Fed’s Anti-Virus Lending Firepower Could Reach $4.5 Trillion

The Federal Reserve could now have as much as $4.5 trillion to keep credit flowing and make direct loans to U.S. businesses through the massive coronavirus stimulus bill being considered by U.S. lawmakers.

Balance Sheet

The bipartisan agreement, which still needs to be passed by the Senate and House and signed into law by President Donald Trump, will include $454 billion in funds for the Treasury to backstop emergency actions by the Fed to support the U.S. economy, Senator Patrick Toomey said on Wednesday.

The central bank will work with the U.S. Treasury to use that money as a backstop against credit risk as it supports markets for corporate and short-term state and local debt, while also loaning directly to large and medium-sized businesses.

Its lending facilities have typically required a loss-absorbing cushion of around 10% from the Treasury to protect it from loans that don’t get paid back, a feature that Toomey indicated he wanted preserved. On that basis, every dollar from the Treasury can stand behind $10 dollars lent by the Fed.

“It is a very, very big thing; it is unprecedented,” the Pennsylvania Republican told reporters Wednesday on a conference call, adding it was an opportunity to lever up “the unlimited balance sheet of the Fed.”

Toomey’s comments suggest Fed facilities could be expanded with the new funds, in effect doubling the Fed’s current $4.7 trillion balance sheet if necessary. On Sunday, Treasury Secretary Steven Mnuchin said the bill would provide up to $4 trillion in liquidity through broad-based lending programs operated by the Fed.

A Fed spokesperson declined to comment.

The central bank has launched a dramatic range of emergency measures to shelter the blow from the virus, which has brought important parts of the economy to a grinding halt as governors in several states ordered a stop to all but the most essential activity. It has slashed interest rates to almost zero and is pumping hundreds of billions of dollars into financial markets to keep credit flowing.

Those actions were ramped up on Monday, when the Fed also announced it was also working hard on a Main Street Business Lending Program to support medium-sized businesses.

Corporate Debt

It also launched two other facilities — one to support the secondary market for corporate debt, and a second to lend or buy bonds directly from large corporations, an unprecedented bypass of the banking system that has redefined the Fed’s role in economic emergencies. With these moves, the Fed has surpassed actions it took during the 2008 financial crisis and has become the nation’s bridge lender of last resort.

Constance Hunter, chief economist at KPMG in New York, said the Fed’s credit facilities are in effect short-term bridge loans critical to keeping both small and large businesses afloat so they can hire back furloughed or laid-off workers when the pandemic subsides.

Chain Reaction

“There is a transmission channel from large corporations, to small- and medium-sized enterprises and to households” as each tries to extend temporary credit or keep paying staff, Hunter said, adding that the Fed programs will be vital.

“What I am hearing business leaders say is, ‘We don’t want to shut out our customers. If they have a temporary decline in ability to pay, we want to extend credit to bridge them to the other side of the crisis as much as possible,” she said.

The U.S. banking system has already been tapped for hundreds of millions of dollars via credit lines as companies try and shore up short-term cash positions.

To keep credit flowing in the financial markets, the Fed has also launched facilities to support the issuance of commercial paper and asset-backed securities, as well as programs to lend to bond dealers and backstop money market funds.

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Fed Could Provide Massive Support for Business, States in Bill

Congress could hand the U.S. Treasury at least $425 billion to backstop potentially much larger support by the Federal Reserve for business and municipal borrowers as part of an economic aid package being hammered out by the Trump administration and Congressional leaders.

The latest draft of the Republican-written bill, which GOP lawmakers are trying to finalize and pass Monday, would authorize the Treasury to use $425 billion “to make loans, loan guarantees, and other investments in support of programs or facilities established by the Board of Governors of the Federal Reserve System for the purpose of providing liquidity to the financial system that supports lending to eligible businesses, states or municipalities.”

Earlier Sunday, Treasury Secretary Steven Mnuchin said the bill would provide up to $4 trillion in liquidity through broad-based lending programs operated by the Fed.

