INSIGHTS

On November 24, 2020

Ammunition Depleted?

Last week, Secretary of the Treasury Steven Mnuchin announced that he will not renew the Fed’s $750 billion corporate credit purchase facilities into 2021. But former Fed Chair Janet Yellen — President-elect Joe Biden's reported nominee for Treasury Secretary — would likely be able to reverse this move at the stroke of a pen.

The Fed and corporate credit

As a reminder, the Fed was finally granted Congressional approval to purchase corporate credit in March 2020 as part of the $2 trillion CARES ACT with $454bn allocated to the Treasury Department to support such programs.

Ammunition depleted?

The Fed’s corporate credit facilities were able to support investment grade credit (and even “fallen angels”) but were utilized far below available capacity — and so effectively served as dry powder in the market’s eyes.

To date, the programs have only been used up to 10% — with the Fed’s purchases dwindling to $30 million a day — compared to the central bank’s Treasury and MBS (mortgage-backed securities) purchases of over $5 billion per day. 

The decision is easily reversible

It has been widely reported that Biden will nominate former Fed Chair Janet Yellen as his Secretary of the Treasury. She would be expected to be confirmed by early February 2021. Yellen will likely have the unilateral ability to reverse Mnuchin's decision at the stroke of a pen, as power over the CARES Act transfers to the new administration.

It seems likely to us that she would exercise that power. Jerome Powell, her successor as Fed Chair clearly initially looked to extend purchases through March 2021. The appointment of Yellen would likely be intended to foster a close collaboration between the Fed and Treasury from the start.

Even if the program isn’t renewed immediately, it’s highly likely the program would be re-instated if economic conditions were to deteriorate. This would put pressure on the Biden administration to allow the Fed to act in line with its peers (most other developed market central banks are able to purchase corporate credit).

Not a game-changer for corporate bonds

Mnuchin’s decision came as a moderate surprise to markets but fell well short of an outright shock — particularly as the Republican Party gets ready to return to “opposition” status and keep Democrats policy spending in check. Corporate spreads widened only modestly, and Treasury yields eased slightly higher following the announcement.

But we do not believe this decision will have a material impact on the economic outlook. Given how few bonds the Fed had purchased, the immediate-term technical impact is unlikely to be material – although it could weigh on near-term market conditions to an extent. Into next year, we expect the program may be reinstated, particularly in the event of any stress in financial conditions.

We believe the famous Fed “put” will remain in play for corporate bonds investors for some time to come.

CRN: 2020-1109-8707 R

The opinions and views of this commentary are that of Insight Investment and are not necessarily that of Advisors Asset Management.

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