The Fed has executed the pump; watch out for the dump
The Federal Reserve decision is on June 10 and it’s shaping up to be a bigger event than anticipated a week ago because of surprising strength in jobs and equity markets.
We’ve quickly moved from a paradigm of Fed action supporting equity markets to the unwinding of Fed action sapping equity markets.
Here is what to watch:
The Main Street Lending facility
On May 19, Fed Chair Jerome Powell said the Main Street facility would be up-and-running by month end. A week ago, he said the program was ‘days away’.
It’s still not running and the last estimate was early-to-mid June. Powell also said it was the toughest facility to set up but it’s increasingly concerning that it’s not running, especially with most of the US now reopened.
The program itself is a $600B lending facility for companies with fewer than 15,000 employees and less than $5 billion in revenue. The name of the program is also a bit of a misnomer because you need to borrow at least $500,000, which is eliminates many of companies we think of as ‘main street’.
The maximum loan size is $25 million for new loans or $200 million for expanded loans. Lenders retain 5% of the loan but the rest goes on the Fed’s balance sheet with the Treasury providing $75 billion for the first (and presumably only) losses. The loans must be paid back in four years and have an interest rate of LIBOR +300 bps but there’s no interest for the first year.
There’s no doubt the Fed desperately wants this operational by June 10. Beyond that, the market will be looking for signs on how aggressively the loans are taken up.
Comments about a better economy
A few of central banks have upgraded Q2 and 2020 forecasts in the past two weeks and the Fed will be next. For instance, the Bank of Canada now sees a Q2 decline of 10-20% compared to 15-35% previously.
Those are still ghastly numbers but they’re not as ghastly. Moreover, the message from the stock market is clear: This isn’t going to be so bad.
Now whether that’s true or not is debatable and no one is forecasting anything with certainty but the implication is that the Fed needs to think about reigning in the liquidity.
I don’t think we’re going to get that kind of announcement but the first step is acknowledging that the economy is looking better than it did a few weeks ago. If Powell gets too upbeat, watch out for a rout in bonds.
Hints at less easing
Some Fed members might be feeling like they overplayed their hand. No one knew what would happen in the pandemic and the FOMC actions undoubtedly helped cushion the blow in the shutdown but it might have helped too much and promised too much.
The optics of 13% unemployment and the Nasdaq at a record high are poor. Markets are functioning fine and buying junk bonds is a bad look for the FOMC.
Since March the Fed has rolled out an alphabet soup of programs including: CPFF, PDCF, MMFLF, PMCCF, SMCCF, TALF, PPPLF and MLP. I suspect few people even within the Fed could identify them all and swap lines and QE are on top of that.
A radical approach for the Fed would be to try capitalism, or at least a bit of it.