Lever Up

Details were unclear, but some analysts took the view that the money identified to support Fed programs would seed much larger assistance from the U.S. central bank.

“This is money the Fed can lever up,” said Michael Feroli, chief U.S. economist at JPMorgan Chase & CO. in New York. “It’s a very positive step. I hope the $4 trillion is enough but there’s no guarantee.”

Senate Banking Committee Chairman Mike Crapo told Bloomberg News that the legislation would expand the Fed’s authority to include state and local governments as entities it can lend to, and buy debt from, to assist them.

Crapo said he supports the measure and would expect other Republicans to do so as well, but also noted that a supplemental appropriations bill would provide direct support to states.

Democrats on Sunday were not yet on board.

Emergency Lending

Last week, the Treasury backstopped two new emergency lending facilities rolled out by the central bank with a combined $20 billion. That was seen as enough to support up to approximately $1.7 trillion of eligible short-term securities.

The Fed has come under pressure from lawmakers and some former central bankers to extend support beyond shorter-dated debt markets and purchase long-run corporate and municipal bonds.

Companies, states and cities have found it increasingly difficult to borrow money as investors flee for safety amid the expanding coronavirus pandemic and the economic havoc its creating.

Cash Drain

”The cash drain on households and businesses, and state and local governments, is going to punch a massive hole in the global glut of savings, and this is an aggressive effort to fill that gap,” said Lou Crandall, chief economist at Wrightson ICAP.

Federal Reserve spokeswoman Michelle Smith declined to comment on what the legislation signaled on future Fed moves.

It’s unclear whether the Fed would require separate congressional approval for buying long-dated corporate and municipal bonds. Eric Rosengren, president of the Boston Fed said March 6 the Fed would need lawmakers’ consent to make such direct purchases.

But that might be open to debate.

Joseph Gagnon, a former Fed official now at the Peterson Institute for International Economics in Washington, has said he believes the Fed can extend credit to any entity as long as the collateral received in exchange is deemed adequate.

— With assistance by Saleha Mohsin, Ryan Beene, and Daniel Flatley

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Fed Restarts Commercial Paper Facility to Ease Market Strain

The Federal Reserve will restart a financial crisis-era program to help U.S. companies borrow through the commercial paper market after it came under “considerable strain” due to the coronavirus pandemic.

The central bank is using emergency authorities to establish the Commercial Paper Funding Facility with the approval of the Treasury secretary, according to a Fed statement on Tuesday. The Treasury will provide $10 billion of credit protection from its Exchange Stabilization Fund.

The move follows mounting pressure to act after the Fed’s Sunday evening emergency interest-rate cut to nearly zero and other measures failed to stem market strains as investors reacted to the risk that the virus will tip the U.S. and global economy into a potentially damaging recession.

Help Businesses

“By providing short-term credit, the CPFF will help American businesses manage their finances through this challenging period,” Treasury Secretary Steven Mnuchin said in a separate statement.

The Fed said it will provide financing to a special-purpose vehicle that will purchase A1/P1 rated commercial paper from eligible companies, and purchases will last for one year unless the Fed extends the program.

Pricing will be based on the then-current 3-month overnight index swap rate plus 200 basis points, and each issuer must pay a facility fee equal to 10 basis points of the maximum amount of its commercial paper the SPV may own.

“This provides a backstop and allows institutions to continue to rely on commercial paper to fund their short-term operations, so that’s good” said Roberto Perli, a former Fed economist and partner at Cornerstone Macro LLC in Washington.

Market Relief

Cross-currency basis swaps recovered from multi-year lows reached earlier on Tuesday amid speculation that the Fed could reintroduce the commercial paper facility and maintained those retracements after the central bank announced the news.

Still, three-month euro cross-currency basis swaps remain notably wider than they have been on average this year.

There was, however, some relief in broader markets with stock prices bouncing and the dollar strengthening immediately after the announcement. The S&P 500 index extended gains after earlier reversing losses, to trade 4.5% higher.

