- The Federal Reserve has taken a proactive approach to support the economy by establishing emergency facilities to aid in the liquidity and order for the fixed income markets.
- The Fed is committed to using its full range of tools to support households, businesses and the US economy as a whole during these unprecedented conditions.
- SVB Asset Management remains committed to capital preservation and liquidity by taking a more conservative stance and will continue to monitor potential risks, market dynamics and our client portfolio holdings during this uncertain time.
- Economic Vista: Looking through the rear-view mirror
- Credit Vista: Diagnosing the impacts of the coronavirus on credits
- Trading Vista: Find your footing
Alphabet Soup: The Federal Reserve releases an array of emergency measures
Eric Souza, Senior Portfolio Manager
The coronavirus has been the primary focus for the markets and for Main Street — and for good reason. On the one hand, the health ramifications are scary for our most vulnerable populations. And on the other hand, social distancing and shelter-in-place mandates have grounded the economy to a halt. Nobody is quite certain how much the economy will contract, and that’s scary, too. But despite all the uncertainties, we can unequivocally state that the Fed understands the gravity of the situation and has stepped up in a big way.
The Fed has taken a very proactive approach to support the flow of credit to households and businesses — steps that go far beyond the usual lowering of the federal funds rate, which it also has done aggressively. After the Fed’s surprise second federal funds rate cut on Sunday, March 15, which brought the federal funds rate to nearly zero percent, the Fed launched a variety of facilities that will help provide additional liquidity and order for both the primary and secondary fixed income trading markets. Here’s a summary of the Fed’s recent extraordinary measures:
|1||Open Market Operations (Quantitative Easing or QE)||The Federal Open Market Committee (FOMC) initially announced on March 15, 2020, that it would purchase at least $500 billion of Treasury securities and at least $200 billion of mortgage-backed securities (MBS). On March 23, 2020, it announced the MBS purchases will include commercial MBS (CMBS) and removed the target amounts for both Treasuries and MBS. In other words, there will be unlimited QE.|
|2||Commercial Paper Funding Facility (CPFF)||On March 17, 2020, the Fed launched CPFF, which will provide a liquidity backstop to US issuers of commercial paper by purchasing unsecured and asset-backed commercial paper rated at least A2/P2. On March 23, 2020, the program was expanded to allow tax-exempt commercial paper as eligible securities. This should encourage investors to engage in term lending within the commercial paper market.|
|3||Primary Dealer Credit Facility (PDCF)||On March 17, 2020, the Fed launched PDCF, which will allow primary dealers to borrow cash for up to 90 days by pledging collateral from a broad range of investment-grade debt securities, including commercial paper, municipal bonds and a broad range of equity securities. This will help support smooth market functioning and facilitate the availability of credit to businesses and households.|
|4||Money Market Mutual Fund Liquidity Facility (MMLF)||On March 18, 2020, the Fed launched MMLF with the initial intent to make loans available to eligible financial institutions secured by high-quality assets purchased by financial institutions from money market mutual funds. The MMLF will assist prime money market funds in meeting demands for redemptions by households and other investors, thereby enhancing overall market functioning and credit provision to the broader economy. Subsequently, on March 23, 2020, the MMLF was expanded to municipal funds and will include a wider range of securities, including municipal variable rate demand notes (VRDNs) and bank certificates of deposit.|
|5||Secondary Market Corporate Credit Facility (SMCCF)||On March 23, 2020, the Fed launched SMCCF to purchase eligible individual corporate bonds as well as eligible corporate bond portfolios in the form of exchange traded funds (ETFs) in the secondary market. Eligible issuers must be rated at least BBB-/Baa3 by a major nationally recognized statistical rating organization (NRSRO) and have a remaining maturity of five years or less.|
|6||Term Asset-Backed Securities Loan Facility (TALF)||On March 23, 2020, the Fed launched TALF to help meet the credit needs of consumers and small businesses by facilitating the issuance of asset-backed securities (ABS) and, more generally, improving the market conditions for ABS. Eligible borrowers will be all US companies that own eligible collateral and maintain an account relationship with a primary dealer. Collateral types will include loans such as auto loans and leases, credit cards, student loans, equipment loans, floorplan loans and insurance premiums.|
|7||Primary Market Corporate Credit Facility (PMCCF)||On March 23, 2020, the Fed launched PMCCF as a funding backstop for corporate debt issued by eligible issuers. The Fed will purchase qualifying bonds directly from eligible issuers and provide loans to eligible issuers. Issuers are rated at least BBB-/Baa3 by a major NRSRO and have a maturity of four years or less.|
|8||Foreign and International Monetary Authorities (FIMA) Repo Facility||On March 31, 2020, the Fed launched the Foreign and International Monetary Authorities (FIMA Repo Facility) and will allow FIMA account holders to temporarily exchange their US Treasury securities held with the Federal Reserve for US dollars. This Facility should help support the smooth functioning of the US Treasury market by providing an alternative temporary source of US dollars other than sales of securities in the open market.|
Source: Federal Reserve Bank as of 4/6/2020.
