Programs offer backstop that will be missed if market strains return: economists
A rare rift between the Treasury Department and the Federal Reserve was taken largely in stride by investors on Friday, but it might be too early to send the all-clear signal.
Treasury Secretary Steven Mnuchin late Thursday, in a letter to Federal Reserve Chairman Jerome Powell, announced that he would allow several emergency lending programs administered by the Fed to expire on Dec. 31. Those include programs designed to support the corporate bond, municipal bond, and asset-backed securities markets, as well as the Main Street Lending Program.
The move came days after Powell said he was in no hurry to end such programs. In a statement, almost immediately following the Treasury action, the Fed said it opposed the decision.
However, credit spreads didn’t blow out Friday. Treasurys, which often serve as a haven, did see some buying interest, pulling down yields, but stocks spent most of the day trading flat to slightly lower before extending losses modestly in the final hour of trade.
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After all, analysts said, the programs have been relatively little-used. But that rationale might miss the point, some economists argued.
That is because markets have been orderly, perhaps in part because of the existence of a safety net. The Treasury’s move takes away a backstop that would be missed if financial markets come under renewed stress, they argued. It was the near breakdown of credit markets in the early days of the pandemic earlier this year that prompted the Fed and Treasury to create the programs in the first place.
Economists and investors could also look back to the early part of this decade at an arguably even more remarkable case of crisis fighting. In 2012, during the darkest days of the eurozone debt crisis, European Central Bank President Mario Draghi vowed to do “whatever it takes” to preserve the euro.
Those words were followed up with the creation of the ECB’s Outright Monetary Transactions program, which would allow the central bank to undertake massive bond purchases if needed to drive down borrowing costs for stressed countries. That program was never actually used, but its existence was enough to ensure that unsustainably high yields on Italian government bonds and other stressed eurozone countries retreated, helping cool the crisis.
Robert Perli, co-founder of Cornerstone Macro Research and a former Fed staffer, argued on Twitter that it was the role the Fed programs played as a backstop that made them worthwhile:
Since markets aren’t in free fall, it was no surprise the announcement had little impact on markets Friday, with investors more focused on the potential for a vaccine-fueled economic recovery next year and less concerned about the risk of a corporate or municipal solvency crisis, said Oliver Jones, economist at Capital Economics, in a note.
“That is surely part of the reason for the very limited market reaction to Mnuchin’s announcement” Jones wrote.
Another reason for the muted response, he said, might be that investors don’t believe the safety net will actually be taken away. Mnuchin’s successor in the incoming administration of President-elect Joe Biden could move to extend the program, he said, though such action might require the cooperation of what’s likely to be a divided Congress.
More broadly, Jones argued that a key lesson of the COVID-19 crisis for policy makers and investors centers on the success of speedy and decisive moves by the Fed and other central banks to backstop markets for risky assets.
“We doubt that this lesson has been lost on investors, or indeed overturned by Mnuchin’s decision,” he wrote. “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.”