The dimensions of U.S. stimulus

In response to what in late February 2020 were rapidly building uncertainties surrounding the widening coronavirus health crisis and the specter of a pending economic shutdown, the U.S. Federal Reserve's first move was to cut interest rates — by 50 basis points on March 3 and then by a full percentage point on March 15. With these cuts, short-term rates returned to levels last seen during the global financial crisis (GFC) of 2008 and 2009. This sudden and dramatically accommodative posture, which brought the federal funds rate to a range between 0.00% and 0.25%, may help put the economy on better long-term footing, but it also marked the end of the Fed’s rate-cutting ammunition.

The second move, which continues to evolve today, was to reinstate and expand a series of asset-purchase programs to provide liquidity and broad support for the financial system. These quantitative easing (QE) measures, through which the Fed has announced its intention to purchase U.S. Treasuries, mortgage-backed securities (MBS), commercial paper—and, for the first time ever, investment-grade corporate bonds as well as some segments of high-yield corporate credit—will support the smooth functioning of U.S. fixed-income primary and secondary markets.

“By decisively moving to support the corporate debt market, [the Fed] has—in our view—reduced the likelihood of a financial crisis from taking place.”

—Frances Donald, chief economist and head of macroeconomic strategy, Manulife Investment Management, March 16, 2020

• Yields will likely remain flat at the short end of the curve
• Spread volatility in corporate credit, highly rated commercial mortgages, and municipal markets may be held in check
• Equity markets may regain a measure of normality from improved liquidity conditions
• The Fed’s balance sheet will grow, potentially well beyond GFC levels

Following the Fed’s interest-rate cuts and renewal of QE programs, the U.S. government’s initial fiscal response to the economic fallout of the crisis was massive and broad based. On March 27, the House approved and the president signed into law the Coronavirus Aid, Relief, and Economic Security (CARES) Act. At $2+ trillion, the Act represented roughly 12% of U.S. gross domestic product and was three times as large as that put forward during the GFC. This couldn’t have come sooner, as tens of thousands of businesses shuttered and tens of millions of people filed new unemployment claims in less than a month following the rollout of quarantine measures by states and cities across the country.

Markets have welcomed this action by the fiscal authorities, but the sheer size of the stimulus along with complications around its disbursement and oversight have raised questions about whether its full impact will be felt by all of the beneficiaries it seeks to assist. Lawmakers appeared to take a “whatever it takes” attitude with respect to fiscal stimulus, and additional phases of fiscal support may be forthcoming, including to make up for any shortcomings of already passed stimulus.

“Only the federal government is adequately equipped to minimize the length of any economic slowdown."

—William W. Priest, CFA, portfolio manager, Epoch Investment Partners, March 20, 2020

Many individuals under certain income thresholds have already received an Economic Impact Payment in the form of a $1,200 direct deposit—or more, for people with qualifying children. In addition, the Act expands eligibility for unemployment insurance and contains a number of provisions affecting retirement savings accounts, including measures that will allow individuals to withdraw funds without penalty from their tax-advantaged savings.

Nearly $350 billion in funding was earmarked by the CARES Act for loans to small businesses. Called the Paycheck Protection Program, provisions in this portion of the new law allow certain businesses to borrow money for qualified costs related to employee compensation and benefits, among other costs to support employees.

However, the lending program was overwhelmed by demand and purportedly ran out of money just weeks after the Act was passed on March 27. That led legislators to pass a new round of funding in late April—a $484 billion aid package—that included $310 billion more for small businesses, as well as $100 billion for hospitals and coronavirus testing.

“Medium to long term, some great valuation opportunities may become possible with banks as they're likely a solution to an economic recovery by providing liquidity and funding.”

—Boston Partners, April 9, 2020

The current economic shutdown implies massive shortfalls in revenue for states and municipalities, and this would threaten widespread disruption of essential services were it not for certain provisions in the Act. Allocating hundreds of billions of dollars of support for public transportation, hospitals, and medical supplies, the Act provides much-needed funding during the current period of acute economic distress, as well as a critical backstop to certain segments of the municipal bond market.

That said, states will continue to look to the government for more assistance given declining tax revenues and soaring healthcare costs. While they were disappointed not to receive additional funding in the $484 billion package signed by the president on April 24, work toward additional state aid may take on greater urgency as economic conditions appear set to deteriorate in the near term, according to a recent report by the non-partisan Congressional Budget Office.

• Flagging consumer and business sentiment may receive a partial offset through direct payments and loan forbearance
• Fiscal policy will lend revenue support just as earnings reports will reveal any widespread damage to corporate balance sheets
• Most states and municipalities will receive some support for lost tax receipts, further shoring up municipal bond markets