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Has The US Finally Done Enough?

25 March 2020 by David Norris

With markets in turmoil and economies around the world shutting down to slow the spread of COVID-19, many investors have been looking to the US to lead the stimulus effort on both the monetary and fiscal policy front. This week they may have got it.

On Monday, for the first time in its history, the US Federal Reserve announced a liquidity program that includes buying corporate debt. This was followed on Tuesday by the announcement of an unprecedented $2tr-plus package of spending and tax breaks agreed between Republicans and Democrats, which will go to a vote in the Senate on Wednesday. The plan includes around $500bn for loans and other types of assistance to firms, including US airlines, in addition to $350bn for small businesses and another $150bn for healthcare providers and medical equipment manufacturers. Importantly, direct distributions will also be made to lower- and middle-income Americans, $1,200 per adult and a further $500 for each child.

What will markets make of all of this? US equity markets certainly responded positively, with the S&P 500 posting its biggest one-day gain since October 2008. For bond investors, buying corporate bonds is a groundbreaking measure that the Fed didn’t even implement during the equally tumultuous times of the global financial crisis, and its importance cannot be understated.

The new measures are classified separately as the Primary Market and Secondary Market Corporate Credit Facility (PMCCF and SMCCF), and while unprecedent for the Fed, they bring its policy response into line with those already deployed by the European Central Bank, the Bank of England and the Bank of Japan. Under both programmes, the Treasury will use the Exchange Stabilization Fund to make an initial $10bn equity investment via a special purpose vehicle (SPV) associated with the facilities.

As with all stimulus measures, the devil is in the detail here with the programmes explicitly detailing which assets – including ETFs – are eligible for purchase. For example, under the SMCCF criteria a security’s issuer must be rated at least BBB-/Baa3 by a recognized rating agency, it must have a remaining maturity of five years or less, and the issuer must also have material operations in the United States. Importantly, eligible issuers do not include companies that are expected to receive direct financial assistance under pending federal legislation.

Fed policy is now operating firmly under the mantra of “whatever it takes” in an effort to keep liquidity flowing through the banking system, with Jerome Powell also announcing purchases of US Treasuries and certain mortgage-backed securities would be “unlimited”, and still more support for the money markets and commercial paper.

Perhaps it was a timely coincidence, but the US investment grade new issue market has seemed to open for business as a result.

Seven borrowers came to market on Monday, issuing $19.4bn in new supply. This was followed on Tuesday by another $19.75bn from eight issuers, which means the US IG market has matched its entire supply for last week in two days. One example was a strong five-part $5bn offering from Proctor & Gamble (Aa3/AA-) on Monday, which came with attractive new issue premiums of around 15bp but saw a healthy tightening of spreads in the secondary market of 25bp-35bp, depending on the tranche.

This was a positive start to the week for a bond market that has been ravaged with dislocations and volatility of late. What is yet to be seen is whether this positive initiative by the Fed will continue to breed confidence among the investor base given what are unprecedented economic and market conditions.

The Fed cannot create demand but it has provided an unprecedented liquidity backstop, and this latest package – described as an all-in move in some places –  has sent an important signal to the corporate debt markets that the central bank’s ammo, and its willingness to use it, remains plentiful. Now it is up to the fiscal policymakers, and the size and scope of the package announced could be a critical first step to allow markets to finally look through the economic impact of the virus to more medium term opportunities.

Given where yields in credit have got to, if the Fed can indeed restore confidence in an investor base that has been paralyzed by uncertainty, then investors who have been scrambling to build up cash in the last couple of weeks could start looking at what we believe will prove to be some of the best buying opportunities over the next decade.

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