That’s quite an array of emergency funding facilities, and it is clear the Fed is committed to using its full range of tools to support households, businesses and the US economy as a whole during this challenging time. At SVB Asset Management, we remain committed to capital preservation and liquidity by taking a more conservative stance in this current environment. We are continually monitoring potential risks, market dynamics and our client portfolio holdings, and we will be proactive in reaching out to clients with our thoughts and recommendations.
Paula Solanes, Senior Portfolio Manager
Amidst COVID-19, the world is a different place, and the economy is changing fast. By its very nature, economic data is backward-looking. So, while some of the statistics may still look rosy, we are bracing for a series of unusual—even gloomy—economic indicators in the coming months. In fact, some of the recent data may be the last bits of good news we get for a while, and forward comparisons are likely to be jarring.
Fortunately, in March the Federal Reserve acted swiftly with two inter-meeting cuts for a combined total of 150 basis points (bps), leaving the federal funds rate at a range of 0.00 to 0.25 percent. In addition, the Fed rolled out a slew of monetary policy facilities to help support the economy in this critical time. Looking at recent data releases, the US economy was on firm footing before entering the COVID-19 shutdown; however, the effects of this pandemic will be deep.
In February the US economy added 273,000 jobs and unemployment was hovering at a 50-year low of 3.5 percent. Average hourly wages were steady at 3.0 percent, and the participation rate was steady at 63.4 percent. What a difference a month makes. The employment picture has deteriorated rapidly, as the country practices social distancing to mitigate the spread of COVID-19. The most recent March employment report illustrated the extent of the damage. In March, 701,000 jobs were lost, ending an unprecedented streak in job creation, and the unemployment rate surged to 4.4 percent.
The recent Institute for Supply Management (ISM) manufacturing index, which was a focal point last year while trade negotiations were ongoing, fell slightly in February to 50.1, though any reading above 50 indicates expansion. Meanwhile, the ISM non-manufacturing index surprised to the upside at 57.3 versus an estimate of 54.8. Given the swift change to economic activity in March, expectations are for these numbers to decline sharply in the next reading —especially the non-manufacturing index, which accounts for retail, leisure and transportation.
On the inflation front, measures continued to be tame. The Consumer Price Index (CPI) decreased to 2.3 percent from 2.5 percent in the prior month, while Core CPI, which excludes volatile energy and food prices, increased slightly to 2.4 percent from 2.3 percent. The increase was driven by higher shelter, apparel and health care services. Core Personal Consumption Expenditures (PCE), which is the Federal Reserve’s preferred inflation measure, was 1.8 percent which was slightly above expectations, however that was before the virus. Looking ahead, the March data will be interesting as it will reflect our new near-term economic reality, as well as the sharp drop in oil prices.
Retail sales were weaker than expected and declined 0.5 percent month-over-month. Nine of 13 categories reported significant declines due to lower discretionary spending and an increase to online sales. This was before COVID-19 cases began to rapidly multiply in the US. Given the shelter-in-place mandate seen across the country, this theme of weak retail sales is likely to persist, with the exception of stockpiling at the grocery store.
The housing sector saw a boost in mortgage applications the first half of the month thanks to a drop-in mortgage rates; however, later in the month, applications retrenched as rates reversed course. Housing starts and building permits slipped 1.5 percent and 5.5 percent, respectively. Finally, existing home sales were up 6.5 percent and new home sales dipped 4.5 percent after rising a revised 10.5 percent the prior month. The effects of the virus outbreak are certain to weigh on the housing sector going forward.
The final revision to fourth quarter GDP was unchanged at 2.1 percent, according to the US Department of Commerce. There is little doubt that February data is the last bit of positive news before the effects of COVID-19 pummeled economic activity. Hopefully, the quick actions by the Fed combined with a strong dose of fiscal stimulus totaling more than $2 trillion will help cushion the blow from the virus. Stay tuned and stay healthy.
Fiona Nguyen, Senior Risk & Research Officer
The US bull market came to a screeching halt late February as worries about a rapid COVID-19 spread outside of China mounted. Within a month, the US economy went from a place of optimistic growth to negative forecast of as much as a 50 percent drop in GDP. The implications of a sudden and deep demand shock coupled with an energy price war prompted strong pullback in major risk assets. To say the speed of the collapse is unprecedented is an understatement. Beyond the scale of human tolls, social distancing measures have brought economic activity to a standstill, causing dislocation and disruptions across many businesses and sectors.
Fortunately, equally unprecedented monetary and fiscal policies were enacted swiftly to prevent further market disorder. By early April, while the situation was still dynamic and fluid, market selloff has slowed as market participants have slowly digested the efficacy of various facilities orchestrated by the Fed. These tools provide funding backstops to prevent liquidity crisis in both financial and corporate sectors. Ultimately, the expansionary monetary and fiscal responses aim to provide smooth market functioning and help companies and consumers reduce the risk of defaults as they shoulder the economic tolls in the next few quarters.
