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Institutional Perspectives

We surveyed Lord Abbett investment leaders for their views on the U.S. Federal Reserve’s policy announcement on March 23, 2020.

The U.S. Federal Reserve (Fed) dialed up monetary policy to “11” on March 23, 2020, announcing an extraordinary series of measures designed to “provide powerful support for the flow of credit to American families and businesses.”  (Read the full announcement.)  In responding to the “tremendous hardship” being caused by the COVID-19 pandemic in the United States and around the world, the Fed said it would purchase U.S. Treasury securities and agency mortgage-backed securities (MBS) “in the amounts needed” to support smooth market functioning and effective transmission of monetary policy, effectively establishing “unlimited QE.”1 The Fed also said it would begin purchasing agency commercial mortgage backed securities (CMBS).

The Fed’s other moves include: providing $300 billion in financing to support the flow of credit to employers, consumers, and businesses,and establishing two facilities to support credit to large employers: the Primary Market Corporate Credit Facility (PMCCF) for new bond and loan issuance and the Secondary Market Corporate Credit Facility (SMCCF) to provide liquidity for outstanding corporate bonds.

The Fed created a third facility, the Term Asset-Backed Securities Loan Facility (TALF), enabling the issuance of asset-backed securities (ABS) backed by student loans, auto loans, credit card loans, loans guaranteed by the Small Business Administration (SBA), and other assets.

The Fed also offered programs to assist municipalities’ credit needs by  expanding the Money Market Mutual Fund Liquidity Facility (MMLF) to include instruments such as municipal variable rate demand notes (VRDNs) and bank certificates of deposit and expanding the Commercial Paper Funding Facility (CPFF) to include high-quality, tax-exempt commercial paper as eligible securities. In addition, the pricing of the facility has been reduced. The Fed expects to announce “soon” the establishment of a Main Street Business Lending Program to support lending to eligible small-and-medium sized businesses

As part of our continuing coverage of the current market volatility, we asked Lord Abbett investment leaders to place the Fed’s latest decision in context for investors. Edited versions of their comments follow.

Giulio Martini
Partner, Director of Strategic Asset Allocation

The Fed deployed aggressive monetary policy very early in response to the threat to the economy posed by mitigation measures designed to limit the spread of the COVID-19 virus by cutting interest rates 150 basis points (bps) and introducing open-ended quantitative easing (QE).

The Fed has taken aggressive action to support market functioning by supplying liquidity to both U.S.Treasury and credit markets by reactivating facilities created during the global financial crisis and introducing new ones.

The Fed has also taken steps permitted under “extraordinary and exigent” circumstances, 13(3) authority, to channel credit directly to borrowers via the CPFF and PMCFF, programs that are designed to guarantee access to funding for business activities, and has also acted to make funds available for lending to small business.

Central banks in other nations have also taken aggressive actions to ease monetary policy and channel credit directly to businesses without relying on banks to make loans.

While having the playbook formulated during the 2008-2009 crisis to fall back on has permitted global central banks to react very early to support the real economy, we believe fiscal policy is needed to extend ongoing measures implemented by the Fed and cushion the impact on the real economy from an unprecedented shock to aggregate demand and supply.

In the face of a tremendous shock to economic activity, there are still very significant unknowns –the depth of the economic downturn and the likely timing and strength of the subsequent recovery-- that investors need to understand better before deleveraging ends and risk appetite is restored.

Leah Traub, Ph.D.
Partner & Portfolio Manager

The Fed’s announcement that it would purchase an unlimited amount of Treasuries and MBS is very welcome by the market. We assumed that would be the case, but having the Fed confirm it now is very important. The Fed purchased roughly half of the $500 billion in Treasuries and $200 billion in mortgages that it said it would buy in total so the market was assuming the total would be increased. Going to unlimited purchases means the market no longer has to guess. The Fed is also adjusting the maturities it buys based on where the acute market needs are.

We believe the lending facilities that the Fed has announced will be crucial to unlocking some of the liquidity challenges different parts of the market are facing. This crisis is different from the one in 2008-09 where the main issue was banks having too much leverage and not enough capital. This time around, the U.S. banks are well capitalized but the real economy is facing a sudden stop, on a massive scale.  Getting money to businesses and individuals is the highest priority, in our view, but historically the Fed can only operate via the banks and hope that the banks pass on any extra liquidity to the real economy. With these lending programs, the Fed is attempting to directly reach the corporate and household sectors.

