The government CARES as the Fed boosts balance sheet

| March 27, 2020

This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.

The CARES Act offers support to pretty much every US business and individual. The size and coverage is a good effort to cushion the blow from the coronavirus. Many are asking if it will be enough, but that is not the right question yet. The more pertinent question is how quickly can the government distribute the money and get to the right people.

I am actually pretty optimistic on this front after listening to Secretary Mnuchin at recent coronavirus task force briefings.  He said that the checks to households will be sent out within three weeks through direct deposit and that funds to small businesses would begin to flow by early April.  Some portion of the $450 billion allocated to help businesses and governments will backstop the Fed’s Main Street Lending Facility and get levered 10 times.  That means several trillion in funding.  The market should hear from the Treasury and the Fed regarding this facility within 10 days.

To be fair, the Fed has its hands full.  The market still needs final details on all of the facilities already announced, so it would be unrealistic to expect the Main Street Lending Facility to be up and running in less than a week or two.  Chairman Powell made a rare appearance on the Today Show on March 26, an effort to reassure the general public that the economy will rebound and that the Fed has plenty of ammo left to continue to support the economy.  It was a good effort and a smart idea.

On the economic front, people have been buzzing about the initial claims figure all week, and the reading exceeded most expectations, surging to more than three million.  Looking at the state-by-state breakdown, there should be more to come in the current week, with the data released on April 2, more likely than not even higher than the March 26 reading.  Hopefully, the number of new filers will peak in the current week and begin to trail off after that, especially since the fiscal bill should help to stem the bleeding of layoffs at small businesses going forward.  Clearly, the March 26 numbers show the depth of the short-term shock.  At this point, Q2 GDP could drop 15% and the unemployment rate could spike to 6% in April.  However, in some sense, the magnitude of the fall in GDP or the spike in the unemployment rate is less important than when things begin to turn and how rapidly the economy gets back to some sense of normal.  We all have our best guesses there, but they remain speculative.

Financial markets have a better tone, but there are still plenty of divides.  For CRT paper, CLOs, or other areas that have yet to see efforts from the Fed, things may not feel better.  But the most liquid markets—financing, Treasuries, agency MBS, investment grade corporates—have improved considerably, though the degree to which Treasury bill rates have moved into negative territory is a little disconcerting.  It will be interesting to see whether the Fed slows the pace of Treasury and agency MBS purchases for next week, perhaps a first concrete signal of modestly less pressure.

An update on the Fed’s balance sheet

The weekly publication of data on the Fed’s balance sheet shows the early infusion of liquidity into various sectors of the financial system, as well as how much remains to be done.

Balance Sheet Changes

The Federal Reserve’s weekly snapshot of its balance sheet came out Thursday afternoons in its H.4.1.  With the announcement of a variety of new programs, this dataset will be the vehicle for tracking the usage of various facilities.  The first weekly edition since many of these programs were announced offers a look at the Fed’s liquidity infusion into the financial system. The details are presented in Exhibit 1.

Exhibit 1: Fed Balance Sheet Components

Source: Federal Reserve

As the exhibit shows, the main source of liquidity infusion continues to be the Fed’s purchases of Treasuries and agency MBS.  The pace of those buys has been massive this week. In fact, the cumulative purchases over the last two weeks has been equivalent to one of the rounds of QE undertaken in the years after the Financial Crisis, though those rounds of QE were executed over extended periods (usually 6-9 months).  With those markets showing less stress, I would expect the pace of buying to recede going forward.

Funding stress has also abated, which is seen in the table by a $90 billion drop in the amount of repos outstanding.  However, another aspect of the stress in funding markets was the shortage of dollar liquidity globally, and the central bank swap facilities opened up and enhanced over the last two weeks were being utilized heavily, with over $200 billion outstanding as of Wednesday.

The Fed has announced six major facilities this month.  Two relate to the commercial paper market, the Commercial Paper Funding Facility (CPFF), and the Money Market Mutual Fund Liquidity Facility (MMLF).  These facilities cover the primary and secondary market for term CP, respectively.  Similarly, the Fed announced the Primary Market Corporate Credit Facility (PMCCF) and Secondary Market Corporate Credit Facility (SMCCF) to support the IG credit market’s primary and secondary markets, respectively.  The Primary Dealer Credit Facility (PDCF) offers inexpensive term funding for a variety of asset types that were experiencing illiquidity.  Finally, the Term Asset-Backed Securities Lending Facility (TALF) is designed to support the continued flow of new issue ABS in an effort to keep credit available to households and businesses.

Programs designed to support primary issuance require a tremendous amount of preparation and infrastructure building, so these facilities are not yet operative. In fact, it could be a few more weeks in some cases before we see anything out of several of these facilities.  If financial market stress continues to abate, some of these programs may not even be used.  There is precedent for that, as a couple of the Financial Crisis-era programs were never drawn on.

As of Wednesday, only two of these “alphabet soup” facilities have begun to operate.  The PDCF had $28 billion outstanding as of Wednesday, while the MMLF had $31 billion outstanding.

Finally, discount window usage roughly doubled to $50 billion.

Coming Attractions

All told, the Fed’s balance sheet swelled to $5.216 trillion as of Wednesday.  To put that figure in perspective, the prior peak of the balance sheet after the Financial Crisis was $4.5 trillion, so the balance sheet run-off that occurred over a two-year period has been reversed plus $750 billion in a matter of weeks, and we have a handful of programs yet to even come on stream.

In fact, prospectively, the largest program of all will be the Main Street Lending Facility laid out in the fiscal relief bill.  With roughly $450 billion in potential backstop, the Fed could lend as much as $4 trillion to businesses in the coming months to keep them afloat.

In sum, the Fed’s balance sheet has expanded rapidly and will likely to continue to do so for the foreseeable future.

john.killian@santander.us 1 (646) 776-7714

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