Three points on the expiry of the Fed’s emergency facilities - Capital Economics
Capital Daily

Three points on the expiry of the Fed’s emergency facilities

Capital Daily
Written by Oliver Jones

Treasury Secretary Mnuchin has asked the Fed to return the unused funds from several of its 13(3) emergency lending facilities set up earlier this year – those designed to support corporate bond, municipal bond and asset-backed security markets, and the so-called Main Street Lending Program – meaning they will expire as scheduled next month. (A few other lending facilities have been extended for another ninety days.) Given the unusual criticism by Fed officials of the decision not to extend all the facilities, and the inevitable speculation about possible market implications, three points are worth making.

  • Lockdowns probably caused euro-zone and UK PMIs to fall sharply in November (Monday)
  • We think personal spending in the US rose only a little in October (Wednesday)
  • We expect the Riksbank to increase the size of its QE programme (Thursday)

Key Market Themes

Treasury Secretary Mnuchin has asked the Fed to return the unused funds from several of its 13(3) emergency lending facilities set up earlier this year – those designed to support corporate bond, municipal bond and asset-backed security markets, and the so-called Main Street Lending Program – meaning they will expire as scheduled next month. (A few other lending facilities have been extended for another ninety days.) Given the unusual criticism by Fed officials of the decision not to extend all the facilities, and the inevitable speculation about possible market implications, three points are worth making.

First, for all the talk about how the facilities were hardly used, some of them at least proved highly effective in the extreme market conditions back in March. There is an important distinction to be made here between the Main Street Lending Program – which does not appear to have done a great job of funnelling credit to small and medium businesses – and the corporate and municipal bond facilities in particular.

Chart 1: Option-Adjusted Spread Over Treasuries Of ICE BofA ML US Corporate Index (bp)

Sources: Refinitiv, CE

The latter two did not need to lend a lot (or even at all) to be effective. The expectational effect of the Fed standing behind the market with plenty of firepower was enough to turn corporate and municipal bond markets around on its own. Chart 1 shows how the peak in corporate spreads coincided with the announcement of the facilities, rather than the start of purchases themselves two months later. Issuance also surged and liquidity returned to more normal levels in that time. The facilities are an extension of the central bank’s traditional lender of last resort function to a new set of borrowers – and can similarly be effective without actually having to be used.

Second, the influence of news about backstop-style facilities is highly asymmetric and dependent on the state of the market. A safety net clearly matters a lot when markets are in freefall, as they were in March. But it inevitably makes little short-term difference when things are already calm, with investors focusing more on the prospect of a vaccine-fuelled economic recovery in 2021 and less on the risk of a corporate and municipal solvency crisis. That is surely part of the reason for the very limited market reaction to Mnuchin’s announcement.

Third, another reason for the small market reaction may be that investors still doubt that their safety net will be gone for good in any case. Secretary Mnuchin ended his letter to Fed Chair Powell leaving the door open for the facilities to be revived again if required. (We are not experts in the legal technicalities, but our understanding is that a future Treasury Secretary could allow the lending facilities to be activated again by reallocating various existing funds from elsewhere, without the need for recourse to a gridlocked Congress.)

More generally, a major theme of the coronavirus crisis has been the speed and decisiveness with which central banks have backstopped risky asset markets. The Fed, the ECB and others, perhaps learning from the last crisis, have gone further than ever before in their interventions across financial markets, largely successfully. We doubt that this lesson has been lost on investors, or indeed overturned by Mnuchin’s decision. In fact, we still think that heightened expectations for central bank support of risky assets in times of trouble will be an important legacy of COVID-19 for financial markets. It is one reason why we expect that risk premiums generally will compress much further as the economy recovers in 2021 – potentially to below levels on the eve of the pandemic in many cases. (Oliver Jones)

Selected Data & Events

GMT

Previous*

Median*

CE Forecast*

Mon 23rd

US

Markit Manufacturing PMI (Nov, Prov.)

14.45

53.4

52.5

53.0

*m/m(y/y) unless otherwise stated; p = provisional

Key Data & Events

US

The Treasury’s decision not to extend the majority of the Fed’s emergency lending facilities beyond the end of the year is unlikely to have a major impact on the economy given that they have made just $25bn of loans. At the margin, however, it could raise the likelihood that the Fed will attempt to provide more stimulus using its other tools, most likely by increasing the pace of its monthly asset purchases.

Ahead of the Thanksgiving Holiday next Thursday, we expect to learn that durable goods orders posted another solid rise in October, although we suspect personal spending rose only a little, as the surge in virus cases started to take its toll. (Andrew Hunter)

Europe

Data published on Friday showed that good news about the vaccine has not yet done much to improve sentiment in the euro-zoneconsumer confidence fell in November, from -15.5 in October to -17.6. With the virus still spreading quickly and lockdowns likely to be extended, confidence will probably deteriorate further in the coming months.

Next week, we expect the flash Composite PMI for the euro-zone, to fall by much more than the consensus anticipates, to just 35 in November, as activity in large parts of the services sector has come to a halt. The money and credit data for October and the account of the ECB’s monetary policy meeting in the same month should also be worth a close look.

Elsewhere, the Riksbank is all but certain to leave its repo rate unchanged next Thursday, but we expect policymakers to expand and extend their asset purchase programme again. Meanwhile, Sweden’s Economic Tendency Indicator for November is likely to point to the economy taking a leg down in Q4.

In the UK, the further rise in retail sales in October brought them 6.8% above their pre-virus level. But the current lockdown means that retail sales, and total consumer spending, will probably fall in November. October’s public finances figures were far better than expected. But an economic contraction in November and the extension of the government’s support measures will probably cause government borrowing to increase sharply over the coming months. Next week, the Chancellor may provide a hint of whether he is planning to raise taxes in the speech that will accompany the release of the Spending Review on Wednesday. Meanwhile, we suspect that the recent lockdown caused the Flash PMIs to plunge below 50 in November. (Melanie Debono & Thomas Pugh)

Other Developed Markets

In Canada, the 1.1% m/m rise in retail sales in September was much better than expected, but sales appear to have stagnated in October and the prospect of restrictions being imposed on all non-essential businesses in some cities does not bode well for the rest of the year.

In Australia, retail sales bounced back in October as restrictions on activity in Victoria were eased. That said, a shift back from spending on goods towards services may weigh on sales over the coming months.

In Japan, output recovered just over half of its plunge in the first half of the year in Q3. That said, services spending was still 9% below its Q4 2019 level last quarter. And while the government’s “Go To” campaigns have been a tailwind to spending on services in recent weeks, they are now likely to end as the government seeks to reign in a third wave of coronavirus. That could slow the recovery over the coming months. (Stephen Brown, Tom Learmouth and Ben Udy)

China

Commercial banks in China left the Loan Prime Rate (LPR), the reference rate against which loans are priced against, on hold on Friday after the PBOC moved to mitigate the impact of corporate bond defaults on interbank liquidity. With growth now back to its pre-virus path and attention turning to financial risks, we think the next move in the LPR will be a rise early next year. (Sheana Yue)

Other Emerging Markets

In emerging Asia, the second estimate of Singapore’s Q3 GDP is likely to be revised upward, due to a surge in the production of pharmaceuticals in September. We have pencilled in growth of around 9.0% q/q (7.9% in the advanced estimate), which would bring the pace of y/y contraction down to -6.0%, from -7.0%. Otherwise, the Bank of Korea is likely to keep its policy rate at an all-time low of 0.50% next week. We will be keeping an eye out for any additional measures from the Bank to curb the recent rise in long-term government bond yields.

In Latin America, we expect to learn that Mexico’s inflation edged down to 4.0% y/y, from 4.1%, in the first half of November, while Brazil’s inflation rose from 3.9% to 4.0%.

In Sub-Saharan Africa, we think that Nigeria’s economy contracted by 6.2% y/y in Q3 on the back of depressed oil output and a weak rebound in the non-oil sector. Even so, elevated inflation will probably prevent the central bank from cutting interest rates on Tuesday. Elsewhere, we expect headline inflation in South Africa to have remained close to the bottom of the Reserve Bank’s target range, at 3.1% y/y, in October. Price pressures are likely to pick up slightly in the coming months, but monetary conditions will remain loose for a long period. (Alex Holmes, Nikhil Sanghani and Virág Fórizs)

Published at 16.12 GMT 20th November 2020.

Editor: John Higgins
john.higgins@capitaleconomics.com

Enquiries: Bradley Saunders
bradley.saunders@capitaleconomics.com

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