This week, Treasury Secretary Steven Mnuchin and Fed Chair Jerome Powell testified before the Senate Banking Committee and the House Financial Services Committee on the quarterly CARES Act report to Congress. The hearings featured a number of questions about their public split on whether to extend a number of lending facilities beyond the end of the year, with Mnuchin defending his decision to end the facilities and Powell explaining that his opposition stemmed from not wanting to send a signal that the Fed is stepping back from supporting the economy. In both hearings, Powell echoed previous statements that although the economy has been more resilient than expected, many job losses have not been recovered and the path to full recovery is still uncertain. He also reiterated concerns that the pandemic is making economic inequality worse and that “the risk of overdoing it is less than the risk of undergoing it” when it comes to stimulus.
Elsewhere on the Hill, a number of bipartisan Senators made progress on a new stimulus deal. Senators Manchin (D-WV), Romney (R-UT), Collins (R-ME), Murkowski (R-VA) and Warner (D-VA) negotiated a $908b package that has also been backed by a number of legislators from both parties. The proposal includes $160b in state and local aid, $180b in additional unemployment insurance, $288b for small businesses, $82b for schools, $45b for transportation, and temporary liability protections for businesses. Notably, the proposal does not include another round of direct checks to individuals. While there are still reportedly party divisions on liability protections for businesses and state and local funding, there has been rapid movement on suggestions for compromise such as a six month moratorium for liability protections.
Key negotiating parties have weighed in, with House Speaker Nancy Pelosi (D-CA) and McConnell having spoken yesterday and McConnell saying “compromise is within reach.” In the hearings this week, Secretary Mnuchin also said that the White House was supportive of getting to an agreement. Pelosi and McConnell have also discussed incorporating stimulus into the government funding bill that must pass by December 11.
Powell’s increasingly direct calls for more stimulus may finally be answered. Although nothing is ever guaranteed in Washington, the current stimulus proposals have more support and momentum than any other efforts since the CARES Act. With direct involvement by the key parties and rapid evolution of negotiations, this attempt at a stimulus measure could make it through, either as a standalone bill or as part of the government funding bill. While it will not include everything on Democrats’ wish lists and could come at a higher price tag than some Republicans are comfortable with, a year-end measure would provide crucial support to many hard-hit areas of the country and economy.
This week, President Joe Biden named a number of economic appointees, including former Fed Chair Janet Yellen as Treasury Secretary, Wally Adeyemo as Deputy Treasury Secretary, Cecilia Rouse as chair of the Council of Economic Advisers (CEA), Jared Bernstein and Heather Boushey as CEA members, and Brian Deese to lead the National Economic Council (NEC). In addition to Yellen’s prominent role as Fed Chair, each of the nominees previously served in the Obama Administration with Rouse as a member of the CEA, Adeyamo as Deputy National Security Advisor and Deputy NEC Director, Deese as Deputy OMB Director and Deputy NEC Director, and Bernstein and Boushey as economic advisors to then Vice President Biden.
In remarks introducing Deese, Biden discussed the necessity of weaving climate solutions into economic policy and referred to him as an expert with the ability to do so. In her speech, Yellen remarked on stagnant wages and racial disparities as well as the urgent need for additional stimulus. Other appointees’ comments had similar themes of focusing on a fair economy and ensuring that the recovery reaches everyone.
Biden’s economic appointments come with little surprise or expectation for substantial divergence from Obama-era policies. The nominees’ backgrounds and comments indicate that income inequality will be a key consideration for economic policy under the Biden Administration. In addition, Biden’s selection of Deese for the NEC along with his naming John Kerry as a climate envoy on the National Security Council suggests that at a minimum there will be serious study of economic solutions for climate change if not new requirements for businesses and financial institutions. Biden’s choice of Yellen for Treasury has received praise from across the political spectrum, recognizing her as a steady and deeply experienced hand to support the economic recovery and continued market functioning. We expect her to work closely with Fed Chair Powell and the rest of the executive branch economic team to do all they can to return the economy to pre-pandemic stature and then focus on bridging wage and wealth inequality.
Today, ICE Benchmark Administration (IBA), LIBOR’s administrator, issued a consultation on its intention to cease the publication of GBP, EUR, JPY and CHF LIBOR, as well as one-week and two-month tenors of USD LIBOR after December 31, 2021. The production of all remaining tenors of USD LIBOR is scheduled to end after June 30, 2023. Comments are due by January 25.
