banks pay to borrow directly from the Fed. They lowered it to a quarter of 1% for their large banks, or what they call their primary banks, and then to ¾% for the non-primary banks, usually the smaller banks. This is a tool, again, to make it easier for banks to access funds and pass along that money in the form of loans to households and to businesses.
And then, finally, they coordinated with other central banks around the world to lower the cost of what they call swap lines, and this is the cost of obtaining U.S. dollars abroad. And what had happened was—in times of stress in markets, you often see demand for U.S. dollars as a safe haven go up. And the cost of obtaining those dollars was very high and rising, and they wanted to lower that so that the borrowers overseas also had access to the dollars they need to reduce some of the stress in the system. So it was a big package of things, and that was definitely, all of it. intended to bring the cost of money down to encourage growth in the economy.
MIKE: Well, many of these tools are similar to what was done back in the 2008–2009 financial crisis. But I’ve heard it said that what’s different this time is that the Fed did it kind of all at once. Is that accurate?
KATHY: Yeah, I would say these are all tools that they employed back in the financial crisis, but they … at the time, they were kind of testing out some of these ideas, and it was dribbled out over time, because they were trying to see what would work and what didn’t work. Based on their experience in the financial crisis, now I think the Fed has a much better feel for what does work, and I think they wanted to come out with a pretty powerful statement that, “Yeah, you know, we’re going to use the things we know work in order to support the economy through this pandemic and whatever comes down the road.”
MIKE: Well, as we said, Kathy, the Fed took these actions on a Sunday afternoon, which was, itself, kind of surprising. Then the Monday market opened and the reaction was an enormous record-setting move to the downside. The Dow Jones Industrial Average plummeted by 3,000 points. Did that outcome surprise you?
KATHY: You know, initially, I was surprised, because I thought that, at least at first, this would send confidence to the market. But I think what happened was that because the Fed did it, you know, on a Sunday, and it was sort of an extraordinary move, it perhaps underscored how serious the situation really is. There had been mixed messages, I think, coming about whether this was going to be a long-term problem, a short-term problem, a big problem, a small problem, and I think it emphasized to everybody that the Fed was taking this really, really seriously.
I think, also, there was some concern, or disappointment, that it wasn’t combined with a fiscal stimulus package. I think there were people who were hoping to see a combined effort by the Federal Reserve, and the Treasury, and maybe Congress to pull all this together to have one big package, and that didn’t happen, the Fed moved independently. So, you know, kind of a mixed message there. There was a little bit of disappointment, and there was a little bit of underscoring the risks.
MIKE: Well, I do think that fiscal package is coming, but it’s not coming as quickly as some people hoped. Now, on Tuesday, March 17, the Fed made another surprise move, announcing that they were reinstating something last seen in the 2008–2009 financial crisis, an emergency facility to provide funding through the commercial paper market. Now, why did it do this?
KATHY: Well, I was actually surprised they didn’t do it on Sunday, but they waited. I’m not really sure what the reasoning was behind that. But the commercial paper market is a way for businesses to get short-term funding. And because the market has been skittish about lending, there really wasn’t a lot of activity in the commercial paper markets. Our rates were moving up, and so the Fed stepped in with this tool and said, “OK, we want to make sure that businesses who use commercial paper for payroll, rent, etc., could actually get access to those funds at a reasonable rate.” So again, they just pulled another tool out of the toolbox and said, “OK, we want to make sure that money is available for businesses in the economy at a reasonable rate so they can continue to function, or at least meet their needs.” Another way to support the market.
MIKE: After all these moves in such a short period of time, one of the concerns out there is that the Fed is using all of its ammunition too quickly. Do you think that’s true? What other ammunition does the Fed have at its disposal?
KATHY: Well, this is a tough call to make, and I hate to play Monday morning quarterback. Some would argue that the Fed should have moved more quickly and used a whole bunch of things right from the get-go. Others say that they should have held back a little bit, including one member of the Federal Reserve, who didn’t want to cut rates all the way to zero right away. She wanted to hold back a little bit.
What else can they do? I think the Fed can increase the size of its quantitative easing program. They can buy more bonds to hold down yields if they need to do that. Again, that would be something that they would use to really signal that, “Hey, we’re going to keep rates low for a long time.” There are some regulatory rules that they could ease up on to free up more capital, similar to what they did with reserve requirements—there might be some steps that they could take there. And they could expand, theoretically, some of the types of assets that they buy. Now, right now, they’re buying Treasuries and mortgage-backed securities. They could expand that to include other securities. It gets a little tricky, though, because if you were to talk about, “Could they buy corporate bonds?” for instance, as the European Central Bank has done and the Bank of Japan has done, then they would have to get an amendment to the Federal Reserve Act, and that’s a lot trickier. So there’s still some steps they could take, but I would say they’ve gone pretty deep into the toolbox now.
MIKE: Well, Kathy, with all that is happening in the markets right now and all that the Fed is doing, here’s probably the question that is most on the minds of individual investors right now. With yields so low, should investors still be investing in bonds?
KATHY: Well, it’s funny, because I have actually had that question since about 1986, and you know, yields continue to fall, right? But beyond the yield, there’s a lot of things that you have to consider about holding bonds. So Treasury bonds, for instance, historically, have been one of the best hedges against a decline in the stock market. So long-term Treasuries tend to do well when the stock market goes down. We’ve seen this pattern historically, we saw it again this time around, and so even with yields low, actually, you know, during this timeframe, people have had nice gains in their bonds, along with the income that’s delivered. So for diversification from stocks, particularly Treasuries, high-quality bonds, but particularly Treasury bonds tend to do very well irrespective of the yield. That’s one reason to hold them.
