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Market Update

What Is the Government Doing to Prop Up the Economy?

We look at the fiscal and monetary policies recently deployed amid the coronavirus pandemic to see what's working and what else needs to be done.

The U.S. government has taken extraordinary measures to address the economic fallout from the coronavirus pandemic through both fiscal policy (Congress deciding how much to spend, borrow, and tax) and monetary policy (the Federal Reserve's decisions on the supply of money and, therefore, inflation and interest rates).

Here are some common questions investors may have about these policies and how we think they'll work to stabilize the economy.

What Has Congress Done to Help Ordinary People and Will It Work?
In the past four weeks, Congress has devoted more money (at least in nominal terms) than it ever has before to address an economic crisis. The three approved bills cover a variety of relief efforts such as help with student loans, delaying mortgage payments, a change in the rules for retirement account distributions, and targeted aid to hard-hit industries.

Much of the relief takes the form of various loans to businesses, direct payments of $1,200 to most Americans (with an additional $500 to families with children), along with sometimes overlooked but critical additional support for the unemployed.

Before the first aid package passed, we were looking to see that Congress planned to balance the need to deliver aid speedily and the need to target it reasonably well to people and businesses that need it the most. So far, Congress has achieved a reasonable balance, although relief should get more targeted in the coming months.

What Is Congress Doing to Help Millions of Now-Unemployed Americans?
The United States' existing unemployment insurance programs were largely inadequate to cope with the scale of job losses associated with the business closures caused by the coronavirus, but the federal government has provided a significant buttress to these systems.

Each state runs its own unemployment insurance fund, and the jobless benefit amounts as well as who can qualify for unemployment vary across states. However, the average unemployment check is just $366 a week, while some state systems cover as little as 30% of workforce--typically by excluding independent contractors and those with shorter work histories. The federal government has added $600 a week for unemployed claimants on top of existing state-defined benefits and expanded eligibility dramatically.States are now struggling to cope with a massive volume of new claimants using antiquated systems, but most states will be able to catch up, and the federal money will help the recently laid-off workers who need the work most. 

Congress also has funded a loan program (twice now) called the Paycheck Protection Program. Private banks administer the program, but it functions as grants for companies that keep their workers on the payroll for eight weeks and use the funds for normal business expenses. Doing so leads to the companies' loans being forgiven. Congress allotted $350 billion for this program initially, followed by an additional $320 billion in a second bill, but even this may not be enough to cope with demand.

What Else Does Congress Need to Do?
Under the most optimistic scenario, the U.S. lifts restrictions on businesses later this year as we get control of the coronavirus pandemic, gradually reviving the economy. However, there's a major economic challenge on the horizon: State and local government budgets are getting pummeled and will need to reduce spending in the third and fourth quarters, leading to a contractionary fiscal policy right as we try to get the economy moving again.

The federal government will need to step in and provide a backstop to lower levels of government in the U.S., which are losing tax revenue, spending to contain the coronavirus, and watching their pension funds suffer huge losses. While Congress has already set aside $150 billion in aid to states, that's not going to be enough to address this crisis. A federal rescue of the rest of the public sector is likely, but the path to this relief will have more twists and turns than the first three coronavirus bills Congress passed because it will be difficult to find agreement on how to equitably provide relief, avoid rewarding states that have been financially irresponsible for years, and target the hardest-hit areas of the country.  

What Has the Fed Done so Far and Has It Worked?
The Federal Reserve has taken a number of extraordinary steps. First, the Fed quickly eased its monetary policy and lowered the federal-funds rate all the way down to 0%. Second, the Fed began large-scale purchases of U.S. Treasury bonds in order to pump more than enough liquidity into the markets. Lastly, the Fed instituted myriad initiatives that can provide up to $2.3 trillion worth of lending capacity to act as a lender of last resort for the credit markets. These initiatives halted the precipitous decline in values for riskier assets at the end of March, allowed companies to access credit to fund operations over the past month, and laid the ground work for monetary policy to support the economic recovery as states begin to lift their shut-in orders.

Why Was the Fed's Intervention Necessary?
During the early stages of the COVID-19 crisis, heightened uncertainty and volatility led many investors to sell first and ask questions later. The sell-off was intensified by the especially rapid pace of price declines, which forced leveraged investors to liquidate whatever they could in order to raise enough cash to cover margins. The Fed's open-market purchases of U.S. Treasuries and residential mortgage-backed bonds provided the liquidity needed by leveraged investors to cover margin requirements and helped to stem even further liquidation sales. Furthermore, during this market turmoil, bank lending and corporate-bond markets had come to a standstill. The Fed's funding of commercial paper and money market funds provided the ability for corporations to roll over their short-term debt until they could access longer-term funding.

Once these forced liquidations came to a halt, the markets stabilized and have since recovered much of their prior losses. The Fed's programs to purchase asset-backed securities and corporate bonds were the backstop that provided the confidence to unlock the funding markets. Over the past month, investment-grade-rated companies have issued record amounts of new long-term debt. Proceeds from this debt will be used to term out short-term debt and provide extra cash as a buffer against the economic difficulties that still lie ahead.

How Novel Was the Fed's Approach?
The Fed's approach consisted of the traditional monetary policy actions that it has historically used in normal economic environments, reinstituted programs that it developed during the 2008-09 global financial crisis, and newly created programs.

The new initiatives include facilities that will purchase corporate (Primary Market Corporate Credit Facility) and municipal bonds (Municipal Liquidity Facility) and a lending program for small and medium-size businesses (Main Street Lending Program). In total, these funding programs will provide up to $2.3 trillion in loans to support U.S. households, businesses, and communities.

What Should Investors Look for Next?
Investors have shifted their attention away from evaluating the potential economic impact of the monetary and fiscal stimulus plans announced over the past few weeks and toward earnings--where we are just now getting our first glimpse at how much of an impact the shutdown has had on companies. In addition, the recent releases of economic indicators for March are revealing the depth of the current economic disruption. While day-to-day coronavirus-related headlines may continue to impact the daily movements of the stock market, the longer-term trend will be driven by earnings and the economy.

We see ample opportunities for long-term investors to purchase stocks at significant discounts to our fair value estimates. While we continue to see value in the equity markets, we note that Morningstar's Market Fair Value metric has risen to 0.93 from 0.70 on March 23, reflecting that much of the easy short-term returns have been made. This sharp rebound highlights the need for long-term investors to stick with their targeted asset allocations and risk-tolerance levels even during periods of market turmoil. Similar to the rebound in the equity markets, corporate bonds have also recovered much of their earlier losses. Yet, even following this rebound, corporate credit spreads still remain wider than their long-term averages and are trading at levels that we think provide good value for investors.

This article has been written on behalf of Morningstar, Inc., and is not the view of DBRS Morningstar.