A spat has broken out between the Federal Reserve – America’s central bank – and the US Treasury department. Steve Mnuchin, the US Treasury Secretary (equivalent of the chancellor over here), has told the Fed that he won’t be renewing some of their emergency lending facilities after they expire at the end of next month.
The US central bank, meanwhile, retorted it "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."
Is this a fit of pique by a tantrum-throwing outgoing administration, or is there a bit more to it than that?
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Why the US Treasury is falling out with the Federal Reserve
You don’t often see public spats between the US Treasury and the Federal Reserve. In fact, you don’t generally see many arguments between central banks and governments. They prefer to play along nicely together.
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But of course, the current US government is on its way out (presumably). A certain amount of chaos was always possible, and the idea that the Trump administration might make it harder for the Fed to support the economy while Joe Biden is getting ready for his turn in the hot seat has certainly rattled markets – though not massively.
So what’s happened? Mnuchin wrote to Fed boss Jerome Powell saying that, while four of the central bank’s emergency lending schemes would be extended for 90 days, he wanted the other five to end on 31 December, as scheduled. And he wants the unused funds back too – a mere $455bn. The Fed immediately said that it would rather keep hold of the money.
Markets were a little rattled after the news: US government bonds rose a bit (ie, yields fell), stocks fell from their highs, and the dollar popped a bit higher. Nothing dramatic, but a wee shiver nonetheless.
What’s the rationale? At first it might seem like an outgoing government is just sticking the spokes in the wheels of the incoming one, but it looks like there’s more to it than that. The five schemes that are being shut down on schedule (despite rising Covid-19 cases in the States) are two of those set up to buy corporate debt; the “Main Street Lending Program” for lending to medium-sized businesses; a scheme for lending to local governments; and one to prop up asset-backed securities (such as mortgage-backed bonds).
The four that are being extended are the ones that prop up markets for lending short-term money – such as the commercial paper market (where companies can borrow for very short periods for working capital and the like).
Why scrap the other funds? The reality is that, as the FT points out, “only a small fraction of the available lending capacity was used.” Why? Mainly because the Fed’s other schemes were so effective. “Some companies and local governments ended up securing better funding terms through regular capital markets”, notes the FT, while some businesses found the terms of the Fed facility too strict.
Taking from the central bank to give to the politicians
You might argue that a "belt and braces” approach is more important – why the urgency to end the schemes? But the problem right now is that what the US really needs – if anything – is extra money from the government to compensate people and businesses for lockdowns. That’s difficult just now because not only is the US between governments, it’s also still going to be divided when Biden takes over. So it’s always going to be hard to agree on further spending.
What’s interesting here is that, by taking this money back from the Fed, it frees the cash to be spent elsewhere by Congress. Long story short, the money was already in the budget, so it’s not “extra” cash that they have to pretend to find somewhere. It can be spent with impunity and a lot less political jockeying. In other words, by taking this money from the Fed, Mnuchin both puts pressure on Congress to take action, and hands them a big chunk of money to do it with.
It’s a charitable interpretation, but it’s also the one that makes most sense, and it explains why markets haven’t exactly cratered. As Mnuchin put it in an interview with Bloomberg, companies that are really struggling with the pandemic need grants, not debt: “The economy has responded very strongly, but there are still areas of the economy that need more support. That’s why I’m encouraging Congress to reallocate this money.”
Bloomberg adds, “presumably it will be significantly easier to sell Congress on appropriating these funds rather than working towards a bipartisan fiscal aid package, which has remained elusive for months and which President Donald Trump might not support anyway.”
So what’s the upshot? Don’t get me wrong. If the Fed’s ability to prop up markets was inhibited by the outgoing Trump administration, then Biden would be coming in against the backdrop of a massive market crash. That wouldn’t achieve much – it’s unlikely to be blamed on Biden after all – but maybe you're jaded enough to believe that Trump might just enjoy a scorched earth outcome.
However, I don’t think that’s what’s happening here. And it’s pretty clear that markets don’t either. We’ll see what happens but I think if anything, it just confirms that the reflation trade remains the outcome to bet on right now.
We’ve more on all that – and I also write about when it might be time to start being more circumspect – in the latest issue of MoneyWeek magazine, out now. Get your first six issues free here.
