What’s the big-picture impact of the stimulus efforts to combat COVID-19-induced economy woes?
Thus far, 2020 has experienced a remarkable series of never-before-seen events. The term "unprecedented" may be losing its luster, but it's still a fitting description of what we're witnessing. COVID-19's impact on the economy, and the government's response, have been swift and dramatic.
The Federal Reserve was the first to respond to fear in the markets. In the span of just a few days in mid-March, it cut interest rates to nearly zero and began to purchase bonds at breakneck speed. For the sake of comparison, from March 16-April 16th, the Fed purchased nearly $80 billion worth of Treasury and mortgage-backed securities per day. This daily spend is nearly equivalent to the monthly average of $85 billion spent on such securities from 2012-2014 — an unprecedented measure as examined further in this Wall Street Journal article.
Congress was a little slower to act, but their fiscal stimulus still proved to be momentous in scale. The $2 trillion CARES Act became law on March 27 and provided much-needed support for taxpayers and businesses. Highlights for taxpayers included economic impact payments and beefed-up unemployment benefits. For businesses, the Paycheck Protection Program (PPP) aimed to help small and medium-sized businesses keep employees on payroll with forgivable loans.
Congress is presently hammering out details of the HEROES Act, which could provide additional aid including incentive pay for essential workers and another round of stimulus checks for all Americans. Meanwhile, the Federal Reserve has pledged to continue to do whatever is required to support markets and the economy.
From a Monetary Policy standpoint, the Fed’s intent is to encourage consumers and corporations to spend confidently. Lower interest rates make it easier for businesses to borrow funds which in turn leads to potential growth and expansion. By reducing yields on interest rates from treasuries to savings accounts, there is less incentive to save which further boosts spending trends and economic growth. With many businesses and consumers afraid to spend amid the current situation, the Fed is taking as much action as they can to prevent the economy from grinding to a halt.
These actions, however, have raised concerns about the long-term effects on inflation. Typically, the lowering of interest rates tends to put upward pressure on inflation. To combat this, the Fed has increased the money supply through Quantitative Easing (the buying back of treasuries) which has a deflationary effect. In recessionary periods the two actions tend to cancel each other out leading to a nominal change to the inflation rate while still stimulating the economy.
The current Fiscal policy, on the other hand, is meant to keep the economy afloat to either weather the storm or provide time for longer-term adjustments to be made. In the short-term, the different stimuli will have a significant impact on the individuals and corporations with reduced incomes. The price to pay, unfortunately, is a substantial increase to the national debt. The more debt the government takes on, the riskier it becomes for one to lend them funds (done when one purchases treasuries). To compensate buyers for the added risk, the Fed will eventually need to raise the yield on treasuries which will cut into income brought in from taxes and other sources.
The monumental amounts of monetary and fiscal stimulus are not only being used to buy treasuries but also for buying corporate debt, mortgages, and municipal bonds. The worries in the market elevated the “spread” between Treasury bonds and these other bond types. An elevated spread means that prices of these bonds moved lower relative to treasuries and consequently they pay a higher yield. This means that we are much more favorable to corporate and municipal bonds as the prices should rise and we are being paid a higher interest rate as we wait.
As far as equity investments, certain companies and industries are very beaten down in price. However, that is not necessarily a reason to buy as many companies in hard-hit industries will go bankrupt. The better play is to buy larger companies with good balance sheets, plenty of cash, the capacity to borrow, and products that will remain in demand. Higher returns are possible from smaller companies with good intellectual properties that may be a target of acquisition, but this is a much riskier path. A short synopsis is that the big, well-positioned companies will get even bigger with market share gains and acquisitions (unless anti-trust starts to intervene).