Uncategorized

Government support

admin | June 12, 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. This material does not constitute research.

Fed QE has worked beautifully so far, lowering rates, steepening the yield curve and tightening spreads even in assets the Fed does not buy. But markets are getting an underappreciated lift from fiscal policy, too. The federal government in April alone poured $250 billion directly into consumers’ pockets and has distributed $510 billion so far in Paycheck Protection Program loans to small business, of which 75% will likely go to payroll. Personal income, employment and mortgage forbearance all show the imprint. Fed support for QE and easy policy is clear, but federal support for more spending is not. That is the next risk the market will have to manage.

CARES Act has an immediate impact on personal income

The CARES Act and amendments to it authorized $2 trillion in spending with more than 60% of it going as cash directly to small businesses and individuals. That included the PPP at $687 billion, rebate checks to individual taxpayers of $293 billion and expanded unemployment benefits of $269 billion (Exhibit 1). That money has had an immediate impact on fundamentals.

Exhibit 1: Most CARES Act spending targets business and individuals

Note: PPP funding came from the CARES Act and amendments authorizing an additional $310 billion in PPP spending. Source: Congressional Budget Office preliminary estimate of CARES Act costs available here.

In April, despite a $73 billion loss in employee compensation, government transfers of nearly $250 billion helped push US personal income to a nearly $164 billion gain (Exhibit 2). More than 85% of that transfer came from $1,200 checks sent to eligible taxpayers. Another 12% came from unemployment benefits, with a substantial lift from CARES Act federal unemployment benefit of $600 a week. A small amount of unemployment benefits also went to sole proprietors, consultants and others not usually eligible. The CARES Act also extended unemployment benefits for 13 weeks for individuals who have exhausted state benefits, which resulted in a small transfer in April.

Exhibit 2: Changes in personal income from prior month

Source: Bureau of Economic Analysis

The rise in personal income and a drop in personal spending resulted in an April savings rate of 33%, the highest since the US began keeping records in the 1960s. Much of the drop in spending likely came from having less opportunity to spend, with many businesses shut down in April. Spending should rise, including the savings from April.

The mortgage market has felt the impact of fiscal policy indirectly through a surprising low rate of update for forbearance. Despite unemployment in the low teens in April and May, reports from mortgage data provider Black Knight show forbearance in the last two weeks has started to decline. As of June 9, only 8.8% of borrowers had taken forbearance. Mortgage originators report that borrowers prefer to make payments if they are able rather than take forbearance, and many take forbearance as a liquidity backstop and still make loan payments. CARES Act spending has clearly facilitated that.

April and May unemployment suggest the impact of PPP

The impact of PPP is less distinct, but the latest employment report suggests it is making a difference. PPP lending only started in early April during the second half of the April unemployment survey window (Exhibit 3). After exhausting the initial round of $349 billion, a second round of $310 billion in PPP funds became available in early May.

Exhibit 3: PPP loans outstanding ramped up in early April and again in May

Note: Dark blue shows PPP loans from Phase I and light blue from Phase II. Source: American Action Forum

PPP likely had a small effect on April unemployment and a large effect in May.

Private payroll employment went from a loss of 19.6 million jobs in April to a loss of 2.8 million in May. Employment in some industries particularly affected by social distancing also swung significantly from April to May. Leisure and hospitality went from a loss of 7.5 million jobs in April to a gain of 1.2 million jobs in May. Retail went from a loss of 2.3 million jobs in April to a gain of 368,000 jobs in May. Healthcare and professional and business services also went from losses of millions of jobs in April to gains of hundreds of thousands in May. Part of the economy did start opening in May, but PPP requires borrowers to bring payrolls back to pre-March levels in order to earn forgiveness, and May looks like the beginning of the process.

As the household balance sheet goes, so goes market fundamentals

Arguably the most important aspect of fiscal spending in this crisis is that it is going to recipients likely to spend it and drive growth and employment up. Economist Daniel Wilson at the Federal Reserve Bank of San Francisco estimates that authorized spending so far could drive GDP up by 11% for several years in a row. This is in contrast to monetary policy provision of funds at low rates to banks. After 2008 and again in recent months, banks have kept most of the funds in excess reserves with limited real economic impact.

