Fed moves to shore up commercial paper; FOMC member explains 'no' vote on cut

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The Federal Reserve Board moved to bolster confidence and liquidity in U.S. financial markets Tuesday as it established a commercial paper funding facility to support the flow of credit to both businesses and households.

The Fed said the commercial paper market has been under stress due to the uncertainty surrounding the COVID-19 virus outbreak. The Treasury will provide $10 billion of credit protection to the Federal Reserve in connection with the CPFF from the Treasury's Exchange Stabilization Fund (ESF). The Federal Reserve will then provide financing to the SPV under the CPFF. Its loans will be secured by all of the assets of the SPV.

“By eliminating much of the risk that eligible issuers will not be able to repay investors by rolling over their maturing commercial paper obligations, this facility should encourage investors to once again engage in term lending in the commercial paper market," according to the Fed. "An improved commercial paper market will enhance the ability of businesses to maintain employment and investment as the nation deals with the coronavirus outbreak.”

Commercial paper markets directly finance a wide range of economic activity, supplying credit and funding for auto loans and mortgages as well as liquidity to meet the operational needs of a range of companies.

The Fed earlier in the day issued a statement encouraging banks to use their resources to support households and businesses. It approved a technical change to phase in, as intended, the automatic distribution restrictions gradually if a firm's capital levels decline.

Also Tuesday, Loretta Mester, President of the Federal Reserve Bank of Cleveland, issued a statement on why she voted against the 100 basis point rate cut the Fed approved on Sunday.

“I dissented from the action of the majority of the Federal Open Market Committee (FOMC),” she said. “As the post-meeting statement issued by the Committee notes, I was fully supportive of all of the actions taken to promote the smooth functioning of markets and the flow of credit to households and businesses but preferred to reduce the target range of the federal funds rate to 1/2 to 3/4 percent instead of to 0 to 1/4 percent as was done.”
She said that if market illiquidity continues, she would support the Fed taking further actions to address funding needs.

“When markets are not functioning well, the transmission mechanism of monetary policy to the economy is disrupted, and any reduction in the target federal funds rate will have less of an impact on the real economy. In current circumstances, with social distancing and the stoppage of spending activity, rate cuts are also less impactful. I dissented because I viewed a 50 basis point reduction in the federal funds rate as appropriate, in support of the liquidity actions we were taking and in light of the outlook. I did not favor returning the funds rate to zero and using up all of our interest-rate policy space at this time when the transmission mechanism of monetary policy to the economy is impaired.

“I preferred to stage our policy actions by first providing liquidity to improve market functioning, supported by a smaller reduction in the funds rate. This would have preserved the option of a further cut in the funds rate, if needed, for a time when market functioning had improved and such an action could be expected to be most effective in supporting the economy as it emerges from the health crisis after the medical response has been put in place, new cases of the virus have begun to stabilize, social distancing has eased, and life begins to return to some semblance of normal.”

Fed survey sees services decline
Activity in the region’s service sector declined in March, according to the Federal Reserve Bank of New York’s Business Leaders Survey.

The business activity index dropped 23 points to negative 13.1, the lowest level in over three years. The business climate index decreased 27 points to negative 29.0, suggesting that companies see the business climate as a lot worse than normal.

Employment levels increased marginally and wages increased at about the same pace as last month. Input and selling price increases slowed notably as did capital spending.

The N.Y. Fed said that the indexes for future activity plunged, and pointed to a marked deterioration in the six-month outlook.

Retail sales drop in February
Retail sales fell 0.5% in February after rising a revised 0.6% in January, originally reported as a 0.3% gain, the Labor Department reported.

Economists surveyed by IFR Markets had expected sales to have risen 0.2%

Sales were up 4.3% from the same time in 2019. Total sales for the December 2019 through February 2020 period were up 4.9% from the same period a year ago.

“Retail sales were disappointing in February confirming the notion that consumers were already losing momentum heading into 2020 before the coronavirus,” said Stifel Chief Economist Lindsey Piegza. “While the U.S. economy was on ‘moderate’ footing at the start of the year, an increasingly fragile consumer in Q1 suggests a pullback resulting from the coronavirus and the policies of containment may be even more impactful come Q2.”

Industrial production up last month
Industrial production rose 0.6% in February after falling 0.5% in January, the Fed said.

Capacity utilization rose to 77.0%, 2.8 percentage points below its long-run (1972–2019) average.

Economists polled by IFR Markets had expected production to have risen 0.4% and capacity to remain at 77.0%.

Manufacturing output rose 0.1% last month; excluding a large gain for motor vehicles and parts and a large drop for civilian aircraft, factory output was unchanged.

The index for utilities rose 7.1%, as temperatures returned to more typical levels following an unseasonably warm January.

At 109.6 percent of its 2012 average, the level of total industrial production in February was unchanged from a year earlier.

Inventories fall in January
Business inventories fell 0.1% in January, the Commerce Department reported. Inventories were up 1.1% from January last year.

Economists polled by IFR Markets had expected inventories to have fallen 0.1%.

Sales and shipments rose 0.6% in January and was up 2.1% from January 2019. The total business inventories/sales ratio based on seasonally adjusted data at the end of January was 1.38 compared to 1.40 in January 2019.

NAHB index dips in March
The National Association of Home Builders/Wells Fargo Housing Market Index fell to 72 in March from 74 in February.

Economists surveyed by IFR Markets has expected a reading of 74.

“Builder confidence remains solid, although sales expectations for the next six months dropped four points on economic uncertainty stemming from the coronavirus,” said NAHB Chairman Dean Mon. “Interest rates remain low, and a lack of inventory creates market opportunities for single-family builders.”

Sentiment levels have held in a firm range in the low- to mid-70s for the past six months.

“It is important to note that half of the builder responses in the March HMI were collected prior to March 4, so the recent stock market declines and the rising economic impact of the coronavirus will be reflected more in next month’s report,” said NAHB Chief Economist Robert Dietz. “Overall, 21% of builders in the survey report some disruption in supply due to virus concerns in other countries such as China. However, the incidence is higher (33%) among builders who responded to the survey after March 6, indicating that this is an emerging issue.”

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