Wells Fargo Research Team
Wells Fargo
Executive Summary
Last night, the U.S. Senate passed a landmark fiscal bill designed to keep the U.S. economy afloat amid the drastic measures taken to combat COVID-19. The vote was unanimous, a testament to the severity of the public health and economic crisis facing the country. If the House of Representatives can also manage to swing a unanimous vote, then passage of the bill should be swift, likely within a day or so. If the members have to be called back to Washington D.C. for a full vote, however, the bill may not pass until early next week. Regardless, we expect final passage in the near future, and for the president to quickly sign it into law once it is through Congress.
The United States economy is facing an unprecedented shutdown of economic activity, but this slowdown is being met with unprecedented monetary and fiscal stimulus, both in terms of size and speed. Although we do not yet have an official score from the Congressional Budget Office, the bill currently working its way through Congress appears to be about $2 trillion in size, or roughly 9% of U.S. GDP. But, even this may understate the true size of the package. Our understanding is that roughly $454 billion of that money will be used as an equity infusion into a Federal Reserve 13(3) emergency lending program designed to lend directly to ‘Main Street', e.g. businesses, states and municipal governments. Assuming the Fed uses the equity to lever up about ten times, that would generate more than $4 trillion in lending power, bringing the potential total size of the package up to a stunning $6 trillion.
In this report, we first walk through a summary of some of the key parts of the bill. Then, we analyze what we think it means for the U.S. economy and the federal budget deficit. In short, the passage of this fiscal stimulus bill gives us reasonable confidence that another Great Depression is not in the cards, and that a healthy bounce back in economic growth will occur starting this fall. But, even these extraordinary measures can only do so much, and in our view the economic contraction in the months ahead will still be quite severe. This is not to say the policies are ill-designed, but rather that until the COVID-19 outbreak is in check, fiscal and monetary policymakers are just buying time until the economy can begin to operate normally again. Our latest federal budget deficit forecasts for FY 2020 and FY 2021 are $2.4 trillion and $1.7 trillion, respectively. If realized, the FY 2020 federal budget deficit would be the biggest deficit as a share of the economy since World War II.
Household Policies
On the household front, the cornerstone policy is a plan to send checks directly to individuals. The cash payments would be $1,200 for individuals making $75,000 or less and $2,400 for couples making $150,000 or less, plus a $500 per child bonus. The payments are slowly phased out past those income levels, with rebates not available above the $99k/$198k threshold for single and married filers, respectively. Ultimately, eligibility will be determined by a taxpayer's 2020 income. But, since this is not yet known, the government will use 2019 tax data, and where this is not available, 2018 tax data. In total, these rebates would cost roughly $300 billion. Paired with this would be a boost to unemployment benefits so that payments are larger (an extra $600 per week for four months), more expansive (e.g. it would include furloughed workers) and can be collected for longer (thirteen weeks past when state unemployment benefits run out). Although more uncertain, this segment of the bill could end up costing another $200-$300 billion.
The bill pushes the tax filing deadline of April 15 back to July 15, and waives the 10-percent early withdrawal penalty for distributions up to $100,000 from qualified retirement accounts for coronavirus-related purposes. Income attributable to such distributions would be subject to tax over three years. The bill also waives required minimum distribution rules for certain defined contribution plans and IRAs for calendar year 2020.
Small Business Policies
At a high level, the small business relief in the bill attempts to make Small Business Administration (SBA) loans available to businesses in a way that, if the money is used for certain purposes, such as keeping workers on the payroll or making mortgage payments, the loans will eventually be forgiven. Specifically, the bill contains $350 billion to provide cash-flow assistance through 100 percent federally guaranteed loans to employers who maintain their payroll during this emergency. If employers maintain their payroll, the loans would be forgiven, which would help workers remain employed and affected small businesses quickly snap-back after the crisis. Businesses with 500 employees or fewer will be eligible to apply for the loans, unless the applicable size standard for the industry as provided by SBA is higher. The size of the loans would be tied to an applicant's average monthly payroll, mortgage/rent, utility payments and other debt obligations over the previous year. The maximum loan amount would be $10 million.