Also, you know, bonds deliver income. Capital preservation, if they’re high-quality bonds, and barring a default, you get your money back. And they can be great for planning. So in other words, if you’re saving for a particular goal, like college education or down payment on a house, or for retirement even, having something that you know exactly when you’re getting your money and how much you will have is very important, and bonds can do that. They’re kind of unique in that way as an asset class because they will mature at par. Barring a default, you know what you’re going to get. And for planning purposes, that could be very helpful.
And you know, finally, look, we never suggest abandoning an asset class. There are lots of different types of bonds. They have lots of different yields, and different purposes in a portfolio, but even with low yields they could be a valuable asset class to hold.
MIKE: Well, obviously, investors are skittish, nervous, anxious right now, so more broadly, what should investors be doing?
KATHY: If you don’t have a financial plan, you should probably get one very quickly, one that sort of aligns with what you’re willing to bear from the market, and what you’re able to bear from the market, and helps you meet your goals. And we always say that you want to have a plan that can get you through the ups and downs, because these things are inevitable.
We feel very strongly, and have felt for quite some time, that the risk-reward on the riskier segments of the market were not that attractive, and that investors should stay up in credit quality, meaning hold bonds that really are higher in credit quality, have higher credit ratings and less risk of default. Because especially if we are going into a recession or a downturn in the economy, these are the bonds that should deliver on the income payments and hold their value, the principle value. So you want to have that in your portfolio at a time like this, rather than the riskier types of bonds that perhaps have a risk of default or certainly could see their ratings downgraded and prices decline very substantially.
So, again, focus on highly-rated bonds, like Treasuries, investment-grade, municipal bonds, and perhaps some higher-rated corporate bonds. And then, also, you know, we have bond specialists available that can help people choose the right bonds for their portfolios, help them put that into work for them as part of their overall financial plan.
MIKE: Well, one more question, Kathy. It’s certainly hard to see the end of this situation now, but we know that this crisis, like all crises, will eventually end. Once we return to a more normal environment, how quickly do you think the Fed will begin taking rates back upwards, or do you think that the economic fallout from the pandemic will be so severe that it will take a long time for the Fed to even begin thinking about raising rates?
KATHY: I think, based on what Fed Chair Powell has said, we’re going to be at low rates for a while here. And the reasoning is, he said they were going to keep the fed funds rate anchored near zero until they’re closer to meeting their goals. And the Fed’s, you know, two mandates, major mandates, are price stability, which they define as 2% inflation according to the most popular measure that they use, and low unemployment, or full employment. And I think as the economy slows down inevitably, perhaps goes into recession as a result of the pandemic, that unemployment is going to rise and inflation is going to continue to fall short of where the Fed would like to see it. If those are the criteria that he outlined, based on that, I think it could be a year or two years before we even, you know, see the Fed considering starting to turn around and raise rates.
MIKE: Well, Kathy, as always, you’ve done a great job of breaking down a lot of complicated developments in a way everyone can understand. I know you’ve been crazy busy in the last couple weeks, so I really appreciate you taking some time to join me on the podcast. Thank you very much.
KATHY: Well, thanks, Mike. Always great being here.
Finally, let me conclude with an update on the presidential race—it’s almost hard to remember we have a presidential primary still going on.
On March 17, former Vice President Joe Biden solidified his lead with big victories in three states—taking nearly 62% of the vote in Florida, about 59% in Illinois, and also winning in Arizona. According to Real Clear Politics, those wins have boosted Biden’s lead to more than 300 delegates over Vermont Senator Bernie Sanders. Sanders’s campaign said on March 18 that it would be assessing the campaign going forward, but the pressure on Sanders to step aside is growing.
At the same time, there are a lot of questions about how the primary season will continue. Ohio voters were supposed to go to the polls on March 17, but voting was cancelled in an incredible series of on-again, off-again moves the day before. Ohio’s governor recommended on March 16 that polls be closed, but courts ruled that only the state legislature could change the date of an election. Late that evening, the governor used a public health declaration to shutter the polls once and for all. Ohio is now looking to hold its primary on June 2.
Several other states have pre-emptively moved their primaries. Georgia was the next big state scheduled to vote—their primary was slated for next Tuesday, March 24, but has been moved to May 19. Louisiana, which was scheduled to vote on April 4, moved to June 20, while Kentucky delayed its primary from May 19 to June 23. Here’s the tricky thing, however—the Democratic National Committee has rules in place that cut the delegates in half for any state that votes after June 9, so Kentucky and Louisiana would be in violation of that rule. And the DNC’s deadline for choosing state delegates to the national convention in July is June 20—an impossible deadline now for Kentucky and Louisiana.
Like so much else in life right now, no one really knows how the presidential race will unfold from here.
Well, that’s all for now, thanks so much for listening. If you like what you’ve heard, please take a minute to leave a rating or a review on Apple Podcasts or your favorite listening app—those ratings and reviews really matter. And make sure you subscribe so you don’t miss an episode.
For important disclosures, see the show notes or schwab.com/washingtonwise, where you can also find the transcript.
I’m Mike Townsend, and you’ve been listening to WashingtonWise Investor. Until next time, stay safe, stay healthy, and keep investing wisely.