The Fed continues its barrage of liquidity and programs with the details of expanded credit programs and the much anticipated Main Street Lending Facility. A total of $2.3 Trillion in liquidity based on $195 Billion in backstop from the Treasury. The Fed using roughly 40% designated to the Treasury through the CARES Act. In the end, similar to the crisis of 2008 taxpayer money is on the line. The melding of the Federal Reserve and Treasury is not a new concept by any stretch. The programs, size and encroachment however are far greater within this period of time.

Powell from April 9, 2020: “when we no longer need these programs we just fold them up and put them away.”12 years after the global financial crisis we know with certainty this is not the case.

March 18, 2009 NYT

“The Fed and the Treasury are starting a joint venture this week called the Consumer and Business Lending Initiative in their latest effort to thaw the still-frozen credit markets. The program will start out with $200 billion in financing for consumer loans, small-business loans and some corporate purposes.”

The move in markets this week is confounding. We see the health, economic and financial reality, yet markets continue to move in destructive ways. Just because markets go up does not mean investors are benefiting. According to the LQD ETF below (investment grade) an up and down credit cycle happened in the period of one month. The downside move is much more in touch with reality.

We have been managing this crisis through 3 buckets: health, financial liquidity/markets and economics. Clearly not mutually exclusive, but the connectivity and immediacy shifting gear by the week. Right now, markets are focused on progress with the virus, extreme Fed action and reopening of the economy. Disappointment with this phase is highly likely as reopening is slow, disappointing and the demand side highly uncertain without a vaccine.

LQD (Investment Grade ETF)

HEALTH

It is incredibly hard to find a silver linking in death projections coming down. The clear devastation within this period of our country’s history will be with us for many years to come.

The optimism on both the Federal and State level has numbers in plateau and in some cases declining. New York State has the number of hospitalizations in decline. And the Bloomberg article below highlighting the projections on the Federal level coming down as well. Not out of the woods, and still requiring strict guidelines. Social distancing & stay at home appear to be effective.

https://www.bloomberg.com/news/articles/2020-04-09/fauci-says-u-s-virus-deaths-may-be-60-000-halving-projections?srnd=premium

Below are the updated numbers from NY, NJ, CT as of Thursday:

• 151,079 total cases
• 7,067 deaths
• 81,803 cases in New York City, including at least 4,571 deaths
• 47,437 cases in New Jersey, with 1,504 deaths
• 8,781 cases in Connecticut, with 335 deaths

We have been discussing the change in dialogue toward the reopening of the economy. It’s happening, and should the numbers continue to improve the conversation will grow louder.

Our general feeling in listening to the healthcare experts and federal, state and local officials is that reopening will be slow, thoughtful and with caution. Reopening will likely focus on a combination of further understanding (testing), progress with public infrastructure, more and more preparedness (hospitals) and fostering a belief with Americans that it’s time. We expect our ability to test in scale will be a key focal point in the weeks ahead (Abbott Labs rapid & serology tests NY).

The President should use the Defense Production Act to allow for the generation of millions of testing kits in the coming weeks. The opening of New York and surrounding areas will be very slow, and with clear economic repercussions in our view. The message from Governor Cuomo is crystal clear.

FINANCIAL LIQUIDITY/MARKETS

Treasuries and Mortgage Backed

With long end supply behind us, the Treasury market traded firm to close the week with the curve re-flattening. The Fed continued their operations across Treasuries and Mortgages, but yesterday the decision to continue cuts heading into next week to roughly $30 Billion a day.

US Short End

The US short end continues to be about supply. Yesterday the Fed auctioned $160 Billion of 4 and 8 week Bills, while also announcing the addition of more cash management and T-bill auctions for next week totaling another $230 Billion. There is not an end in sight for short end supply, as the efforts to support the crisis on all fronts continues. The Treasury’s General Account now sits well above $850 Billion. The increased supply has moved short end yields into positive territory with slope between OIS and T-bills.

TGA (Treasury General Account)

T-Bill versus OIS

Credit

The Fed slides down the credit curve and the spread market gaps lower. The move lower in spreads also brought a sharp decline in volatility. Similar to what the Fed has achieved with the Treasury market, the extraction of paper from the market has been a very powerful force in moving volatility lower. The announcement from yesterday added capital to the existing programs, while expanding the target audience. At some point, spread levels will need face the economic reality of a real ensuing credit cycle. Short term, moves have been exclusively related to the Fed’s actions.

HY OAS All versus CDX Investment Grade Volatility Index

Fed Programs

As the Fed downsizes Treasury purchases, it can’t sit still and quickly moves its focus to the credit and lending markets with the announcement of $2.3 trillion in lending powers across multiple programs: some already announced, some new. Criticism abound.