While monetary policy has had a clear impact on asset prices, fiscal policy is having significant impact on small business and individual balance sheets. With consumer spending nearly 70% of GDP, as the consumer goes, so goes growth and employment. And as growth and employment goes, so goes the consumer and corporate credit backing large parts of the US fixed income markets.

Hedge an uncertain commitment to continued fiscal spending

With enhanced unemployment benefits due to expire on July 31 and the vast majority of the PPP spending also done in July, that month should bring a new policy debate on more spending. Differences of opinion on the strength of the economy, deficit spending and incentives to work should sharpen.

It is unlikely in July that the economy will be able to stand on its own, so market volatility will likely pick up. Higher volatility tends to widen all spreads from mortgages to corporate debt. The best hedge is to get long volatility now, before the debate begins in earnest.

It seems most likely that policymakers and politicians will ultimately agree to spend more money. Leaving an economy at risk does not seem like a great way to get elected in November. But that has rarely stopped a little brinksmanship in the meantime.

* * *

The view in rates

The June FOMC brought the Fed’s economic projections back and confirmed the market’s expectations that the Fed will keep rates near zero through 2022 or beyond. The current 0.70% rate on 10-year Treasury debt implies an average real rate of -51 bp and inflation of 122 bp. Implied inflation has continued to climb since mid-March. That should keep pressure on the yield curve to steepen from 2-year to 10-year and from 5-year to 30-year.

The view in spreads

The Fed, banks, money market funds and lately fixed income mutual funds all have sizable amounts of money to spend, and their demand for high quality assets should keep squeezing spreads tighter. As spreads tighten in the highest quality assets, investors will have to move to the next tier of higher risk to get sufficient spread, but it is likely to happen. There is fundamental risk in the most leveraged corporate balance sheets, and only there might spreads continue lagging the rest of the market.

The view in credit

Prices on leveraged loans, rating agency downgrades in leveraged loans and high yield and rising bank loan loss reserves signal a wave of distressed credit. Rising unemployment and delinquency rates in assets from MBS to auto loans show pressure on the consumer balance sheet. However, monetary and fiscal policies are both shoring up these fundamentals. The course of leveraged corporate and consumer credit also depends on renewal of CARES Act unemployment benefits and support for small businesses, along with moratoriums on eviction and foreclosure.

admin
jkillian@apsec.com
john.killian@santander.us 1 (646) 776-7714

This material is intended only for institutional investors and does not carry all of the independence and disclosure standards of retail debt research reports. In the preparation of this material, the author may have consulted or otherwise discussed the matters referenced herein with one or more of SCM’s trading desks, any of which may have accumulated or otherwise taken a position, long or short, in any of the financial instruments discussed in or related to this material. Further, SCM may act as a market maker or principal dealer and may have proprietary interests that differ or conflict with the recipient hereof, in connection with any financial instrument discussed in or related to this material.

This message, including any attachments or links contained herein, is subject to important disclaimers, conditions, and disclosures regarding Electronic Communications, which you can find at https://portfolio-strategy.apsec.com/sancap-disclaimers-and-disclosures.

Important Disclaimers

Copyright © 2025 Santander US Capital Markets LLC and its affiliates (“SCM”). All rights reserved. SCM is a member of FINRA and SIPC. This material is intended for limited distribution to institutions only and is not publicly available. Any unauthorized use or disclosure is prohibited.

In making this material available, SCM (i) is not providing any advice to the recipient, including, without limitation, any advice as to investment, legal, accounting, tax and financial matters, (ii) is not acting as an advisor or fiduciary in respect of the recipient, (iii) is not making any predictions or projections and (iv) intends that any recipient to which SCM has provided this material is an “institutional investor” (as defined under applicable law and regulation, including FINRA Rule 4512 and that this material will not be disseminated, in whole or part, to any third party by the recipient.

The author of this material is an economist, desk strategist or trader. In the preparation of this material, the author may have consulted or otherwise discussed the matters referenced herein with one or more of SCM’s trading desks, any of which may have accumulated or otherwise taken a position, long or short, in any of the financial instruments discussed in or related to this material. Further, SCM or any of its affiliates may act as a market maker or principal dealer and may have proprietary interests that differ or conflict with the recipient hereof, in connection with any financial instrument discussed in or related to this material.

