“We’re not going to run out of ammunition”

US Federal Reserve Chair, Jerome Powell – March 27th, 2020

March 23rd was an important day in this cycle. Not only was the stock market down about 35% off its highs in less than a month, and so far, that day has proven to be the bottom in markets in this cycle, but that day was when the reported deaths from CV-19 seemed to be reaching a climax. At that point, the world’s governments and central banks began racing to support people and businesses until the virus could be contained. The only questions at that time were how much money to shovel into the economy, how to go about doing it, and whether it was even going to work.

Well, two months later, we kind of have an idea. In the US alone, the unemployment tally is up to about 40 million Americans unemployed, over 100,000 are the estimated deaths due to the virus, and the fiscal AND monetary stimulus employed are like we’ve never witnessed before at any time in our history.

After the 2008-09 Great recession, it was mainly a financial crisis, and it seemed like every bank on the planet could go broke. Of course, they didn’t, but the stimulus used at that time equaled about 5% of US GDP. Today, in what started as a serious health crisis and became a serious economic crisis, the numbers as you can see on the chart below are reaching an astounding 20% of GDP in many of the G7 nations (and note, the situation has been very fluid, the numbers have ramped up in many countries since this chart was published):

The USA, the world's largest economy, has taken a broad range of steps to combat the economic disruption caused by COVID-19. Congress passed trillions of dollars in fiscal programs, while the U.S. central bank, the Federal Reserve, added trillions of dollars in monetary stimulus.

Monetary Stimulus
 

The Fed's stimulus measures fall into three basic categories, interest rate cuts, loans and asset purchases, and regulation changes. The Fed cut its benchmark interest rate, the Fed funds rate, twice during March 2020, once by 0.50% and a second time by 1.00%. This lowered the fed funds rate from 1.50%-1.75% to 0.00%-0.25%. This is notable because the Fed hadn’t moved interest rates in increments greater than 0.25% since it cut them during the Great Recession. On March 15, 2020, the Fed also cut its "discount rate," another key interest rate, by 1.5%, down to 0.25%. Loans and asset purchase intervention was more extensive, covering a wide array of programs. The simplest asset purchasing program is the quantitative easing (QE) program, in which the Fed directly buys assets like U.S. Treasuries and mortgage-backed securities (MBS). The Fed, which originally created the program during the Great Recession, restarted it on March 15, 2020. The scale of the program is currently open-ended, with the Fed saying it will buy "in the amounts needed to support the smooth functioning of markets."

The Fed enormously expanded its repo operations in March 2020, by $1.5 trillion dollars, then adding another $500 billion to ensure there was enough liquidity in the money markets.  Repo operations effectively allow the Federal Reserve loan money to banks, by purchasing treasuries from them, and selling them back to the banks at a later date.

To add more liquidity to money markets, the Fed launched the Money Market Mutual Fund Liquidity Facility (MMLF) on March 18, 2020. This program lends money to financial institutions so they can buy money market mutual funds. The MMLF is similar to the AMLF program launched in 2008 after the collapse of Lehman Brothers caused a major money market fund to fail. The program does not have a specific lending limit, but is currently scheduled to end on Sept. 30, 2020. The treasury department gave the MMLF $10 billion of debt credit protection for the program.

To help small businesses, in concert with the CARES Act, the Fed launched the Paycheck Protection Program Lending Facility (PPPLF) on April 9, 2020. This program lends money to banks so that they can, in turn, lend money to small businesses through the Paycheck Protection Program. On April 30, 2020, the program was expanded the types of lenders who can participate in the program. There is no current limit to the amount of credit that can be extended through the program, but it will stop extending credit to the program on Sept. 30, 2020.

The Fed created several new programs that establish legal entities known as, special purpose vehicles, to make specific loans or purchase assets indirectly. The Fed established the Commercial Paper Funding Facility (CPFF), which purchases short-term debt known as commercial paper to ensure those markets stay liquid. This is actually a relaunch of a program begun during the Great Recession, when many businesses were hurt as liquidity in the commercial paper markets dried up. While it has no set limit on the amount it will purchase, the CPFF will stop purchasing debt on March 17, 2021, and the SPV will continue to be funded until its assets mature.