Corporate Policies/Federal Reserve Lending Facility
Generally speaking, the rescue package for larger corporations takes the form of more traditional loans. The bill contains $500 billion for such measures, with $46 billion directed specifically at three industries: passenger air carriers ($25 billion), cargo air carriers ($4 billion) and $17 billion for "businesses important to maintaining national security". The remaining $454 billion would be "for loans, loan guarantees, and investments in support of the Federal Reserve's lending facilities to eligible businesses, states, and municipalities."
Our understanding is that this $454 billion would be used as an equity infusion into a Federal Reserve 13(3) lending facility designed to lend directly to businesses and other non-bank entities. Critically, when the Federal Reserve sets up these 13(3) lending programs, it typically takes an equity infusion from the federal government (often from the Exchange Stabilization Fund) and then uses that equity cushion to lever up. Based off of other 13(3) lending programs, as well as comments from lawmakers over the past few days, we believe that the Federal Reserve would take this money and generate more than $4 trillion in direct lending power.
The bill also relaxes the limitations on a company's use of losses to improve cash flow and liquidity. Net operating losses (NOL) were limited as part of the Tax Cuts and Jobs Act, and at present they cannot be carried back to reduce income in a prior tax year. The bill provides that a net operating loss arising in 2018, 2019, or 2020 can be carried back five years. The bill also temporarily removes the taxable income limitation to allow an NOL to fully offset income. In addition, the bill would temporarily increase the amount of interest expense businesses are allowed to deduct on their tax returns, by increasing the 30-percent limitation to 50 percent of EBITDA for 2019 and 2020.
Miscellaneous Policies
While far from an exhaustive list, below are a few more key items included in the bill.
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Suspend federal student loan payments for six months, with no accruing interest.
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Allow businesses to defer payments of the employer side of the Social Security payroll tax.
The deferred employment tax would be paid over the following two years, with half of the amount required to be paid by December 31, 2021 and the other half by December 31, 2022. -
Give depository institutions the option to temporarily delay measuring credit losses on financial instruments using the new Current Expected Credit Losses (CECL) accounting standard.
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Authorize a slew of supplemental appropriations for federal agencies/programs, hospitals, and state and local governments, among others.
This portion of the bill contains roughly $340 billion in funding, including $117 billion for hospitals and veterans' health care, $45 billion for the federal emergency management administration (FEMA), $30 billion for K-12 and higher education, $25 billion for public transportation emergency relief and $25 billion for child nutrition and the supplemental nutrition assistance program (SNAP).
What Does This All Mean?
The traditional Keynesian stimulus solution to an economic slowdown is for fiscal stimulus to boost aggregate demand. For example, increasing infrastructure spending creates jobs for individuals who can then take their newfound income and spend it on a variety of goods and services, thus boosting aggregate demand in the economy. While this is the goal of this bill to some extent, the current slowdown is unique in nature. Several segments of the economy are shut down, and huge swaths of the U.S. population are confined to their homes, making increased consumption and investment nearly impossible in some sectors. Thus, this fiscal package is designed to achieve a somewhat different goal: keep households, businesses and municipalities liquid and solvent through a temporary, though severe, crunch so that the economy can bounce back strongly on the other side of the virus outbreak.
To that end, this bill should help plug some of the sizable hole in lost income that is developing as a result of measures taken to stem the spread of COVID-19. As we discussed in a recent research note, total U.S. income is approximately $900 billion per month, and the combination of direct checks to households, expanded unemployment benefits, grants/loans to various levels of government and generous loans to U.S. companies should help ease what is likely to be a significant decline in U.S. total income. This in turn should help many households and businesses remain current on their financial obligations for the next couple months.
