Gill Capital Partners March 20, 2020 Market Update
Coronavirus and the Government Response
As the global response to the coronavirus continues to unfold, everyday life has changed dramatically for everyone. Businesses and schools are working to adapt to the new remote and social distancing reality. Global markets have reacted in a swift and unforgiving manner, repricing assets based on the new and evolving economic assumptions. Economists are anticipating significant economic disruption, particularly for the second calendar quarter of 2020, as much of the first quarter’s economic performance was already sealed prior to the coronavirus impact. For the second quarter, economists are forecasting a severe contraction in GDP with estimates currently in the 5%-10% range. Most economists see this sharp contraction lasting one quarter, followed by a strong economic rebound in the second half of 2020. We are in uncharted territory and it is impossible to know what the societal and government reaction will be going forward; however, it is safe to say that we are looking at a significant economic disruption in the short-term. Based on the deteriorating economic forecast, the government has taken numerous steps, utilizing both monetary and fiscal stimulus tools. With the non-stop news feed, it is challenging to keep up with the barrage of information, so we thought we would take this opportunity to summarize the various stimulus plans and what the federal government hopes to accomplish.
Monetary Policy and Stimulus Overview
Monetary stimulus is controlled by the Federal Reserve, and changes in monetary policy are designed to increase demand. The most significant and visible tool wielded by the Federal Reserve is the ability to change interest rates. The Fed also has the ability to utilize various tools aimed at increasing the supply of credit in the system. Below is a summary of the actions the Federal Reserve has taken over the past couple of weeks, as well as their desired impact:
Lowered the target interest rate by a full percentage point nearly to zero, and provided guidance that rates would remain at this level until “it is confident that the economy has weathered recent events and is on track to achieve its maximum employment and price stability goals.” This move followed a 50-basis-point (0.50%) rate cut on March 3.
o Desired Impact – Make borrowing more attractive. Whether taking on a new loan or lowering the rate on adjustable rate debt, this move will reduce interest expense for corporations and individuals.
Committed to buy $700 billion in bonds, made up of Treasury ($500 billion) and mortgage backed ($200 billion) securities.
o Desired Impact – Keep the bond market trading smoothly and provide liquidity to these markets. The U.S. Treasury market is the foundation for trading both domestically and abroad. Less price disruption creates more stability in pricing of many different assets.
Lowered the cost of dollar swaps with foreign central banks.
o Desired Impact – Facilitate borrowing by foreign banks in U.S Dollars.
Encouraged banks to borrow from the Fed’s discount window by reducing the penalty banks pay above market rates and extending the maturity of the loans.
o Desired Impact – Make it easy and cheap for banks to access capital.
Encouraged banks to utilize intraday credit from the Federal Reserve; that is, to temporarily overdraft their Fed accounts if required.
o Desired Impact – Give banks access to capital anytime they need it and don’t create a stigma around using it.
Encouraged banks to utilize the liquidity and capital they have built up in recent years to extend loans.
o Desired Impact - Help banks to draw on liquidity and capital resources as they may need to meet the elevated credit needs of their household and business customers.
Reduced banks’ reserve requirements to zero. They were already very low and served no purpose in the “ample reserves” monetary policy regime now being implemented.
o Desired Impact – Remove the regulatory barriers and provide flexibility to allow banks to focus on the needs of the customers.
The Fed is doing its part to keep the financial system functioning, limit economic damage, and encourage a strong rebound when the epidemic passes. It is obvious that the Fed learned from 2008, and their quick and substantial reaction is reassuring. Keeping businesses alive so they will be around when normal activity resumes will minimize any permanent damage to the economy’s capacity to deliver goods and services. That goal will be easier to realize if households and businesses retain access to credit to ride out the rough weather.
Fiscal Policy and Stimulus Overview
Fiscal stimulus refers to increasing government consumption or lowering taxes, with the hope of stimulating economic consumption during a recession. Fiscal stimulus is controlled by the U.S. government and generally enacted through the U.S. Treasury, and therefore requires the approval of Congress. Below is a summary of fiscal stimulus measures that have been recently approved, as well as those that seem likely to be approved shortly.
Phase One - On March 6, 2020, President Trump signed an $8.3 billion spending bill, creatively named "Phase One" of stimulus efforts, to fund efforts to fight the pandemic. “Phase One” provides the following:
Funding for vaccine research
Money for state and local governments to fight the spread of the virus
Money to help with efforts to stop the virus' spread overseas
Phase Two - On March 19, President Trump signed the “Phase Two” stimulus package, passed by the House earlier in the month, without changes. The “Phase Two” stimulus package includes the following:
Free virus testing
Expanded unemployment benefits
Additional funds for Medicaid
A provision requiring paid sick leave for some workers affected by COVID-19
Tax Extensions & Deadlines - Today, Treasury Secretary Steven Mnuchin announced that the tax filing deadline for individuals and businesses has been extended to July 15th. Taxpayers and businesses will have an additional three months to file and make payments without interest or penalties. This will free up billions in extra liquidity over this period.
Phase Three - There are at least three “Phase Three” proposals in the works. On March 19th, Senate Majority Leader Mitch McConnell released a proposal for a “Phase Three” stimulus package entitled the “Coronavirus Aid, Relief, and Economic Security Act,” or the “CARES Act.” Both the White House and Senate Democrats are working on proposals of their own. Negotiations are in the early stages, but it seems almost certain at this point that we will see a “Phase Three” package and it will be substantial. Included in the proposed stimulus packages are:
Direct payments of at least $1,000 to many or all U.S. adults, possibly subject to income restrictions, and potentially with additional payments for each child
$50 billion in bailouts for the airline industry
Roughly $500 billion in business loans, primarily for small businesses
Various other measures to support both individuals and businesses during the pandemic and into the recovery
Summary - While nobody can yet determine the effectiveness of any of these programs, it is fair to say that the government’s reaction from an economic stimulus perspective has been swift and commensurate. In 2008, it took many months for the Federal Reserve to enact monetary stimulus measures. This time around, the government is doing what they can to increase liquidity and maintain credit market operations. This is encouraging to see and is designed to mitigate the long-term impact of the current situation.
As always, please let us know if you have any question or concerns, or if we can provide assistance with any other financial planning matters including education, taxes, insurance or estate needs.