Unlike 2001 Or 2008

Some claimed that when the Fed expanded repo operations, started another round of QE, and cut rates to zero, that it had nothing left to ease financial conditions. That was mistaken analysis. The Fed unveiled new tools to deal with this crisis, which are a massive deal. Firstly, on Friday the Fed stated it would expand its asset purchases to muni bonds which was important because the premium on muni yields over treasuries hit a higher peak than in 2008. Plus, muni bond ETFs were trading below their net asset values. There was some concern with how cities’ budgets would look with the increase in unemployment. The Boston Fed is lending to eligible banks and financial institutions which can use municipal bonds (single state and other tax exempt munis) with maturities of less than 1 year as collateral.

Ordinarily, you’d say the Fed buying munis is a big deal, but we don’t live in ordinary times. March 2020 was an extraordinary month that will go down in financial history as such. The big news on Monday was something we have discussed for a few days on Twitter. The Fed is buying corporate debt like other central banks. In a technical sense they aren’t because they set up special purpose vehicles (SPV) owned by the Treasury. The Treasury puts up some money and the SPV borrows from the Fed. The decision to effectively buy corporate bonds is a big deal because credit spreads have been widening recently. The Fed did an end-around what most thought was illegal to support the economy.

It took about a 30% drop in stocks for the rule book to be thrown out the window. The new rules are that the Fed can’t own more than 20% of any one ETF or 10% of an individual corporate bond. The LQD and VCLT ETFs rallied sharply on this news. They had been trading below their net asset values. It’s seems likely that the Fed won’t be shy about keeping this program up until it is very clear the situation is rectified.

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