A move by the Treasury Department to pull back funds from the Federal Reserve spooked investors on Friday, with markets dipping slightly to end a mishmash week of trading.
MANHATTAN (CN) — Optimism on Wall Street about two Covid-19 vaccine candidates was undercut by moves by the Treasury Department, which seeks to take back hundreds of billions of dollars in emergency spending by the year’s end.
Late on Thursday, Treasury Secretary Steven Mnuchin sent a letter to the Federal Reserve instructing it to return $455 billion in unused funds meant to prop up bond markets in the wake of the pandemic.
“The Federal Reserve facilities supported by the Treasury’s contribution of CARES Act funds have clearly achieved their objective,” Mnuchin wrote, citing recent bond spreads as evidence that the market had normalized and stating Congress should re-appropriate the funds. “While portions of the economy are still severely impacted and in need of additional fiscal support, financial conditions have responded and the use of these facilities has been limited.”
Markets did not seem to like the move, as the Dow Jones Industrial Average shed 100 points at the opening bell and more than doubled those losses by the closing bell, losing 219 points for the day, a 0.75% drop. The S&P 500 and Nasdaq also fell, by 0.6% and 0.4%, respectively.
Mnuchin spent Friday defending the move, saying that several lending facilities, including the central bank’s Paycheck Protection Program Liquidity Facility, would continue to operate. Speaking on Friday morning to CNBC, Mnuchin said the decision was “not a political issue” and that the funds were set to expire at the end of the year anyway.
“As the Fed has always said, these are emergency tools [and] when the emergency’s over, let’s put ’em away,” Mnuchin said. “Well, the medical emergency may not be over, but I think we’d agree the financial conditions are in great shape. Corporate bonds have come in, municipals have come in, mortgages have come in, the stock market has rebounded.”
He also noted Democrats initially had worried about giving him a blank check to spend money, and now some of them are now criticizing him for returning the funds to be used to help small businesses.
“The options are the options,” Mnuchin said. “Whether it’s myself or somebody else, these can be reactivated with exchange stabilization funds.”
The Fed may not agree, though. “The Federal Reserve would prefer that the full suite of emergency facilities established during the coronavirus pandemic continue to serve their important role as a backstop for our still-strained and vulnerable economy,” the central bank said in a statement.
Many investors and analysts had credited the Fed with propping up markets with its various liquidity programs, as well as keeping interest rates low.
Technically, the Fed could use its Core Exchange Stabilization Fund to reestablish the lending facilities that expire at the end of the year. But some speculate the central bank’s firepower under those programs would be reduced tenfold.
“The emergency lending facilities have been little-used, but their existence has been key in ensuring a credible safeguard against financial market stress,” wrote Gregory Daco, chief economist at Oxford Economics. “With the Covid-19 crisis worsening and activity slowing in the absence of fiscal aid, the decision to curtail the Fed’s firepower could unsettle markets and exacerbate economic stress.”
Daco noted there would be risk to struggling small- and mid-sized companies, as their access to credit would be constrained, as would that of municipalities facing a budget crisis. “With partisanship in Congress preventing the delivery of urgently needed fiscal aid, and low rates negating any imminent debt servicing concern, Mnuchin’s justification appears poorly grounded,” he wrote.
That sentiment was echoed by Neil Bradley, chief lobbyist at the U.S. Chamber of Commerce, who predicted that ending the liquidity programs “prematurely and unnecessarily ties the hands of the incoming administration, and closes the door on important liquidity options for businesses at a time when they need them the most.”
Others lauded the decision, however, noting that the Fed funding programs had a lot of money untapped.
“They weren’t needed as much as originally thought,” wrote James Mayer at Tower Bridge Advisors. “My guess is that we will learn that the economy probably needs less additional stimulus than we thought even a few weeks ago. Do we really need to write checks for most Americans when unemployment is back below 7% and GDP is rising even with a virus surge?”
According to the Fed’s recent balance sheets, as of November 18, the Fed has received more than $114 billion in Treasury funding for its lending programs, including $37.5 billion for the Corporate Credit Facilities and $17.5 billion for the Municipal Liquidity Facility.
Pennsylvania Senator Pat Toomey said in a statement that the lending facilities were meant to be temporary. “Congress’s intent was clear: these facilities were meant to be temporary, to provide liquidity, and to cease operations by the end of 2020,”said Toomey, who is a Republican.
Peter Boockvar, chief investment officer at Bleakley Advisory Group, said it was “good riddance” to a few of the Fed’s corporate credit facilities. “It was a bridge too far to argue that buying the bonds of Apple and McDonald’s was needed, as if there weren’t any private buyers for them,” wrote Boockvar, who often criticizes the Fed. “The Main Street Lending Program sounds great on paper, but what many small- and medium-sized businesses need right now is equity, not more debt.”
As to what effect the current virus surge will have on the economy, it is still anybody’s guess. According to data compiled by Johns Hopkins University, there have been more than 57 million cases of Covid-19 worldwide, with 1.3 million deaths. In the United States, 11.7 million Americans have contracted the disease, while about 253,000 have died. On Thursday, the United States reported more than 187,000 new cases, a new daily record.
Fortunately, news on the vaccine front continues to be positive. On Friday, Pfizer and BioNTech officially announced they would soon emergency use authorization from the U.S. Food and Drug Administration for its proposed coronavirus vaccine, which could make doses available for some of the population as soon as mid-December.
But the news did not move markets — unlike the rally that occurred two weeks ago upon news that the vaccine candidate was more than 90% effective in preventing Covid-19 infection. Pfizer has since amended its research to show its candidate is 95% effective in preventing infection.
The Pfizer candidate is not the only promising vaccine. On Monday, Moderna announced that its candidate was 94.5% effective in preventing coronavirus. Markets showed sizeable but not huge gains following the news, with the Dow gaining 471 points and the S&P 500 climbing 40 points.
While the vaccine news has been a boon to investors, some say it does not fundamentally change economic projections.
On Tuesday, European Central Bank President Christine Lagarde warned that any benefits from the quicker deployment of a vaccine are being offset by the larger-than-dreaded second wave of the pandemic.
“I’m not sure that is going to be a major game changer for our forecasts, simply because what we had anticipated in our baseline was that at some state in the first half of 2021 there would be a vaccine and that it would be rolled out in the course of 2021,” Lagarde said. “It might be a little bit accelerated … but I don’t think it will be a game changer so to speak.”
The ECB will update its economic forecast on December 10.
Other economic indicators during the week provided more of a mixed bag of optimism and pessimism.
Earlier in the week, the National Association of Home Builders reported greater optimism among its members, as its survey gained 5 points from October, setting a new record high in builder confidence. With favorable mortgage rates and an ongoing suburban shift, the NAHB says builders are being restrained only by a lack of materials or space.
“Though builders continue to sign sales contracts at a solid pace, lot and material availability is holding back some building activity,” said NAHB Chairman Chuck Fowke in a statement. “Looking ahead to next year, regulatory policy risk will be a key concern given these supply-side constraints.”
Fowke noted that construction costs are continuing to rise, making affordability an ongoing concern.
On Thursday, however, new unemployment claims picked up by 31,000, the first increase in about a month. The number of claims under the Pandemic Unemployment Assistance program also increased, from 296,000 the week ending November 7 to 320,000 last week.