But, this fiscal stimulus is not a panacea. The household measures should help for a time, but the longer the COIVD-19 shutdown is in effect, the less these temporary boosts to personal income will be able to keep households afloat. And while in principal the small and large business lending programs should provide much needed liquidity and solvency, the usual lag in policy implementation, combined with the untested nature of these programs, raise questions about their ultimate efficacy in a period of rapid economic change. This is not to say the policies are illdesigned, but rather that until the COVID-19 outbreak is in check, fiscal and monetary policymakers are just buying time rather than solving the true underlying problems. In sum, the passage of this bill gives us reasonable confidence that another Great Depression is not in the cards. That said, the economic contraction in the months ahead will still be quite severe, in our view (Figures 1 & 2).
Source: U.S. Department of Commerce and Wells Fargo Securities
At $2 trillion, the bill that appears likely to become law would be about 9% of GDP, nearly double the size of the stimulus passed in February 2009 during the Great Recession. While we do not have a score yet from the Congressional Budget Office, the actual deficit impact will likely not be quite as big, as some of this $2 trillion are loans that will be paid back over time. Still, from a near term standpoint, the deficit and net Treasury issuance are set to explode. Our latest federal budget deficit forecasts for FY 2020 and FY 2021 are $2.4 trillion and $1.7 trillion, respectively. Relative to our forecast back in early February, these estimates are up from $1.05 trillion for FY 2020 and $1.1 trillion for FY 2021.
Should our latest forecasts prove correct, this would amount to federal budget deficits as a share of GDP of 11.2% in FY 2020 and 7.9% in FY 2021 (Figure 3). If realized, the FY 2020 federal budget deficit would be the biggest deficit as a share of the economy since World War II, when budget deficits were 25-30% of GDP at their peak (Figure 4). We will be updating our net Treasury issuance projections in an upcoming report, but as our readers can imagine, issuance will need to surge across the entire curve to meet this financing demand. Fortunately, the Federal Reserve's openended quantitative easing commitment should ease some of the pressures on private investors to take down this supply. Still, the increase in gross coupon auctions across the curve are likely to be shocking in size.
Source: U.S. Department of the Treasury, Office of Management and Budget and Wells Fargo Securities
Recently, the stock market has experienced high levels of volatility. If you are thinking about participating in fast moving markets, please take the time to read the information below. Wells Fargo Investments, LLC will not be restricting trading on fast moving securities, but you should understand that there can be significant additional risks to trading in a fast market. We've tried to outline the issues so you can better understand the potential risks. If you're unsure about the risks of a fast market and how they may affect a particular trade you've considering, you may want to place your trade through a phone agent at 1-800-TRADERS. The agent can explain the difference between market and limit orders and answer any questions you may have about trading in volatile markets. Higher Margin Maintenance Requirements on Volatile Issues The wide swings in intra-day trading have also necessitated higher margin maintenance requirements for certain stocks, specifically Internet, e-commerce and high-tech issues. Due to their high volatility, some of these stocks will have an initial and a maintenance requirement of up to 70%. Stocks are added to this list daily based on market conditions. Please call 1-800-TRADERS to check whether a particular stock has a higher margin maintenance requirement. Please note: this higher margin requirement applies to both new purchases and current holdings. A change in the margin requirement for a current holding may result in a margin maintenance call on your account. Fast Markets A fast market is characterized by heavy trading and highly volatile prices. These markets are often the result of an imbalance of trade orders, for example: all "buys" and no "sells." Many kinds of events can trigger a fast market, for example a highly anticipated Initial Public Offering (IPO), an important company news announcement or an analyst recommendation. Remember, fast market conditions can affect your trades regardless of whether they are placed with an agent, over the internet or on a touch tone telephone system. In Fast Markets service response and account access times may vary due to market conditions, systems performance, and other factors. Potential Risks in a Fast Market "Real-time" Price Quotes May Not be Accurate Prices and trades move so quickly in a fast market that there can be significant price differences between the quotes you receive one moment and the next. Even "real-time quotes" can be far behind what is currently happening in the market. The size of a quote, meaning the number of shares available at a particular price, may change just as quickly. A real-time quote for a fast moving stock may be more indicative of what has already occurred in the market rather than the price you will receive. Your Execution Price and Orders Ahead In a fast market, orders are submitted