Consumer and business spending have taken a hit as widespread quarantines, more travel bans, and business closures occur. Consumer confidence has fallen and the blow of over 6 million jobless claims (as of the week ending on April 3rd) all combined will drive unemployment levels higher over the next six months. This increases the pressure on household income levels and their balance sheet. Similarly, as the knock-on effects are being felt across the globe, large corporations are prepared to adapt to quarterly profit swings as a result of lower consumption due to social disruptions, and the potential higher costs of goods tied to disrupted supply chains.
Thus far, energy companies have seen heavy impact from falling demand, exacerbating by a global oversupply and collapse in oil prices. Global benchmark Brent crude sliding below $30 per barrel triggered a few credit actions against large energy conglomerates such as ExxonMobil, Chevron and Shell. But most actions pertain to a change in outlook rather than downgrade across the board as these issuers are diverse, integrated oil companies with multiple revenue sources and long liquidity runway.
The automotive and industrial sectors have also been significantly affected by the COVID-19 shock given their sensitivity to consumer demand and sentiment. However, unless the economic shutdown prolongs beyond 2020 and complicates business outlook, it is unlikely that these conglomerates will face liquidity crunch as strong balance sheet and ample cash reserves provide them with sufficient buffers to withstand profitability shocks.
Lastly, one of the sectors that remains highly correlated with the economic cycles is financial. Along with coronavirus impacts, monetary policies have further dampened the revenue outlook for banks. The Fed’s interest rate cut to zero and a flat yield curve will compress net interest margins, and a deterioration in asset quality will lead to higher loan loss provisions reducing banks’ profitability. However, banks in major developed countries are better equipped to deal with economic downturn today than they were in the 2008 financial crisis. Among the credit strengths are capitalization and liquidity reserves, which remain on solid footing, providing mitigation against the increasing downside risks.
Although it is difficult to predict how the coronavirus outbreak will evolve and affect future economic performance, for now, we remain vigilant on risk management to mitigate any potential negative impact. We will continue with our disciplined credit analysis and credit selection process that is focused on high-quality names in defensive sectors to help weather near- to medium-term challenges.
Jason Graveley, Senior Manager, Fixed Income Trading
It’s difficult to fathom that in February, investors were cheering all-time highs across equity indexes, record low unemployment, tight credit spreads and a seemingly ever-resilient bull market. How drastically things can pivot in such a short time. Fast-forward to today and the market is trying to digest a more than 30 percent sell-off in equities (as of late March), credit spreads that have gapped out dramatically and a sharp incline in jobless claims and unemployment projections. A move of this magnitude is almost unprecedented, with the current market volatility best compared to depression-era dynamics. These events have prompted a swift and heavy response on the fiscal and monetary policy fronts. The question will be if all of these actions are enough to blunt the market and economic impacts of COVID-19.
Liquidity has been the primary driver of market reaction over the last week in both equity and bond markets, as market participants hoard cash and pile into safe-haven assets in times of economic uncertainty. Prime funds — those money market fund complexes that incorporate commercial paper and similar non-Treasury debt into their holdings — have seen almost 25 percent of their portfolio redeemed over a two-week period in March. Those redemptions have been redirected into government and Treasury money market funds, pulling down these fund yields and leaving prime fund managers scrambling to sell holdings to meet redemptions. This spike in outflows has put further strain on an already-stretched marketplace. Dealers, who have their own balance sheet constraints in times of heightened volatility, have been unable to effectively intermediate these prime fund redemption requests and have begun to widen their prices to insulate themselves. These wider prices cascade, almost to the point of sticker shock in certain sectors.
We have seen some residual impact on our client portfolios but given that our investment strategy’s top priorities are to preserve capital and liquidity, our investment focus has been on mostly insulated sectors such as investment-grade corporate debt, AAA-rated asset-backed securities and AAA-rated government money market funds and Treasuries. The outperformance in Treasuries has been especially noted, while commercial paper has underperformed on the back of prime liquidations and general market saturation.
However, it’s vital to remember that the market has been evolving by the day, even by the hour on some days. And despite the numerous Federal Reserve programs directed to improve market flows and maintain the status quo, particularly in the sectors we invest in such as the Money Market Mutual Fund Liquidity Facility (MMLF) and the Secondary Market Corporate Credit Facility (SMCCF), the plumbing still needs maintenance. Improvements have been incremental, but it could be some time until conditions normalize. Until then, spread premiums will remain elevated, and it’s important to take a conservative stance when re-entering the marketplace. Our focus will be on continuing to build liquidity in portfolios.
|Treasury Rates:||Total Returns:|
|3-Month||0.06%||ML 3-Month Treasury||0.29%|
|6-Month||0.14%||ML 6-Month Treasury||0.52%|
|1-Year||0.16%||ML 12-Month Treasury||0.99%|
Source: Bloomberg, Silicon Valley Bank as of 03/31/20
SVB Asset Management's monthly Market Insights covers current topics on portfolio management, credit considerations and market events that influence corporate investment strategy.
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