In the end, the programs are emanating from legal powers designated in the Federal Reserve Act, Section 13 (3), and amended with the Dodd-Frank Act: Emergency lending powers and modified by Dodd-Frank. In other words, lending must be broad based within the context of industries across a multitude of companies. Not a statement whether we agree or not.

The Chairman hosted a webcast from the Brookings Insititute yesterday. Summary below:

1) Path of virus key (claims/reopening)- Agree

2)Emergency lending: forcefully and aggressively- Would hope not

3)Dodd-Frank eliminates winner and losers. Lending must be broad based and not specific to one company- not entirely

4)No Limits within legal guidelines(Federal Reserve Act and Extreme situations)- up to debate

5) $450 Billion total ($195 today)- True

6) Will change and adapt focus of current and new programs as needed- proven

7)Mortgage Servicers of concern. Watching closely- No doubt

8)YCC– not now. Lending facilities of primary importance. Programs intended to replace global pullback of private capital- Obvious

Summary directly from the Fed this week ($195 Billion of $450 from the CARES Act)

• Bolster the effectiveness of the SBA Paycheck Protection Program(PPP) by supplying liquidity to participating financial institutions through term financing backed by PPP loans to small businesses. The PPP provides loans to small businesses so that they can keep their workers on the payroll. The Paycheck Protection Program Liquidity Facility (PPPLF) will extend credit to eligible financial institutions that originate PPP loans, taking the loans as collateral at face value
• Interim rule for capital for lending banks below. Zero risk weighting, fully backed by the US Government.

https://www.federalreserve.gov/newsevents/pressreleases/bcreg20200409a.htm

• Ensure credit flows to small and mid-sized businesses with the purchase of up to $600 billion in loans through the Main Street Lending Program. The Department of the Treasury, using funding from the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) will provide $75 billion in equity to the facility. Leverage will be 8:1, loans inside of 4 years, middle market companies with employees up to 10,000, SOFR+250-400, Banks retain 5% of the loans Pari Passu, worker retention clauses and restrictions on buybacks and dividends.
• Increase the flow of credit to households and businesses through capital markets, by expanding the size and scope of the Primary and Secondary Market Corporate Credit Facilities (PMCCF and SMCCF) as well as the Term Asset-Backed Securities Loan Facility (TALF). These three programs will now support up to $850 billion in credit backed by $85 billion in credit protection provided by the Treasury. Leverage will be 10:1 for investment grade and anywhere from 3/7:1 for slightly below investment grade. The split between credit and TALF will be $750/$100 Billion and TALF collateral will include CMBS and Leveraged Loans.
• Help state and local governments manage cash flow stresses caused by the Coronavirus pandemic by establishing a Municipal Liquidity Facility that will offer up to $500 billion in lending to states and municipalities. The Treasury will provide $35 billion of credit protection to the Federal Reserve for the Municipal Liquidity Facility using funds appropriated by the CARES Act. The lending will be with municipalities greater than 2 million residents with states being able to direct funds locally. The eligible collateral will be two years and under including tax, revenue and bond anticipation notes. The Fed also indicated they were watching primary and secondary municipal markets closely. Sounds like more to come with the municipal market.

ECONOMICS

The initial claims numbers continue to drive the economic outlook short term in the US. Another 6.6 million in losses bringing the total of the last three weeks over 15 million. In the end, as we speak about the new loan programs and the extreme need for cash, the claims and jobs numbers will ultimately tell us largely what we need to know in the weeks ahead. Regardless of flow of funds from here, the economy will unfortunately lose millions of more jobs. It’s very concerning for the country.

On the fiscal side, the Senate democrats blocked the Republicans effort for another $250 Billion for the PPP and EIDL program. In the end, and as we discussed earlier in the week, the Democrats want this bill to be more comprehensive with the inclusion money for states, localities, hospitals and certain segments of the business community that may lack proper banking relationships. The Republicans are looking for a quick one-off injection for small business loans.

As of last night, indications are for 555,000 applications with e-Tran SBA numbers, $140 Billion is allocated money across 4,100 lenders. Still no indication that money is flowing successfully through to the businesses. In speaking with one big bank yesterday, the process takes days to work through initial steps and then obviously more time from there for proper approvals and release of funds. Existing banking relationships help, but certainly no panacea. Additionally, the terms of the EIDL short term bridge loan of $10,000 changed as well: to cap out at number of employees. In other words, a business with 6 employees would be eligible for $6,000 versus the original blanket $10,000. We hear what the powers that be are saying, but what matters is the happenings on the ground. 

In the end, simply throwing money at this (monetary and fiscal) is not the solution. Congress and the Fed needs to listen, and very closely, to what’s going on ground floor. Less, yet more effective, is not a bad option.