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Last week, the Federal Reserve (Fed) initiated new and unprecedented measures of monetary stimulus to ease the economic and financial strains caused by the coronavirus outbreak.
The Fed will expand into high yield debt and exchange-traded fund purchases just two weeks after announcing its first-ever program to buy investment grade corporate bonds. High yield bond purchases will be limited to borrowers recently downgraded following the outbreak of the coronavirus in the United States. As just one example of this program’s immediate impact, Ford Motor Credit Company 10-year bonds rallied 15 points last Thursday on the news.
The Fed will also begin lending directly to states and certain large cities and counties whose budgets are under pressure from the coronavirus outbreak. Declining tax revenues, coupled with higher spending on health care and unemployment benefits, will create severe strains on state and local budgets. States with balanced budget amendments will likely face the most extreme challenges.
The Fed will also expand purchase activity to include AAA-rated collateralized loan obligations (CLOs) and commercial mortgage-backed securities. CLO purchase activity will be limited to new issues, with restrictions on reinvestment activity by CLO managers. This purchase activity is designed to ease pressure on CLO warehouse lines, credit facilities offered by large banks and investment banks that enable CLO managers to build a portfolio of leveraged loans. The leveraged loan collateral backing these warehouse lines has plummeted in value and faced heavy downgrade activity since early March, as many areas of the economy hit a brick wall.
The Fed is also offering one new and one enhanced “Main Street” lending facility. These measures have the most potential to do more than simply ensure financial market stability but make a real impact on economic conditions. In particular, the Paycheck Protection Program is designed to incentivize small businesses to keep workers on the payroll in a time when new unemployment claims are skyrocketing.
I believe Chair Jerome Powell and other Fed members deserve high grades for doing “whatever it takes” to help ease the economic and financial burdens created by the coronavirus outbreak. Record monetary and fiscal stimulus is helping to provide a backstop for individuals, businesses and municipalities until a medical solution allows the world to return to some level of normalcy.
Until that time, please stay safe and be well.