Not Generous

Perli said he was somewhat surprised by the facility’s pricing, at 2 percentage points above the overnight index swap rate. “That’s a big premium,” he said. “That’s not particularly generous or lenient.”

The step comes as central banks and governments around the world roll out emergency liquidity measures for markets and economic stimulus programs designed to soften the impact of the spreading coronavirus. A number of economists have said virus-triggered closures and national lock-downs are making a global recession increasingly likely.

The Fed on Sunday slashed interest rates to nearly zero, announced enhanced dollar swap lines with other central banks and said it would buy at least $700 billion in Treasuries and mortgage backed securities to ensure market functioning and keep credit flowing.

Flight to Safety

In financial markets, the rush of investors into cash and other safe havens has threatened to deny companies a crucial source of short-term lending. Firms frequently issue commercial paper — IOUs that generally mature in fewer than 270 days — to fund everyday expenses, like rent and payroll.

The facility reprises a program the Fed rolled out in the depths of the financial crisis in October 2008 as global credit markets seized up. At the time, companies were even more reliant on short-term lending and the crisis left several industrial giants, including General Electric Co., scrambling for cash.

The controversy that surrounded that program, and several other facilities implemented during the crisis, however, spurred lawmakers to put greater restrictions on the Fed’s use of emergency lending.

Under changes created by the Dodd-Frank Act, the Fed has to secure permission from the U.S. Treasury to purchase commercial paper, and must also report to Congress on the program’s recipients and the collateral that is offered to secure the loans.

Despite clearing those hurdles, the step could prove controversial again, with some Democrats likely to call it a bailout for corporations and banks while Americans struggle to pay bills. Some Republicans may also attack it as unnecessary government intervention in the market.

— With assistance by Rich Miller, and Alex Harris

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Fed to Widen Treasury Buying, Expand Repo to Ease Market Strain

The Federal Reserve took aggressive steps Thursday to ease what it called “temporary disruptions” in Treasury financing markets, flooding the market with liquidity and widening its purchases of U.S. government securities in a measure that recalls the quantitative easing it used during the financial crisis.

The Federal Reserve Bank of New York said in a statement that the moves were “to address temporary disruptions in Treasury financing markets” at the direction of Fed Chairman Jerome Powell in consultation with the Federal Open Market Committee.

U.S. stocks trimmed staggering losses of more than 8% earlier in the day as investors absorbed the Fed’s muscular decision.

The buying will include coupon-bearing notes and match the maturity composition of the Treasury market, it said. Ten-year U.S. Treasury yields fell sharply to trade around 0.68%.

“The Treasury securities operation schedule includes a change in the maturity composition of purchases to support functioning in the market for U.S. Treasury securities,” the New York Fed said.

Term repo operations in large size have also been added to help markets function, it also said. The New York Fed said it would offer $500 billion in a three-month repo operation at 1:30 p.m. and repeat the exercise tomorrow, along with another $500 billion in a one-month operation, and continue on a weekly basis for the rest of the monthly calendar.

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$50 Trillion in Question as U.S. Treasury Liquidity Dries Up

Coronavirus-induced market mayhem has pushed so much liquidity out of U.S. Treasuries that the true value of more than $50 trillion in assets around the globe is in doubt.

Yields in the world’s largest debt market have been on a mind-bending, three-week roller-coaster ride. At one point, the entire U.S. yield curve was below 1% for the first time ever. But this week rates have jumped from Monday’s all-time lows even though fear of the virus has intensified, and U.S. stocks sank into a bear market Wednesday. The biggest oil-price plunge since 1991 also stirred chaos this week.

This volatility is happening as trading-platform order books thin out to a degree last seen during the 2008 financial crisis, making it harder to use Treasuries as a gauge of investor anxiety.

And that’s not just a problem for the bond market’s elite since rates on everything from mortgages to municipal bonds and emerging-market debt are pushed and pulled by U.S. yields.