This was a big one: On March 23, 2020, the Fed created the Primary Market Corporate Credit Facility (PMCCF) to buy corporate bonds to ensure corporations can get credit. At the same time, it created the related Secondary Market Corporate Credit Facility (SMCCF), which buys up corporate bonds and bond ETFs on the secondary markets.  The combined purchase limit for the programs is $750 billion, up from an initially $200 billion. The premise is that this program makes banks more willing to lend to corporations, because they know that they can sell the loans to the Fed. What basically did is allow the Fed to buy at will any type of corporate bonds, including “junk” bonds. Both programs will stop purchasing bonds on Sept. 30, 2020, and they will continue to be funded until their holdings are sold or mature.    

Also on March 23, the Fed resurrected an old program from the Great Recession, the Term Asset-Back Securities Loan Facility (TALF). It will make up to $100 in loans to companies and takes asset-backed securities (ABS) as collateral. This includes a variety of securities, such as those based on auto loans, commercial mortgages, or student loans.

On April 9, 2020, the Fed announced the Main Street Lending Program, which sets up an SPV that will purchase up to $600 billion in small and medium-sized business loans.  The Fed will only purchase a 95% stake of each loan, with the bank keeping 5%. To qualify, businesses need to have 10,000 or fewer employees or have $2.5 billion or less in 2019 revenue. It will purchase stakes in both new loans and loan extensions, and under the CARES Act, the Treasury Department will make a $75 billion equity investment in the SPV. On April 30, 2020, the Main Street Lending Program was expanded in several ways. The number of maximum employees was raised to 15,000 or fewer, and the annual revenue was $5 billion or less. The minimum loan size was lowered to $500,000, and a third type of loan was added allowing the Fed to purchase 85% of loans to more heavily leveraged companies. It will continue to purchase stakes in loans until Sept. 30, 2020, and it will continue to be funded until its assets mature or are sold. 

Also on April 9, 2020, the Fed announced the Municipal Liquidity Facility (MLF), which will purchase up to $500 billion of short term notes issued by U.S. States (and D.C.), counties with at least 2 million people and cities with at least 1 million.  On April 27th, the population required to receive aid was lowered to 500,000 people for counties, and 250,000 people for cities. Under the CAREs Act, the Treasury Department will make an initial equity investment of $35 billion to the SPV. It will stop purchasing notes on Dec. 31, 2020, and the Fed will continue to fund it until its assets mature or are sold.

Fiscal Policy

Throughout March and April 2020, the U.S. government passed three main relief packages, and one supplemental one, totaling nearly $2.8 trillion.

The first relief package, the Coronavirus Preparedness and Response Supplemental Appropriations Act, 2020, since nicknamed Phase One, allocated $8.3 billion to do the following:

• Fund research for a vaccine
• Give money to state and local governments to fight the spread of the virus
• Allocate money to help with efforts to stop the virus's spread overseas. The second relief package, the Families First Coronavirus Response Act (FFCRA) or Phase Two, allocated $3.4 billion in relief and included the following provisions:
• Providing money for families who rely on free school lunches in light of wide-spread school closures.
• Mandate companies with fewer than 500 employees provide paid sick leave for these suffering from COVID-19, as well as providing a tax credit to help employers cover those costs.
• Nearly $1 billion in additional unemployment insurance money for states, as well as loans to states to fund unemployment insurance.
• Funding and cost waivers to make COVID-19 testing free for all

The third, and by far the largest, relief package was signed into law on March 27, 2020. By nominal dollar amount, it is the largest single relief package in U.S. history. This law, called the Coronavirus Aid, Relief, and Economic Security Act (and nicknamed the CARES Act or Phase 3), appropriated $2.3 trillion for many different efforts:

• One-time, direct cash payment of $1,200 a person, plus $500 per child
• Expansion of unemployment benefits to include people furloughed, gig workers, and freelancers until Dec. 31, 2020
• Additional $600 of unemployment per week until July 31, 2020
• Waived early withdrawal penalties for 401(k)’s for amounts of up to $100,000 until Dec. 31, 2020
• Mortgage forbearance for federally-backed mortgages for 180 days
• $500 billion in government lending to companies affected by the pandemic
• $367 billion in loans and grants to small businesses through the Paycheck Protection Program (PPP) and expanded Economic Injury Disaster Loan (EIDL) program
• More than $130 billion for hospitals and health care provides
• $150 billion in grants to state and local governments
• Almost $60 billion for schools and universities 

A supplementary stimulus package, nicknamed Phase 3.5, was signed into law on April 24, 2020. It appropriates $484 billion, mostly to replenish the PPP and the EIDL, and contains additional funding for hospitals, and CV-19 testing.

The Trump administration enacted a number of other measures to provide fiscal stimulus in Spring, 2020.

