Expect the U.S. Fed to respond to the lack of fiscal stimulus: John Wilson
Treasury Secretary Steven Mnuchin said his agency and the Federal Reserve have enough fire-power to continue to support the economy, a day after calling for several emergency lending programs to be sunsetted by the end of the year.
“Markets should be very comfortable that we have plenty of capacity left,” Mnuchin said Friday on CNBC. He said he was “merely, simply following the intent of the law. It was not a decision on whether we needed these or didn’t need this.”
Financial markets for now suggested Mnuchin’s take was right. The S&P 500 Index saw a modest retreat Friday morning, down 0.3 per cent as of 12:10 p.m. New York time, while a gauge of U.S. credit risk ticked higher. Cruise operator Carnival Corp. -- which has been walloped by the COVID-19 crisis -- proceeded with selling bonds without collateral, showcasing that the issuance market remains open.
Even so, Fed officials expressed disappointment, highlighting that even if unused, the facilities that will no longer be able to purchase assets served a useful role as a backstop.
“That backstop role might be important for quite some time, so it’s disappointing,” said Chicago Fed President Charles Evans. “The virus spread is increasing, so there are risks from that,” he said on CNBC Friday.
Atlanta Fed President Raphael Bostic similarly said late Thursday on Bloomberg TV that “it’s prudent to keep those things open so that when people, if they do have stress, they can draw upon it.”
UBS Group AG aligned with that perspective, and predicted that U.S. credit markets would deteriorate as a result of the pullback of the Fed facilities that went to support corporate bonds.
“We view the Fed backstop as a material pillar of support,” UBS strategist Matthew Mish wrote in a note to clients Friday. “The backstop has been a key driver of inflows, which we think will stall on the news,” he said, boosting his year-end forecast for high-yield bond premiums by half a percentage point.
The Markit CDX North American Investment Grade Index climbed 2.5 basis points to 56.3 basis points, prices compiled by Bloomberg show. The index has plunged from as high as 159 basis points at the peak of the market turmoil in March.
News of the sunsetting of five Fed facilities backed by Treasury funding came with a letter from Mnuchin to Fed Chair Jerome Powell released on Thursday. Mnuchin did ask for a 90-day extension for four of the central bank’s programs, including those backing commercial paper -- a vital short-term funding tool for companies -- and money market mutual funds, another crucial element of the financial system.
“They always like to keep things open,” Mnuchin said of the Fed. “In deference to them that’s why I kept” the four facilities that will be extended, he said. “We don’t need to buy more corporate bonds.”
The Treasury chief said the Fed must return unused funds, which would then give Congress the chance to re-appropriate US$455 billion and spend the money elsewhere.
Minutes after the Treasury’s release Thursday, the Fed board responded with a short statement saying it “would prefer that the full suite of emergency facilities established during the coronavirus pandemic continue to serve their important role as a backstop for our still-strained and vulnerable economy.”
Mnuchin also faced wider backlash, with some Democrats and outside critics saying he was blocking a smooth transition with President-elect Joe Biden’s administration during a time of crisis.
House Speaker Nancy Pelosi accused Mnuchin of trying to hobble the next administration’s ability to deal with the economic fallout of the continuing pandemic. She cited the Fed’s “highly unusual” public dispute with the Treasury secretary over letting several emergency lending programs expire.
“Again, why? Why? -- Because they want to impede the ability of the administration to have everything available to them?” Pelosi said Friday at her weekly news conference.
Mnuchin said it was “ironic” that Democrats want the facilities extended given how they had in the spring criticized the potential for the Treasury to use its expanded funding authorization as a “slush fund.”
“We’re not trying to hinder anything. We followed the law as we’re supposed to,” Mnuchin said. He added that he was with lawmakers in March when they wrote the Cares Act and that “the law was very clear” that the money would need to be returned on Dec. 31.
One possible reason for the Treasury Department to make the announcement this week is to avoid releasing market-sensitive decisions in December, when markets tend to be less liquid and more susceptible to swings as it absorbs new information.
Mnuchin, and his successor in the Biden administration, can still work quickly with the Fed to renew lending facilities that may be necessary. The agency has roughly US$75 billion available to use toward Fed facilities that can be used without Congress’s approval.
Whether Congress would reappropriate the returned funds from the Fed is unclear. Republicans and Democrats have proven unable to agree on a fresh fiscal stimulus package that the Fed and private economists alike say is vital to support the recovery in the face of record coronavirus case counts.
Mnuchin said Friday that he will discus fiscal stimulus efforts with Senate Republican leader Mitch McConnell later in the day. House Speaker Nancy Pelosi and Senate Democratic leader Chuck Schumer are scheduled to meet separately with Biden.
In the meantime, expectations are building that the Fed will take further monetary policy action at its Dec. 16 meeting.
Evercore ISI analysts Krishna Guha and Ernie Tedeschi said there’s now an increased likelihood the Fed will tilt its Treasuries purchases toward longer-dated securities in its key quantitative easing program.
“And if things get bad enough, a faster pace of purchases too,” they wrote Friday. “However, QE is a very imperfect substitute for a credit market backstop.”