While stabilization of economic data has certainly been a positive driver for the markets in 2020, the biggest impact thus far has been the fiscal and monetary policy response. Unfortunately, there was no added ammo for the policy bazooka in Q3.
As noted on 3/31/20: The Federal Reserve (through monetary policy) and the US government (through fiscal policy) are responding to the incredibly fast economic slowdown by running the 2008-2009 playbook at a breakneck pace. The magnitude of the programs is shown below relative to similar programs in 2008/2009 (a more in depth breakdown is in section 2.1d). Such broad based programs are what policy makers refer to as “the bazooka”, due to their size relative to typical policy interventions.
The most important of these programs were the ones targeting market liquidity, and thus the ability for the financial markets to continue functioning despite the stress from the growing pandemic.
First, the Fed rapidly reinstated an array of money market liquidity programs, originally introduced in 2008, to support the functions of the commercial paper market, a key source of short term funding for day to day business operations. It then quickly followed up by announcing two new programs, the PMCCF and SMCCF (the Primary and Secondary Market Corporate Credit Facilities) enabling the Fed to intervene directly with corporate bond and/or bond ETF purchases, as well as to buy bonds directly from issuers. On top of that, the Fed has committed to support small and mid-sized businesses through the Main Street Lending Facility, though program specifics are yet to be announced. These are reflected above as Fed: Liquidity.
Second, the US government passed a total of $2.2 trillion in spending, headlined by the Coronavirus Aid, Relief, and Economic Security Act (CARES), an array of programs from the US Treasury, ranging from $1200 payments to individuals ($300 billion) to $350 billion in Small Business loans to prevent workers form being fired, the Payment Protection Program (PPP).
As the chart shows, each of these programs is larger than its GFC precedent. And more importantly, they were deployed quickly, as noted on 3/31/20: whether you use the July or October start date, it took 4-6 months to deploy all the tools the Fed and Treasury needed to stabilize the economy in 2008. In 2020, the Fed’s liquidity programs were all announced from 3/17 to 3/23, and the $2 trillion CARES Act was passed on 3/30. While there will inevitably be adjustments, adaptations, and program growing pains in 2020 (just as in 2008/2009), in this instance the response is taking 4-6 WEEKS instead of 4-6 months.
During Q2 these programs were deployed and in Q3 they continued to function, but no additional resources were added. On the monetary front, the Fed shifted its framework (addressed in the next section). Beyond that, the Fed has stood pat on policy moves, such as negative interest rates or yield curve control, two added programs that some had hoped for. The Fed has stated its already announced actions have done their job to support the financial markets, and what is needed now is fiscal action (not to mention progress in treating Covid-19).
Despite Fed exhortations and financial market expectations, there still has not been a “CARES 2” Act. The first CARES Act had two shortcomings. First, most of the programs (added unemployment benefits, the PPP hiring extension, airline benefits) were set to run through the end of August or September. With Covid-19 still disrupting large segments of the economy, these programs need some extended resources, even if not in the amount of the original CARES Act. Second, the CARES Act did not offer extensive support to state and local governments, as its priority was economy-wide support. However, states and local municipalities have borne the brunt of Covid-19, with lost revenues from sources like sales and meal taxes, paired with higher expenses for first responders, reopening schools, and other critical services that still are needed, but come with extra costs. As businesses and individuals had less resources, they were prioritized in the first CARES Act. Municipal governments have carried on, but now face budget crises that will both result in firing workers and reducing services.
For much of Q3, the House had a $3.4 trillion bill passed and on the table. The counter proposal from the Republican side was never fully crystallized, as the Senate suggested stripped down $500 billion to $1 trillion concepts, while the White House seemed to endorse an amount closer to $1.5 trillion. And, based on some of the key features, $1.5 to $2 trillion seemed to be the market’s expectation, and that supported the stock market rally through Q3. But the end of Q3 has come and gone without a deal, and with just a month to the election, a compromise is unlikely. The hope for the market now has shifted to a post-election deal, though with programs now lapsing, there will be at least some drag on the economy.
So far in 2020, the major response to Covid-19 has been The Fed and the Treasury Take Aim with the Policy Bazooka. They seem to have hit the target and supported the economy and markets through Q3, but there was no additional ammo. The Fed did not add a more aggressive program such as yield curve control. Even though fiscal policy was supporting economic activity in Q3, many programs came to a close as Q3 was ending. Thus the impact on the economic data will start to be felt in Q4 even as the market has held up on the hope for eventual fiscal support.
Also of concern is the fiscal “ammo” will eventually be limited by rising budget deficits (the US deficit has risen from $1 trillion to $3 trillion this year), while the monetary “ammo” would require new policies, like yield curve control or negative rates, to give yet another jolt, even though these moves would have diminishing benefits. If either (or both) go too far, then there is the risk of policy side effects.
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