On April 9th, Jerome Powell and the Federal Reserve announced $2.3 trillion in new programs to support the US economy. Today’s announcement came shortly after the Labor Department reported that 6.6 million new unemployment applications were received the week ending April 4th. This was on the heels of 6.9 million claims and 3.3 million claims for the weeks ending March 28th and March 21st, respectively.
Three major developments from the announcement:
- The Fed will begin buying corporate junk bonds
- A new round of loans for small-to medium-sized businesses
- A lending program designed for states and local governments
The Fed will begin buying corporate junk bonds
Most notable was the decision by the Fed to begin buying high-yield (or “junk”) corporate bonds. This expands on their move in late March to purchase
investment-grade corporate bonds and bond funds. Today’s announcement — that the Federal Reserve will enter the high-yield portion of the corporate bond market — is truly unprecedented.
These corporate bond purchases by the Fed will be made in the primary and secondary markets. The primary market describes bonds that are purchased directly from the issuing company, while the secondary market describes when bonds are re-sold on an exchange. Both the primary and secondary corporate debt markets have seen a liquidity crisis in recent weeks, as the volume of sellers has vastly exceeded the volume of buyers. Today’s announcement means that the Fed is a potential buyer.
In particular, this decision by the Fed is meant to support “fallen angels,” companies that have recently lost their investment-grade rating and are now considered junk. (Examples of fallen angels include Ford, Macy’s, and Kraft Heinz.)
○ In order for a company to qualify as a “fallen angel,” they must have had a rating of at least BBB-/Baa3 by two or more credit agencies as of March 22, 2020, and their current rating must be at least BB-/Ba3.
○ This decision will allow the Fed to purchase bonds from these companies — and many others — on the primary and secondary market.
New loans for small- and medium-sized businesses
The Fed also announced that $600 billion in new loans are now available to small and mid-sized businesses. These funds are in-addition-to money that was earmarked for the Payroll Protection Program (PPP).
This program, facilitated through the Fed’s Main Street Lending Facility, will be available to businesses with up to 10,000 employees or $2.5 billion in revenue during 2019.
Loan amounts will generally be between $1 and $25 million, and the rate on these loans will be the Fed’s overnight rate (0.01% at the moment) plus 2.50% to 4.00%.
○ Loan terms are four years, with interest payments deferred for the first year.
Like PPP, the distribution of these loans will be handled by major banks. Each bank must retain a 5% interest in each issued loan and the Fed’s Main Street Lending Facility will hold the remaining balance. The Treasury Department will provide a “backstop” of $75 billion to manage losses on issued loans.
A lending program designed for states and local governments
Through the Fed’s Municipal Liquidity Facility, there will be $500 billion in low-interest loans available to states and municipalities. This program is designed to help municipalities that have been especially hard-hit by COVID-19. As with the Main Street lending program, the Treasury will “backstop” $35 billion of loans issued through the program.
While the Fed has purchased U.S. Treasuries in the past, there has been long-standing resistance to entering the municipal bond market. Unlike the U.S. Treasury, states andlocal governments have no control over the money supply, and the vast majority of state and local governments (i.e., municipal bond issuers) are largely required to keep a balanced budget.
○ The lack of flexibility on the issuer side increases the Fed’s potential risk as a prospective bondholder; therefore, for now, the primary focus of muni-bond purchases appears to be on short-term debt.
Conclusion
“Our country’s highest priority must be to address this public health crisis, providing care for the ill and limiting the further spread of the virus,” said Federal Reserve Board Chair Jerome H. Powell. “The Fed’s role is to provide as much relief and stability as we can during this period of constrained economic activity, and our actions today will help ensure that the eventual recovery is as vigorous as possible.”
References: CNBC, Bloomberg, Press Release from the Fed, Wall Street Journal
This is for information purposes only and does not serve as personal advice.
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