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Here’s the Federal Reserve’s Next Move -- ICYMI

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First, the Federal Reserve lowered its short-term lending rate by 0.5 percentage points to prepare a threatened economy now ravaged by the coronavirus. That was March 4. 

Then, the central bank began buying trillions of dollars of Treasurys across the duration spectrum to keep interest rates low. 

Then when companies of all sizes - stunned by disappearing revenues - saw their ability to issue commercial paper vanish (and those interest rates spiked), the Fed said it would enact several bond-buying measures to keep the commercial-paper market liquid. 

Congress is now close to passing a $2 trillion stimulus plan that includes lending and grants to large corporations, hurting small businesses and households. 

Between March 4 and March 23, the S&P 500 fell 28.5%. 

Clearly, no stimulus could change the fact that businesses remain inactive as people stay home to avoid getting sick. The Fed's job was to ease financial conditions so that hiring and investment could resume after the virus passes. 

But Wall Street has to keep watching the virus, which is likely putting the U.S. into recession for at least as long as the virus will last. 

Stocks began turning to the upside as sentiment eased and investors recognized that the government is keeping people, small businesses and large corporations liquid while the virus spreads. 

And on Thursday stocks shot up - the Dow Jones Industrial Average rose 5% - as several sources, both macro and in the biotech space, cited indications that the spread of the virus could soon slow

Still, the government must get cash to people and businesses quickly. Weekly jobless claims were a record 3.2 million, or roughly 1% of the U.S. population. 

And the cost of corporate borrowing must come down quickly to avoid further deterioration in short-term liquidity, layoffs and investment.

The Fed's purchase of treasuries has ben aimed at lowering yields, making riskier corporate bonds more attractive, driving money into those assets, bringing the yields down a bit. 

Recently, some on Wall Street have begun to see evidence that that is working, but most agree the Fed may have to do more. 

High-yield-credit spreads, for example, are still 10%. That means the interest rate on high yield corporate bonds is almost 10 percentage points higher than that of the 10-year Treasury, which is just below 1% currently. Historically, the spread sits at around 5%. 

Here are some things the Fed could do soon. 

Buy Riskier Debt

"The Fed is essentially saying that they're going to backstop corporate markets," Steve Friedman, senior macroeconomist at Mackay Shields Global Fixed-Income's Team and staff member of the Federal Reserve during the 2008 financial crisis, told TheStreet. 

"They'll be involved in the investment-grade market. There's some chance that they could expand that into the high-yield market." 

While the Fed is currently not permitted to enter markets for risk assets, it may ask Congress for permission to do so. 

"There are several things that the Fed is not specifically permitted to do currently, such as buy risk assets," Lauren Goodwin, economist and multiasset portfolio strategist at New York Life Investments, told TheStreet. "However, rules can change. These restrictions could be lifted to bridge a severe circumstance that we’re facing."

The strategist team at Unigestion Assert Management, which recently had roughly $23 billion under management, went a step further, as far as risk assets are concerned. 

"In order to mitigate these concerns, a new type of `helicopter money' intervention would be necessary in our view: a revised version of TARP [troubled asset relief program] that would buy all assets including equities, ETFs and corporate high yield," the firm said.

TARP was enacted after the 2008 financial crisis. The government extended both debt and equity financing to large corporations, centered on distressed banks and financial institutions. That was just under a $500 billion program. 

The virus crisis, though, is not self-inflected. Rather, it is a health crisis, one that is here indefinitely and the government has already spent trillions.

Finance $2 Trillion of Fiscal Spending

The government has to finance this spend.  

Some observers have expressed concern about the budget deficit. Others have said the government will print money, running the risk of inflation. The Federal Reserve may have no problem with the latter prospect, as inflation has been muted since the financial crisis of 2008. 

For now, the Treasury needs to keep its borrowing costs low. 

"We're going to see a large increase in Treasury borrowing," Friedman said. "The Treasury wants to see that happen at as low a cost as possible." 

So the Treasury will issue more debt, pressuring prices on safe bonds, which is a negative for rates. But the Fed will maintain its massive bond-buying program to keep rates low.  

Speed Up Lending

The Fed also wants to get its lending facilities of all sorts up and running. Not all facilities have begun. The Fed lends through a special-purpose vehicle, essentially an emergency direct lending fund. 

One concern Wall Street has is that money isn't getting into pockets and bank accounts fast enough. 

As for stocks, investors still demand a risk premium over the 10-year Treasury of 5.6%, as prices have risen of late. That's still above the historical long-term average of 3%, but below the 7% it was at last week. 

The trillion-dollar question: When will the virus go away? 

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