On March 17, 2020, Treasury Secretary Steven Mnuchin extended the deadline for paying both individual and business taxes to July 15, an effort which he claimed would free up $300 billion in liquidity.  On March 20, 2020, Mnuchin also extended the date to file taxes to July 15. 

On April 19, 2020, the Trump administration said businesses can delay payment of tariffs for 90 days if they have suspended operations during March and April and if they "demonstrate significant financial hardship."

That is an incredibly long list from the USA alone, and doesn’t include everything. The total estimates of all US stimulus thrown at this are in the $8 to $10 trillion dollar mark. Those are TRILLIONS.

Oh, and don’t forget about the $9 Trillion thrown at the US Repo market disaster which began in September.

In Canada, the list is similar, but unlike the USA whose stimulus seems to focus on the job creators and jobs market, the Canadian packages seemed more geared towards individual benefits and support. At last count last week from an article in the National Post, the Auditor General seems to be indicating a Canadian federal budget deficit in the $240-250 billion dollar range. An astonishing number for a country with a population of only 37 million. I’m old enough to remember when $20 billion deficits created outrage.

After the 2008 financial crisis, there was a lot of talk about moral hazard. The common refrain was that in bailing out banks and other financial institutions, the government had rescued the very actors who caused the crisis. Anything that resembled a bailout became taboo.

But consider this small comparison:

The AIG Bailout in 2008-09: $85B (an outrageous amount at the time)
QE Infinity right now before the CV-19 crisis hit was: $85B a month
Add on:
1) $625B a week in Quantitative Easing (QE)

2) De facto Yield Curve Control via QE price discretion

3) Commercial Paper purchases

4) Municipal bonds purchases

5) Corporate Bond purchases unlimited via ETF’s

6) A $4.5 Trillion lending facility

7) Small business lending

It would seem but a decade later, bailouts are all the rage. The Cares Act authorizes the Treasury Secretary to spend up to $877 billion in taxpayer money helping corporations, large and small. The Federal Reserve, using money authorized by the Cares Act and through its own initiative, has launched an array of programs to inject even more liquidity into the financial system and to help companies access the credit they need to survive. These interventions both replicate and expand on the tools used in 2008.

But despite all this stimulus, there’s a good chance that’s it STILL not enough.

While not growing as fast, the US jobless claims is still adding 2 million a week. This 10 weeks in now, so these have to be more than just retail and service industry jobs adding to the totals. And my guess is the white- collar cuts and a lot of manufacturing jobs have not started yet. This induced coma of the global economy will have more lasting damage than is currently evident, there are supply chains which may have forever been wrecked, and economies still have to “morph” to whatever the new normal will be coming out of this.

Global trade and globalization itself were already threatened prior to CV-19 with the US /China trade war. Things are probably worse now as China faces some global backlash.

Events of this weekend in many large US cities of outright civil disobedience come at an interesting time. Yes, the tragic death of an innocent man was the trigger, but it comes after a prolonged shutdown which already segregated the “haves” (those still getting paid to be at home) and the “have nots” (those who were not). It is evident there is a lot of political pressure growing out there as the socio-economic chasm gets wider. In addition, as those cities were just began to reopen and getting some economic activity, it also won’t encourage visitors, tourism, dining out, business travel, etc. …

From an investing standpoint, while it’s yet early to determine if “enough” has been done on the stimulus front, the policy response has been both overall very quick, and sizable, which truly differentiated this crisis response from that of 2008-09, and it allowed investors to look for brighter days ahead and created a huge bounce off the bottom as we saw in April and May.

The markets look like they were oversold in March, mainly because at the time, the expectation was that corporate profits would decline 80% out of this. Now that number seems to be in the 30-40% range, still a large drop, just not as bad as previously thought.

We talked about Modern Monetary Theory (MMT) and Universal Basic Income (UBI) in our last piece. It has now been experimented with and many in the populace have had a taste. Not sure they want to give it up quickly. MMT was tried in the UK in the 1970’s and it didn’t work out so well until Margaret Thatcher had the political will to eliminate it. Personally, I think the genie is now out of the bottle, and I don’t see any Maggie Thatcher’s out there.

While we have to keep in mind this is not a man-made crisis, the North American demographics favouring income generating securities have not changed. With the collapse in interest rates to virtually zero during the CV-19 event, and perhaps even going negative in the very near future, the search for anything that can produce income has only intensified.

We are continuing to work diligently to design our portfolios that can balance both the risk component along with the forward income needs of an aging society.

Stay tuned,
Vito Finucci, B.COMM, CIM, FCSI
Vice President and Director, Portfolio Manager

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