h The Fed offered a kitchen sink of “unconventional easing” measures today including commitments to purchase up to $1.15 trillion of Treasury and agency securities. We view this as a positive step towards easing financial conditions and supporting the eventual stabilization and recovery of the economy.
· Last week, we estimated that it would “cost” the Fed $1 trillion to $1.6 trillion of balance sheet expansion to generate an unconventional easing in financial conditions equivalent to a 100bp cut in the funds rate. Today’s announcement and consequent move in the GS Financial Conditions Index implies a “bang for the buck” of about $1 trillion per 100bp-equivalent easing, although it is too early to judge the full impact of the move.
· As we noted last week, the key caveat of our balance-sheet-to-funds rate analysis was that it focused only on “P”—the price of credit—rather than “Q”—the quantity of credit. That emphasis is appropriate for the measures the Fed offered today. However, the Fed is also trying to increase the flow of lending directly, via the Term Asset-Backed Securities Lending Facility (TALF) program. Officials are so optimistic about this approach that they have hinted via media reports at a second major expansion of the concept (to include legacy assets) before the first subscription period has even been completed.
· To gauge the possible “bang for the buck” of the Fed’s attempt to boost the “Q” of credit via TALF, we estimate the potential impact on auto loan volumes—and ultimately on sales and GDP. As a best-case scenario, we consider the possibility that issuance of auto-related ABS returns to the average rate over the 2006-2008 period. If all of the incremental issuance translated into new lending, and new lending translated one-for-one into domestically manufactured vehicle sales, this would boost GDP by roughly 0.5% at a balance sheet cost of less than $100 billion. This implies that the TALF approach could be an order of magnitude more efficient (from a balance sheet standpoint) than the approach of buying assets to lower credit spreads. However, unlike with asset purchases, the ability to scale the TALF is constrained by banks’ willingness to lend and the ultimate end demand for borrowing.
The Fed offered a kitchen sink of “unconventional easing” measures today: a stronger commitment to a zero funds rate, an expansion of agency debt purchases by $100 billion and of agency mortgage backed-securities purchases by up to $750 billion, and a commitment to buy up to $300 billion of Treasury securities. Although we thought the Federal Open Market Committee would ultimately take these actions, doing them all at once and in large size sends a clear message that the Fed recognizes the downside risks to economic activity and is determined to mitigate them as much as possible. We view this as a positive step towards easing financial conditions and supporting the eventual stabilization and recovery of the economy.
Last week, we estimated that it would “cost” the Fed $1 trillion to $1.6 trillion of balance sheet expansion to generate an unconventional easing in financial conditions equivalent to a 100bp cut in the funds rate (see “Unconventional Easing—Not Much Bang for the Buck So Far,” US Daily, March 10). Today’s action by the FOMC gives us another data point for our analysis. Given the size and broad market implications of the announcement, we can simply look at the total move in the GS Financial Conditions Index (GSFCI) and convert it to a funds-rate equivalent (for more on the GSFCI, see our “Understanding US Economic Statistics” publication, pp. 15-17).
On the day, the GSFCI eased 41 basis points, equivalent to 117 basis points of Fed easing (given the 35% weight of the short-term reference rate in the GSFCI). With a total “cost” of $1.15 trillion in asset purchases, this implies a cost of just under $1 trillion per 100 basis points of conventional Fed easing—at the low end of our previously estimated cost range of $1 trillion-$1.6 trillion, and hence at the high end in terms of “bang for the buck.” (The true cost might be smaller, and hence effectiveness greater, if asset markets partly anticipated the move today, although our sense from media reports and conversations with clients is that most market participants did not expect a major announcement; any “consensus” for balance sheet expansion would have been in the low hundreds of billions at most.) Of course, it’s a bit early to definitively judge the impact of the Fed’s action, as the purchases under this program have not yet begun.
As we noted at the time, the key caveat of our balance-sheet-to-funds rate analysis was that it focused only on “P”—the price of credit—rather than “Q”—the quantity of credit. That emphasis is appropriate for the measures the Fed offered today, since they do not directly generate new lending but simply provide an incremental source of demand for debt securities.
However, the Fed also is trying to ease balance sheet constraints and increase “Q”—the flow of lending—directly, via the Term Asset-Backed Securities Lending Facility (TALF) program. Broadly speaking, this is an effort to restart the securitization process by providing low-cost, non-recourse funding to investors who purchase asset-backed securities (ABS) that meet the Fed’s requirements. Officials are so optimistic about this “private capital, public leverage” approach that they have hinted via media reports at a second major expansion of the concept (to include legacy assets) before the first subscription period has even been completed.
To gauge the possible “bang for the buck” of the Fed’s attempt to boost the “Q” of credit via TALF, we estimate the potential impact on auto loan volumes—and ultimately on sales and GDP. As a best-case scenario, we consider securitization of auto-related ABS returning to the $73bn annual rate it averaged over the 2006-2008 period, from essentially zero in recent months. If this additional issuance translated dollar-for-dollar into new lending—an aggressive assumption, especially since issuers could begin by securitizing loans made in the last 18 months—and all of that represented incremental spending on domestically manufactured vehicles, the boost to GDP would also be $73bn, or 0.5%. (Keeping ABS issuance at that level would continue to support the level of GDP, but would not provide any further growth.) Of course, this incremental easing of credit conditions would not show up directly in the GSFCI, again because it measures financial conditions in price rather than quantity terms.
This example, vastly oversimplified though it is, makes two points clear. First, unconventional easing that actually generates a higher volume of lending—i.e. the “Q” approach to credit easing that the TALF is pursuing—has the potential to have much higher “bang for the buck.” A 0.5% boost to GDP from $73bn of balance sheet expansion (actually a bit less, since the investor has a small equity stake) would imply nearly a 7% boost to GDP from $1 trillion in balance sheet expansion—an order of magnitude higher than our FCI calculations for “P” approaches suggest. Second, however, the extent to which the Fed can employ the “Q” approach is quite constrained: there is only so much end demand, and banks are only willing to lend so much even at a very low cost of funds. Conversations with several market participants suggest that the actual impact of the TALF on auto ABS issuance is likely to be significantly smaller than our “best case” scenario above. Also, auto loans are probably the area where incremental lending translates most clearly to spending, since most vehicles are bought on credit. So while the TALF approach is potentially highly efficient, it remains to be seen how scalable it will be.
Andrew Tilton
No comments:
Post a Comment