“Treasuries are the risk-free benchmark that anchors the over-$50 trillion in global dollar-denominated fixed-income securities,” said Joshua Younger, head of U.S. interest rate derivatives strategy at JPMorgan Chase & Co.

“The level of volatility and lack of clarity in Treasuries makes it much harder to make sense of the value of all other assets,” added Younger, who has an astrophysics Ph.D. from Harvard University. “It can create a self-perpetuating flow of expectations that is not really reflective of financial markets and the true level of risk aversion.”

One key gauge of Treasury liquidity — market depth, or the ability to trade without substantially moving prices — has plunged to levels last seen during the 2008 financial crisis, according to data compiled by JPMorgan. That liquidity shortfall, JPMorgan says, is most profound in long-term Treasuries.

The ease of transacting in Treasuries is important for regulators as well. Liquidity drew greater scrutiny after Oct. 15, 2014, when Treasuries convulsed with no apparent trigger in what was dubbed a flash rally.

Following that mysterious move, the Financial Industry Regulatory Authority began collecting transactions data in 2017 for regulators. Just this week, Finra for the first time began releasing aggregate weekly statistics to the public.

Read more
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  • Treasury Rally Was So Intense CME Halted 30-Year Futures Trading

Amid the current liquidity shortage, the cost to trade Treasuries is spiking. In the interdealer market, about 66% of 30-year bond trades are taking place at wider-than-average bid/ask spreads, or the difference between prices to buy and sell, JPMorgan data show.

All that said, even though liquidity is scant, it’s still possible to cash out of Treasuries. Such selling could partly explain why yields have risen for two days.

Treasuries are the “only product with any semblance of liquidity,” said Bill Finan, senior managing trader at Columbia Threadneedle. “So to hedge, however inefficient the hedge, you sell rates.”

For Todd Colvin, senior vice president at Ambrosino Brothers, what has transpired since the beginning of March in the Treasury market is worse than what he experienced after Long-Term Capital Management blew up in the 1990s, requiring a bailout orchestrated by the Federal Reserve.

The hedge fund lost $4 billion in 1998 after Russia’s default prompted investors to shun corporate and mortgage-backed bonds and buy less risky, more easily traded government securities. The carnage drove yields on 30-year Treasuries to a 1990s low of 4.72% in October 1998, down from a 1997 peak of 7.17%.

This week, a Treasury rally on Monday produced the biggest intraday decline in 30-year yields since at least October 1998, when Bloomberg began recording daily highs and lows. The rate fell as much as 59 basis points to a record low 0.699%, its first-ever breach of 1%. Of the 10 steepest intraday declines, one occurred last week and four were in 2008 or 2009.

The 30-year yield, which sits around 1.24% Thursday, is down from this year’s high of 2.42% set in early January. The 10-year yield is at 0.74%, down from its 2020 peak of 1.94%.

The bond market was far smaller before the turn of the century. America’s debt pile has grown to nearly $17 trillion from about $2 trillion in 1990. Some think that can feed volatility.

“The ability for markets to move is greater because the size of the market is much bigger now,” Colvin said.

And back in the 1990s markets weren’t highly electronic like they are now. Back in those days, what happened in other markets around the globe didn’t hit as close to home. That’s changed with globalization.

Today, investors and economists are struggling to figure out the path of the global economy as well as monetary and fiscal policy amid the spread of the deadly virus. Coupled with the worst trading conditions since the great recession a decade ago, pricing Treasuries has become a nightmare.

“In a crisis you’re going to sell what you have, not what you want to,” said Priya Misra, rates strategist at TD Securities. “This is not a normal functioning market.”

— With assistance by Stephen Spratt, Emily Barrett, and Elizabeth Stanton

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Fed Doesn’t Want Another Repo Crisis, But Treasury Isn’t Helping

The Federal Reserve has doled out tens of billions to calm the short-term lending markets after they went haywire in September.