This material (i) has been prepared for information purposes only and does not constitute a solicitation or an offer to buy or sell any securities, related investments or other financial instruments, (ii) is neither research, a “research report” as commonly understood under the securities laws and regulations promulgated thereunder nor the product of a research department, (iii) or parts thereof may have been obtained from various sources, the reliability of which has not been verified and cannot be guaranteed by SCM, (iv) should not be reproduced or disclosed to any other person, without SCM’s prior consent and (v) is not intended for distribution in any jurisdiction in which its distribution would be prohibited.

In connection with this material, SCM (i) makes no representation or warranties as to the appropriateness or reliance for use in any transaction or as to the permissibility or legality of any financial instrument in any jurisdiction, (ii) believes the information in this material to be reliable, has not independently verified such information and makes no representation, express or implied, with regard to the accuracy or completeness of such information, (iii) accepts no responsibility or liability as to any reliance placed, or investment decision made, on the basis of such information by the recipient and (iv) does not undertake, and disclaims any duty to undertake, to update or to revise the information contained in this material.

Unless otherwise stated, the views, opinions, forecasts, valuations, or estimates contained in this material are those solely of the author, as of the date of publication of this material, and are subject to change without notice. The recipient of this material should make an independent evaluation of this information and make such other investigations as the recipient considers necessary (including obtaining independent financial advice), before transacting in any financial market or instrument discussed in or related to this material.

Important disclaimers for clients in the EU and UK

This publication has been prepared by Trading Desk Strategists within the Sales and Trading functions of Santander US Capital Markets LLC (“SanCap”), the US registered broker-dealer of Santander Corporate & Investment Banking. This communication is distributed in the EEA by Banco Santander S.A., a credit institution registered in Spain and authorised and regulated by the Bank of Spain and the CNMV. Any EEA recipient of this communication that would like to affect any transaction in any security or issuer discussed herein should do so with Banco Santander S.A. or any of its affiliates (together “Santander”). This communication has been distributed in the UK by Banco Santander, S.A.’s London branch, authorised by the Bank of Spain and subject to regulatory oversight on certain matters by the Financial Conduct Authority (FCA) and the Prudential Regulation Authority (PRA).

The publication is intended for exclusive use for Professional Clients and Eligible Counterparties as defined by MiFID II and is not intended for use by retail customers or for any persons or entities in any jurisdictions or country where such distribution or use would be contrary to local law or regulation.

This material is not a product of Santander´s Research Team and does not constitute independent investment research. This is a marketing communication and may contain ¨investment recommendations¨ as defined by the Market Abuse Regulation 596/2014 ("MAR"). This publication has not been prepared in accordance with legal requirements designed to promote the independence of research and is not subject to any prohibition on dealing ahead of the dissemination of investment research. The author, date and time of the production of this publication are as indicated herein.

This publication does not constitute investment advice and may not be relied upon to form an investment decision, nor should it be construed as any offer to sell or issue or invitation to purchase, acquire or subscribe for any instruments referred herein. The publication has been prepared in good faith and based on information Santander considers reliable as of the date of publication, but Santander does not guarantee or represent, express or implied, that such information is accurate or complete. All estimates, forecasts and opinions are current as at the date of this publication and are subject to change without notice. Unless otherwise indicated, Santander does not intend to update this publication. The views and commentary in this publication may not be objective or independent of the interests of the Trading and Sales functions of Santander, who may be active participants in the markets, investments or strategies referred to herein and/or may receive compensation from investment banking and non-investment banking services from entities mentioned herein. Santander may trade as principal, make a market or hold positions in instruments (or related derivatives) and/or hold financial interest in entities discussed herein. Santander may provide market commentary or trading strategies to other clients or engage in transactions which may differ from views expressed herein. Santander may have acted upon the contents of this publication prior to you having received it.

This publication is intended for the exclusive use of the recipient and must not be reproduced, redistributed or transmitted, in whole or in part, without Santander’s consent. The recipient agrees to keep confidential at all times information contained herein.