The Federal Reserve Board lowered the target range for the Federal Funds Rate to 0%-0.25% earlier this year. One of the goals of this policy move and other initiatives was “to support the flow of credit to U.S. consumers and businesses.” By reducing the cost of borrowing (through lower interest rates) and buying public securities (Treasuries, Mortgage Backed Securities, and Corporate Bonds), the Federal Reserve was trying to create an environment where borrowers could continue to access the market at attractive rates.
This policy appears to have worked on the surface as 30-year mortgages dropped to record low levels and investment grade corporate bond issuance has already set a calendar year record in August.
Despite the sizeable increase in issuance this year and the expected decline in earnings, yields are dropping to record low levels. The Financial Times recently reported that Google issued a 10-year bond with a 1.1% coupon payment. Below investment grade issuers have also participated with high yield bond and leveraged loan issuance combining to over $500 billion year to date. A high yield rated company recently issued a 10-year bond with a 2.875% coupon, which was a record low.
At the same time, public companies have been able to issue record amounts of debt at record low levels, lending standards for small-sized corporations have tightened the most since 2009.
One of the other programs that the Federal Reserve announced to address the economic impact from the COVID-19 related lockdowns and recession was the Main Street Lending program. As of August 19th, under $500 million in loans had been made. The program has lending capacity for $600 billion.
The housing market is another area that has seen strong activity as existing home sales and new home construction activity have been accelerating in recent months. Some portion of this increase in activity is being attributed to the recent drop in 30-year mortgages to below 3%. At the same time, lending standards have tightened by the most since 2009.
Based on data from the most recent New York Federal Reserve Consumer Finance report, 70% of all mortgages originated in Q2 2020 had a FICO score above 760 (top 30% of credit scores). The average percentage of total origination with a FICO score of 760 or higher since 2003 is 45%.
While the Federal Reserve has been trying “to support the flow of credit to U.S. consumers and businesses,” many of the policies have worked to lower borrowing costs and provide capital to people and/or companies that were in less need of assistance. Many of the areas that the programs were designed to help are not able to access capital because of changes in credit and liquidity risk. If this situation persists, the current monetary policy initiatives will likely continue to have limited impact on the broad economy and liquidity issues will remain in place for small private companies and lower rated consumer borrowers.
Rank Dawson, CFA
Vice President, Research and Strategy
Boyd Watterson Asset Management, LLC
The views expressed herein are presented for informational purposes only and are not intended as a recommendation to invest in any particular asset class or security or as a promise of future performance. The information, opinions, and views contained herein are current only as of the date hereof and are subject to change at any time without prior notice.