But initiatives by the U.S. Treasury Department — to ensure it always has enough cash to pay its bills as the deficit soars to a trillion dollars — could make it harder for the Fed to prevent a repeat.

As the department copes with higher spending, large swings in the amount of money it has on deposit with the central bank have already undercut the Fed’s ability to keep bank reserves stable. Last year, one particularly big shift helped to drain so much liquidity from the banking system that it contributed to a spike in overnight lending rates.

Now, as Treasury considers setting aside even more money, market watchers say the swings are bound to get worse. That could lead to more disruptions and upend the Fed’s goal of scaling back its involvement in the repo market.

Treasury’s cash needs “have created dislocations that are putting greater strains on the Fed’s reserve management and funding markets,” said Ward McCarthy, chief financial economist at Jefferies & Co. and a former senior economist at the Richmond Fed. “But the Treasury needs to fund the government, so the Fed has to work around around that.”

The situation also underscores how America’s fiscal imbalance, which has been exacerbated by the combination of tax cuts and spending increases under the Trump administration, is putting strains on the financial system.

Though arcane even in finance circles, repurchase agreements — or repos for short — are what keep the global capital markets spinning. And that includes the $16.7 trillion market for U.S. government debt.

Big Swings

The Treasury General Account, as it’s officially known, operates like the government’s checking account at the Fed. Money comes in when taxes are paid out of bank accounts of individuals and corporations (which drains banks’ reserves held at the New York Fed) and money goes out when the government pays its bills (which does the opposite).

While the Fed has had to deal with fluctuations before, the sheer size and swings of the account in recent years stand out. Under the Obama administration, Treasury in 2015 instituted a policy of keeping at least five days’ worth of expenditures, or a minimum of $150 billion, in case unexpected disruptions from natural disasters or cyber attacks locked it out of the debt markets. Prior to the change, Treasury had enough cash for just two days.

But that cushion has grown and become more volatile as deficit spending rose and cash flows in and out of the account increased. And the fluctuations have at times been exacerbated when Congress dragged its heels on the debt limit.

Since the start of 2019, the account balance has averaged $303 billion, versus about $240 billion in the prior four years. It has also swung as high as $451 billion and dropped as low as $112 billion.

All that money flowing in and out of Treasury’s account has made it harder for the Fed to keep reserves in the banking system stable, and crucially, to manage monetary policy. That’s contributed to abrupt swings in repo rates, which spiked to 10% in mid-September.

The turmoil forced the Fed to step in with tens of billions of dollars in emergency repo financing. It also began to purchase $60 billion a month in T-bills to permanently lift reserves. The central bank has continued to backstop the repo market — in various amounts and over various terms — so it doesn’t seize up again. It has said it will continue its repo operations at least through April, but ultimately wants to step back from active involvement once reserves rise enough to ensure ample liquidity in the banking system.

Of course, one way Treasury could help is by keeping most of its cash in accounts of the nation’s commercial banks instead, as it did before the financial crisis. That would keep the Fed from having to manage the daily swings in Treasury’s cash cushion to prevent liquidity from drying up.

Treasury Secretary Steven Mnuchin isn’t convinced. In fact, he suggested such a shift could lead to even bigger financial-stability problems.

“If you’re a regulator, you wouldn’t want a major bank’s balance sheet to go up and down based upon what could be very, very large cash movements,” he told Bloomberg News in an interview last month. “It shouldn’t impact the market one way or another whether we put money at the Fed or at a bank.”

Fed Chairman Jerome Powell said in December that bank officials had yet to discuss the topic with their Treasury counterparts. Nevertheless, he added that “there may come a time when we talk about that.”

Even if there’s some kind of agreement between the two, some analysts say the best, and perhaps only, option for the Fed is to simply accept the fact that its repo operations have become a fact of life — and to stand ready to provide more cash whenever it’s needed.

“The Fed should just plan to do repos, beyond just as an emergency tool, as needed,” said Wrightson ICAP’s Lou Crandall.

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