For the second week in a row, COVID-19 has us scrapping our list of “normal” financial topics in favour of a clean sheet. RPI reform, the Libor transition, the spectacle of a conservative government unveiling a budget that many Blairites might have labelled “courageous” – all will have to wait for now.
Instead, we turn to another week of emergency central bank action, capped by the Federal Reserve’s surprise announcement on Sunday evening. US rates are to fall by another full percentage point, taking the Federal Funds target range to the historic low of [0-0.25]% that was first hit during the last financial crisis.
At this point, the primary purpose of aggressive rate cuts is to generate confidence that policymakers are willing to do whatever it takes to support the financial system. The headline announcement was therefore accompanied by a raft of other measures designed to have a more direct and immediate impact on the economy. In the US, this means a largescale rebooting of the Fed’s quantitative easing (QE) programme: purchases of $500 billion worth of Treasury securities and $200 billion of government mortgage-backed securities. That is in addition to the expanded repurchase operations that had already been announced, pumping an additional $1.5 trillion of liquidity into the dollar repo market. All told, “QE ad infinitum” is back on the menu.
As in 2008, the Fed is acting in concert with central banks around the world. A unified move by the Fed; European Central Bank; Bank of England; Bank of Japan; Bank of Canada and Swiss National Bank saw all six lower pricing on USD swap arrangements by 0.25%. First used during the financial crisis, these arrangements are intended to provide USD liquidity to financial institutions across borders. Meanwhile, the Bank of England announced its own emergency rate cut of 0.5% – also alongside a broader package of measures to try and keep liquidity flowing towards businesses that need it. Perhaps the most significant of these was the decision to cut the countercyclical capital buffer rate to 0%, allowing UK banks to lend out an additional £190 billion to businesses without increasing their capital requirements.
Lagarde holds the line
On the surface, the European Central Bank (ECB) stands out for having refused to further cut its headline deposit rate – already at a historic low of -0.5%. But President Christine Lagarde also announced a range of targeted measures, from additional asset purchases and a relaxation of banks’ capital requirements to an expansion of the ECB’s longer-term refinancing operations. The aim is clear: to encourage banks to continue lending to small and medium sized companies as much as possible.
The only fly in the ointment took the form of some ill-advised remarks by Lagarde on how the ECB was “not here to close spreads”. These were interpreted by the market as a swipe at Italian sovereign bonds, which duly experienced their worst day on record. After the spread between Italian 10-year bonds and 10-year German Bunds had widened out to 2.6%, Lagarde apologised for her comments, stating that the ECB would indeed use its policy tools “to avoid dislocations in bond markets”.
So much for the good news. The bad news is that the liquidity crunch central bankers are trying to avoid may already have arrived. The US bond market is bracing itself for a wave of credit rating downgrades, with nearly $300 billion worth of “investment grade” bonds trading at yields above 6% – territory that is normally occupied by “junk” bonds. A swathe of listed companies, from Cineworld to Tui, have announced that in the coming months they will be unable to meet their debt obligations. Others are hoarding as much cash as they can. Last week, Boeing was reported to have drawn down on its full $13.8 billion credit line. Against this backdrop, expect the M&A boom to stall for now. Equity sponsors are much more likely to be considering emergency funding requirements than new deals.
Let’s end on a slightly more hopeful note. As many have pointed out, this is emphatically not a repeat of the financial crisis. The financial system is under stress, but it is not frozen. By comparison with 2008, everybody has a reasonable idea of who owes what to whom. At the moment, there is no suggestion that any major financial institution may fail. On the contrary, there is every suggestion that this outbreak will eventually pass, and that the global economy can expect a rapid recovery once the shock to supply and demand is over. In the meantime, we wish all our readers and their families the very best.
By Joshua Roberts, Associate Director at Chatham Financial