March 24, 2020

What Happened

The US Federal Reserve (Fed) announced new, extensive measures to support the US economy. The central bank pledged an unlimited level of quantitative easing (i.e., purchases of US Treasuries and agency mortgage-backed securities) “in the amounts needed to support smooth market functioning and effective transmission of monetary policy to broader financial conditions and the economy.” Additionally, the Fed established two corporate credit facilities
—the Primary Market and Secondary Market Corporate Credit Facilities—that will help US companies access much needed funding. It is also expanding its Money Market Mutual Fund Liquidity Facility to allow a broader scope of purchases, like municipal variable rate demand notes and bank certificates of deposit. The Fed will also offer up to $300 billion in new financing to consumers and businesses and anticipates the creation of a business lending program to support small- and medium-sized businesses.

Our Take

The ongoing pandemic demands decisive action from global central banks. Having learned from previous sudden shocks, the Fed is taking aggressive steps to support the economy and the functioning of the capital markets. In sum, these measures are designed to cushion businesses and households from the inevitable economic fallout of the COVID-19 outbreak. Addressing the crisis requires a three-pronged approach from monetary, fiscal, and health care policymakers.

The Fed’s actions over the past two weeks have demonstrated a thoughtful, deliberate approach with the goal of maximizing the new policies’ impact. The natural state of the US economy and financial markets is being severely disrupted. These measures will provide assistance on both fronts. Large US employers will have access to affordable credit to support their operations and limit job cuts.

Corporate and municipal bond credit spreads remain elevated, exhibiting the stress being felt by those issuers. The new lending facilities will provide critical access to financing to help US companies weather the ongoing storm. It should also help reduce the atypical levels of volatility in short-dated municipal securities. Fixed income markets will benefit from another massive injection of liquidity, and issuers will receive some near-term relief while the economy remains shuttered.

Bottom Line

We view the Fed’s latest measures as necessary and beneficial for the fixed income markets. Unlimited quantitative easing positions the Fed as a willing buyer of US Treasuries and agency mortgage-backed securities (MBS) and its new credit facilities broaden the scope of its eligible purchases to corporate and municipal bonds. These policy tools should help alleviate some of the liquidity constraints in the corporate and municipal bond markets.

We expect to see corporate credit spreads and overall market function improve as a result. However, without a slowdown of the coronavirus pandemic, we expect volatility and price dislocations to remain elevated. The Fed’s unprecedented actions are no panacea, but they should help ease the severe dislocations we are observing in fixed income markets.


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