However, right now the lending facilities--$300 billion in total – are too small to make a huge difference, in our opinion.  The Fed cannot take credit risk onto its balance sheet directly. So it needs to set up a Special Purpose Vehicle to buy any credit securities that have an equity piece that is funded by the U.S. Treasury. The Treasury has allocated $30 billion from its Exchange Stabilization Fund (ESF) to provide this backstop.

In order to increase the size of the lending facilities, Congress needs to allocate more funds to the Treasury to fund a much larger equity position. We hope that will be included in the stimulus bill that the U.S. Congress was putting together at the time of this writing.

Kewjin Yuoh
Partner & Portfolio Manager

The Fed continues to do what it can, while many of us believe that a large fiscal stimulus has to happen.  Here are a few observations, general and specific:

  • The Fed has uncapped the amount of Treasury and MBS purchases they can make, and also added agency CMBS to the program.  The agency CMBS market is one dominated by multifamily properties, so it’s a continued focus on consumer support.
  • The ESF (Exchange Stabilization Fund) is too small in size ($300 billion) to really matter, in our view, but the signaling and intent are certainly a positive. What the ESF does with regard to an ability to purchase and support new asset types is very important, including primary and secondary corporate bonds with a BBB- or better rating, maturities of five years or less, and no more than 10% of the most bonds outstanding from that issuer over the prior year.
  • The VRDN in the municipal bond space is also important to help ensure proper market functioning, as my colleagues on the municipal bond side have indicated
  • Perhaps the Fed will recognize the liquidity issues in short, high-quality ABS, but the TALF program announced on March 23 doesn’t address that right now, unfortunately.
  • To us, one other encouraging takeaway from the Fed’s press release is that it expects to announce assistance to small businesses.

Jeffrey Herzog, Ph.D.
Portfolio Manager

We are witnessing across the world a significant jump in fiscal and monetary policy coordination. Today’s events show that the Fed is under the same pressure as other central banks, which are using the combination of Treasury backing and central bank bond purchases to try to cushion the blow of the coronavirus or at least limit secondary effects stemming from financial market instability. The last major era of fiscal and monetary coordination was during WWII when the Fed controlled rates so that the Treasury could finance the war. It seems clear to me that this type of coordination will be with us for some time.

The Fed also showed that it can continue to expand its toolkit, and the Fed demonstrated this on March 23 by expanding its possible purchases to corporate bonds, agency CMBS, and investment grade credit exchange-traded funds. As the current crisis shows, central banking has become the “art of the possible.”

Timothy Paulson
Investment Strategist

While the Fed’s actions earlier in March were significant, the bombshell announcement on March 23 is a much larger step in relieving credit market stress, taking direct aim at clearing up both some of the supply/demand imbalances on the front end of the curve, and also in giving investors confidence that the companies who can access this facility will be able to ride out this shutdown, no matter how severe the short-term damage will be.

This is the first time that the Fed has bought corporate credit, and allowing all eligible corporations to borrow directly from the central bank, in addition to the Fed’s ability to purchase bonds in the secondary market, could ultimately go a long way to clearing up some of the imbalanced selling pressures, and restoring confidence to the market, in our view. The program is also remarkable because there is no claim by the Fed that losses incurred will be limited to the equity from the U.S. Treasury (financed by the Equity Stabilization Fund). 

I believe it will take time to clear out some of the selling pressures in the marketplace. Looking at past examples, such as the Asset Purchase program that was finally launched in March 2009, it took some time for the Fed to ultimately resolve selling pressures from forced sellers.  Notably, actual implementation of that program, several months after the initial announcement, also coincided with an equity market bottom.  The PMCCF was operational as of March 23.

There is no silver bullet in my view, nor would this latest program launch indicate that the market has reached a bottom. The COVID-19 virus is causing a severe amount of economic damage and there may be more to come.  However, Fed Chair Jerome Powell has said policymakers will do “whatever it takes” to ensure the proper functioning of markets. The March 23 announcement is evidence that they have the desire to do so, and the willingness to thoughtfully and aggressively approach today’s unique problems.

 

1”QE” refers to quantitative easing,  is a monetary policy whereby a central bank buys predetermined amounts of government bonds or other financial assets in order to add money directly into the economy.

 

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