After ICE had announced its plans earlier in the week, the Fed, OCC and FDIC voiced their support for a clear cessation date and encouraged banks to stop entering into new USD LIBOR transactions – with limited exceptions for market making or hedging purposes – as soon as possible, but in any event by December 31, 2021. The agencies also warned banks that they would examine their practices in light of potential safety and soundness concerns about new USD LIBOR contracts.
The Financial Conduct Authority (FCA), IBA’s primary regulator, issued a similar statement of support, welcoming the prospects of a clear end date to the USD LIBOR panel. It too suggested that it would consider limiting the use of USD LIBOR for FCA-supervised firms after 2021. On Friday, both the International Swaps and Derivatives Association (ISDA) and the Alternative Reference Rates Committee (ARRC) provided additional commentary on this week’s announcements. ISDA published a webinar featuring representation from the FCA, Fed and the ARRC. The ARRC itself published a guide summarizing the key implications for the future of USD LIBOR, reiterating that its recommended best practices and target dates remain consistent with the US interagency guidance and of critical importance to market participants as the transition from LIBOR continues.
The final act of LIBOR’s demise has begun. Following the FCA’s 2017 announcement that it had secured an agreement with panel banks to submit to LIBOR until the end of 2021, regulators have warned financial institutions that the publication of LIBOR beyond that date could not be guaranteed. LIBOR is now about to have a definitive expiration date - for the first time.
Some are mischaracterizing IBA’s June 30, 2023 target date as an extension, given that transition plans and guidance had until now been calibrated for a possible cessation of LIBOR after the end of 2021. The 18 months between January 2021 and June 2023 will be anything but business as usual considering that the Fed, OCC and FDIC will likely hold steadfast on their expectation that banks cease transactions in new products tied to USD LIBOR after 2021. Hence, banks should continue full steam ahead in their efforts to bring to market new products based on alternative reference rates as well as upgrade their models, systems and processes to establish capabilities to transact in risk-free rates.
There are significant operational and legal risks associated with the large number of legacy LIBOR-based exposures without any contractual provisions that contemplate LIBOR’s permanent cessation. The later-than-anticipated proposed cessation date would allow some of these contracts to mature prior to LIBOR’s cessation, while affording market participants extra time to remediate longer-dated contracts where possible. That additional time, however, may come at an economic cost. The restrictions on new LIBOR based products after 2021 will undoubtedly have adverse liquidity impacts on instruments indexed to USD LIBOR, including interest rate swaps and other instruments used to manage interest rate risks on existing transactions. With liquidity in hedging instruments possibly reduced to a fraction of today’s levels, hedging and risk management of USD LIBOR exposures might become a rather costly affair.
Those that do not participate in forthcoming consultations are effectively declining to have a voice in addressing the remaining open questions. Whatever questions remain, “wait and see” shouldn’t be the answer to any of them.
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Yesterday, the Financial Stability Oversight Council (FSOC) released its 2020 annual report. This year’s report focuses on the impact of the pandemic on the financial system and the economy. It provides an overview of the overall stresses and policy response as well as recommends a series of next steps for regulators and market participants. Specifically, it recommends that regulators review short-term funding markets, including money market funds (MMFs), in light of the significant outflows this sector experienced in the early stages of the crisis and take appropriate action to mitigate vulnerabilities. It also recommends that regulators consider whether action is needed to address vulnerabilities in investment funds, including redemption risk in open-end funds and risks associated with leverage. Other recommendations include examining the role hedge funds and mortgage real estate investment trusts play in the repo market, monitoring the levels of nonfinancial business leverage, and encouraging firms to strengthen their capital and liquidity buffers commensurate with the levels of commercial real estate concentration on their balance sheets.
The report also highlights a number of issues unrelated to the pandemic, echoing familiar themes from the reports over the last several years including risks associated with cybersecurity, the LIBOR transition, the growth of fintechs and cryptocurrency.
The FSOC report’s focus on vulnerabilities revealed by the crisis - including certain aspects of MMFs and open-end funds - echoes many concerns highlighted in the recent FSB report, reflecting a clear consensus among US and international regulators that work needs to be done. Like the FSB report, the FSOC report stops short of including any specific policy suggestions but instead calls for regulators to review the highlighted vulnerabilities for future policy consideration. While it may be some time before we know what specific policy proposals are in store, suggestions from market participants have included new liquidity requirements with a focus on countercyclicality, measures to promote the universal availability of swing pricing, and the expansion of the use of central clearing in the Treasury market. Meanwhile, the non-pandemic-related risks outlined in the report notably leave out any mention of climate change or inequality. As this report will be the last led by current Treasury Secretary Steven Mnuchin, it is likely that these themes will play a bigger role in future reports under Janet Yellen.
These notable developments hit our radar over the past week: