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?
Subscribe to MoneyWeek
Subscribe to MoneyWeek today and get your first six magazine issues absolutely FREE
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.
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.
John is the executive editor of MoneyWeek and writes our daily investment email, Money Morning. John graduated from Strathclyde University with a degree in psychology in 1996 and has always been fascinated by the gap between the way the market works in theory and the way it works in practice, and by how our deep-rooted instincts work against our best interests as investors.
He started out in journalism by writing articles about the specific business challenges facing family firms. In 2003, he took a job on the finance desk of Teletext, where he spent two years covering the markets and breaking financial news. John joined MoneyWeek in 2005.
His work has been published in Families in Business, Shares magazine, Spear's Magazine, The Sunday Times, and The Spectator among others. He has also appeared as an expert commentator on BBC Radio 4's Today programme, BBC Radio Scotland, Newsnight, Daily Politics and Bloomberg. His first book, on contrarian investing, The Sceptical Investor, was released in March 2019. You can follow John on Twitter at @john_stepek.
What pension providers don't tell you about your retirement money
Check the small print from your pension provider or risk losing thousands.
By Merryn Somerset Webb Published
Should you invest in sector funds?
Sector funds can be a useful way to fine-tune a portfolio or track a theme, but check what the index holds.
By Cris Sholto Heaton Published
UK wages grow at a record pace
The latest UK wages data will add pressure on the BoE to push interest rates even higher.
By Nicole García Mérida Published
Trapped in a time of zombie government
It’s not just companies that are eking out an existence, says Max King. The state is in the twilight zone too.
By Max King Published
America is in deep denial over debt
The downgrade in America’s credit rating was much criticised by the US government, says Alex Rankine. But was it a long time coming?
By Alex Rankine Published
UK economy avoids stagnation with surprise growth
Gross domestic product increased by 0.2% in the second quarter and by 0.5% in June
By Pedro Gonçalves Published
Bank of England raises interest rates to 5.25%
The Bank has hiked rates from 5% to 5.25%, marking the 14th increase in a row. We explain what it means for savers and homeowners - and whether more rate rises are on the horizon
By Ruth Emery Published
UK wage growth hits a record high
Stubborn inflation fuels wage growth, hitting a 20-year record high. But unemployment jumps
By Vaishali Varu Published
UK inflation remains at 8.7% ‒ what it means for your money
Inflation was unmoved at 8.7% in the 12 months to May. What does this ‘sticky’ rate of inflation mean for your money?
By John Fitzsimons Published
VICE bankruptcy: how did it happen?
Was the VICE bankruptcy inevitable? We look into how the once multibillion-dollar came crashing down.
By Jane Lewis Published