April 01, 2020
Central Banks to the Rescue
April 01, 2020
Federal Reserve Board1
As COVID-19 continues to spread rapidly around the world, central bankers’ fears surrounding potential impacts have materialized. Responding to the economic impact of the virus, the Federal Reserve (Fed) conducted two unscheduled meetings in March, which resulted in monetary easing and more accommodative monetary policy. The Fed lowered the target range for the federal funds rate to 0.00% - 0.25%. In addition to the rate cut, the Fed implemented several facilities to alleviate stresses in the marketplace. Most notably for short-term fixed income markets, these include the Money Market Mutual Fund Liquidity Facility (MMLF), Commercial Paper Funding Facility (CPFF) and Primary Dealer Credit Facility (PDCF). Additionally, the Federal Open Market Committee (FOMC) announced an open-ended quantitative easing (QE) program that will increase its holdings of Treasury securities, agency mortgage-backed securities and commercial mortgage-backed securities in the amount needed to support the smooth functioning of these markets. The market continues to digest these Fed initiatives along with the fiscal stimulus provided by the U.S. government.
European Central Bank1
In tandem with central banks around the world, the European Central Bank (ECB) also delivered emergency relief measures to combat the economic impacts of COVID-19. Although market participants expected the ECB to lower rates in March, it kept rates unchanged. The ECB announced additional QE, buying an additional €120 billion worth of securities throughout the year. In addition to QE, the ECB illustrated that it plans to “support liquidity and funding conditions for households, businesses and banks and help preserve the smooth provision of credit to the real economy” by means of longer-term refinancing operations (LTROs). The ECB said it will “reassess” policy and the current market conditions at its next meeting on April 30th.
Bank of England1
Similar to the Federal Reserve, the Bank of England (BOE) Monetary Policy Committee (MPC) lowered the Bank Rate to 0.10%. The move was prompted by steep declines in demand, elevated market uncertainty and risk-off investor appetite stemming from COVID-19. Citing the potential economic fallout from the measures being taken to contain COVID-19, the committee also voted to increase government and corporate bond purchases by £200 billion.
In response to market dynamics, the Fed implemented multiple policy changes to support the credit markets in March. Notably, the MMLF was created on March 18 to support the “flow of credit to households and businesses.” This was a turning point for the industry as SEC Rule 2a-7 prime funds were able to pledge their assets to the Fed at amortized cost, alleviating liquidity stress due to dealer balance sheet constraints. As the month progressed, we prioritized adding liquidity to the portfolios, ending the month in excess of 45% weekly liquid assets across our Prime funds. Going forward, we remain comfortable maintaining elevated levels of liquid assets and conservative positioning, seeking to ensure that we uphold our mandates of capital preservation and liquidity.
The significant rate cuts by the FOMC and the uncertain impacts to the economy from the virus drove investors to buy U.S. Treasuries in mass, driving yields down significantly and to negative levels in the very front end of the curve. Additional buying pressure in Treasuries also came from large inflows into government and Treasury money market funds across the industry. The combination of large client inflows in a relatively short time frame with limited supply drove yields to single digits across the better part of the curve. Once Congress passed the stimulus package, the U.S. Treasury Department quickly announced and issued multiple cash management bills and continues to issue record amounts of bill supply to fund the package. The new supply pushed Treasury yields higher by several basis points as the market digests this ongoing supply. Overnight repo rates fell to low single digits due to market dynamics and high demand. During the month, we bought fixed-rate Treasuries and agencies in various tenors up to one-year to lock in fixed yields. We also bought longer-term Treasury and agency floating-rate notes. We continue to seek to ensure high levels of liquidity and manage the portfolios to be responsive to changes in market conditions and interest rate levels.
The increase in tax-exempt money market fund yields in March was largely caused by excess supply and a lack of demand related to recent redemption activity across the money market fund industry. To combat the economic slowdown from the prolonged shutdown, the Fed announced that it would extend asset purchases (QE) to support the economy to an unlimited amount and also include other assets such as corporate and municipal bonds. The Fed also announced that the MMLF would include variable rate demand notes as eligible securities to pledge, so long as they were tendered by a money market fund (either tax-exempt or prime). There was also an announcement that the CPFF would be expanded to include municipal CP issuers once it becomes fully operational sometime in mid-April. The pace of new issuance slowed dramatically as plans by several state and local governments to borrow were upended by the credit freeze. The SIFMA Index5 of weekly variable rate securities rose 405 basis points from 1.15% at the end of February to 5.20% on March 18. On April 1, the index reset at 1.83% as supply tightened. The Bond Buyer One-Year Note Index6 rose 236 basis points from 0.47% on March 9 to 2.83% on March 20 to finish the month at 1.05%.
Protecting the safety and liquidity of the portfolio’s assets remained our first priority. In the recent turbulent markets, our emphasis has been on managing liquidity and exposure to sectors and issuers that may come under stress as a result of a prolonged economic slowdown caused by the global pandemic. We continue to invest in tax-exempt securities, including VRDOs, where our credit and risk teams have confidence in the quality of the issuer, the structure of the program and the financial strength of the supporting institutions. We will continue to closely monitor the implications of the slowing economy on municipal government balance sheets.