US Fed Reserve & ECB ramp up bond buying to steady markets
US Federal Reserve (Fed) and the European Central Bank (ECB) have unleashed their full firepower to support the economy through the coronavirus outbreak via a spending spree on government bonds, as reported on the Financial Times.
Fed bond buying measures
The Fed pledged to buy government bonds in unlimited amounts and unveiled two new facilities that allow it to purchase corporate bonds, including new issues.
The first facility to prop up large employers involves bridge financing for up to four years for investment-grade companies, in exchange for purchases of newly issued corporate debt by the Fed. Businesses could defer principal and interest payment to preserve cash for up to six months, but they would not be allowed to buy back shares or pay dividends if they tap the facility.
A second programme would allow the Fed to purchase corporate debt in the secondary market.
The Fed also on Monday revived the term asset-backed securities loan facility (TALF) — a facility dating back to the 2008 financial crisis — which gives the Fed the ability to buy securities backed by student, car and credit-card loans, as well as loans to businesses through the Small Business Administration.
The US central bank said TALF and the other new programmes combined would provide up to $300bn in financing for “employers, consumers, and businesses” backed by the US Treasury department, which is offering $30bn in equity from its Exchange Stabilisation Fund to support the measures.
Separately, the Fed also expanded existing programmes to ease strains in the markets for municipal debt and the short-term loans known as “commercial paper” and said it would soon announce a “Main Street Business Lending Programme” to lend directly to small businesses.
The Fed had originally planned to purchase at least $500bn in US Treasuries and at least $200bn in “agency” mortgage-backed securities — those issued by quasi-governmental entities Fannie Mae, Freddie Mac and Ginnie Mae — as it slashed its main interest rate to near zero eight days ago. In recent days it has sped up the pace of these purchases, after earlier interventions failed to address strains in both debt markets.
By Friday, it had completed roughly half of its planned Treasury purchases, as well as about a third for the agency mortgage-backed securities. Following a meeting of the Federal Open Market Committee, its monetary policy setting committee, the US central bank is no longer putting a numerical cap on its purchases of Treasuries and mortgage-backed securities, instead signalling that it is prepared to buy as much as necessary.
“This is shock and awe from the Fed,” Jim Paulsen, chief market strategist for the Leuthold Group tells the FT. “This has some real merit of easing some of these short-term financial illiquidity issues.”
ECB bond buying measures
The ECB plans on purchasing €750 billion in additional bonds to contain the financial fallout from the coronavirus pandemic, which analysts say could leave it open to legal challenges.
Almost all constraints that applied to the ECB’s previous asset-purchase programmes have been removed or significantly loosened, according to the legal decision detailing the ECB’s latest plan, which was published on Wednesday night in the official journal of the EU.
The details of the new programme support the declaration by Christine Lagarde, the ECB’s president, who said on Twitter after it was announced last week: “There are no limits to our commitment to the euro.”
Describing the decision as “a bombshell”, Frederik Ducrozet, strategist at Pictet Wealth Management, tells the FT: “There is a risk that the ECB faces legal risks and a political backlash down the road.” But he added that it “strengthens the ECB’s quasi-fiscal support to the most vulnerable sovereign states”.
Eurozone bonds rallied on the news, reducing financing costs for countries hit hardest by coronavirus such as Italy, as investors said the ECB’s removal of constraints bolstered the credibility of its pledge to backstop markets.
Crucially, a self-imposed limit to buy no more than a third of any country’s eligible bonds will not apply to the extra €750bn of bonds it has committed to buy this year in response to the coronavirus crisis under its Pandemic Emergency Purchase Programme.
This so-called issuer limit was put in place to ensure that the ECB does not buy so many bonds that it is accused of directly funding national governments, which is against EU law.
The central bank also expanded the criteria for eligible securities under the new programme to securities with a maturity of more than 70 days, compared with its previous restriction to buy only sovereign bonds with maturities between one and 30 years.
Ducrozet says “this also changes everything” because about three-quarters of Germany’s planned €150bn of extra borrowing this year will be in the form of bills with a maturity below one year and these will now be eligible to be bought by the ECB.
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The details of the ECB’s new programme, which went into operation on Thursday, came as former ECB president Mario Draghi said the economic shock from coronavirus required “a significant increase in public debt” similar to those undertaken “in times of war”.
The ECB has consistently said that the issuer limits are not a binding constraint on its asset purchases and as many European countries are expected to issue large amounts of debt to fund their responses to coronavirus it will ease the pressure.
Italy’s 10-year yield fell by 0.1% points to 1.45% on Thursday, the lowest in nearly two weeks. It had risen to nearly 3% last week before the announcement of the €750bn of purchases. Short-dated yields dropped even further, while bonds issued by Portugal and Greece joined in the rally. Yields fall when bond prices rise.
“They are saying to countries like Italy ‘we have got your back’,” Iain Stealey, international chief investment officer for fixed income at JP Morgan Asset Management, tells the FT. “It’s been a painful few days. But now, although we are not back to levels [of before the coronavirus crisis] we are not a million miles away.”