Friday's Market Minute: Treasury And The Fed Are At An Unnecessary Impasse

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Equity markets are set to open down on news that the Fed’s corporate credit, municipal lending, and Main Street Lending Program will not be renewed by Treasury Secretary Mnuchin. Despite Fed Chair Powell’s desire for them to remain in place, Treasury has declined to extend several emergency loan programs established jointly with the Fed that are set to expire on Dec. 31.

In passing the CARES Act of 2020, Congress appropriated almost half a trillion dollars for one part of the government to invest in another. The creation was a Treasury fund of some $454 billion that was to be invested in Federal Reserve-created emergency facilities. This raised opportunities of close collaboration between two vital parts of the government’s financial architecture, but also invited pressure on a traditional line between monetary and financial policy controlled by the central bank, and the financial, economic, and fiscal policy controlled by the President and Congress.

Although the programs were not used extensively, their presence alone reassured financial markets and investors that credit would remain available to help businesses and local government agencies through the pandemic downturn. Designed as backstops, borrowers would likely only use them when traditional financing options were dire. Since the funds have been available, bond issuance volumes have returned to their pre-Covid-19 levels along with normalized borrowing spreads. In fact, bond yields and spreads are at near-time record lows.

On several occasions, the Fed has clearly indicated the importance of the stability fund. On Nov 9th, the Federal Reserve Financial Stability Report noted that money markets have stabilized, but would be vulnerable in the absence of emergency facilities. A week later, Chair Powell said the time is not right yet to put away the Fed’s emergency tools and that if things deteriorate, the emergency facilities could be extended.

Programs, including the ones that support corporate bonds, have worked by convincing investors that the Fed is ready to step in as a backstop and has been one of the only sources of stability in Washington. Removing the Fed’s latitude to offer support in a recovery is another unnecessary, distressing development investors must contend with.

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