to market makers and specialists at such a rapid pace, that a backlog builds up which can create significant delays. Market makers may execute orders manually or reduce size guarantees during periods of volatility. When you place a market order, your order is executed on a first-come first-serve basis. This means if there are orders ahead of yours, those orders will be executed first. The execution of orders ahead of yours can significantly affect your execution price. Your submitted market order cannot be changed or cancelled once the stock begins trading. Initial Public Offerings may be Volatile IPOs for some internet, e-commerce and high tech issues may be particularly volatile as they begin to trade in the secondary market. Customers should be aware that market orders for these new public companies are executed at the current market price, not the initial offering price. Market orders are executed fully and promptly, without regard to price and in a fast market this may result in an execution significantly different from the current price quoted for that security. Using a limit order can limit your risk of receiving an unexpected execution price. Large Orders in Fast Markets Large orders are often filled in smaller blocks. An order for 10,000 shares will sometimes be executed in two blocks of 5,000 shares each. In a fast market, when you place an order for 10,000 shares and the real-time market quote indicates there are 15,000 shares at 5, you would expect your order to execute at 5. In a fast market, with a backlog of orders, a real-time quote may not reflect the state of the market at the time your order is received by the market maker or specialist. Once the order is received, it is executed at the best prices available, depending on how many shares are offered at each price. Volatile markets may cause the market maker to reduce the size of guarantees. This could result in your large order being filled in unexpected smaller blocks and at significantly different prices. For example: an order for 10,000 shares could be filled as 2,500 shares at 5 and 7,500 shares at 10, even though you received a real-time quote indicating that 15,000 shares were available at 5. In this example, the market moved significantly from the time the "real-time" market quote was received and when the order was submitted. Online Trading and Duplicate Orders Because fast markets can cause significant delays in the execution of a trade, you may be tempted to cancel and resubmit your order. Please consider these delays before canceling or changing your market order, and then resubmitting it. There is a chance that your order may have already been executed, but due to delays at the exchange, not yet reported. When you cancel or change and then resubmit a market order in a fast market, you run the risk of having duplicate orders executed. Limit Orders Can Limit Risk A limit order establishes a "buy price" at the maximum you're willing to pay, or a "sell price" at the lowest you are willing to receive. Placing limit orders instead of market orders can reduce your risk of receiving an unexpected execution price. A limit order does not guarantee your order will be executed -" however, it does guarantee you will not pay a higher price than you expected. Telephone and Online Access During Volatile Markets During times of high market volatility, customers may experience delays with the Wells Fargo Online Brokerage web site or longer wait times when calling 1-800-TRADERS. It is possible that losses may be suffered due to difficulty in accessing accounts due to high internet traffic or extended wait times to speak to a telephone agent. Freeriding is Prohibited Freeriding is when you buy a security low and sell it high, during the same trading day, but use the proceeds of its sale to pay for the original purchase of the security. There is no prohibition against day trading, however you must avoid freeriding. To avoid freeriding, the funds for the original purchase of the security must come from a source other than the sale of the security. Freeriding violates Regulation T of the Federal Reserve Board concerning the extension of credit by the broker-dealer (Wells Fargo Investments, LLC) to its customers. The penalty requires that the customer's account be frozen for 90 days. Stop and Stop Limit Orders A stop is an order that becomes a market order once the security has traded through the stop price chosen. You are guaranteed to get an execution. For example, you place an order to buy at a stop of $50 which is above the current price of $45. If the price of the stock moves to or above the $50 stop price, the order becomes a market order and will execute at the current market price. Your trade will be executed above, below or at the $50 stop price. In a fast market, the execution price could be drastically different than the stop price. A "sell stop" is very similar. You own a stock with a current market price of $70 a share. You place a sell stop at $67. If the stock drops to $67 or less, the trade becomes a market order and your trade will be executed above, below or at the $67 stop price. In a fast market, the execution price could be drastically different than the stop price. A stop limit has two major differences from a stop order. With a stop limit, you are not guaranteed to get an execution. If you do get an execution on your trade, you are guaranteed to get your limit price or better. For example, you place an order to sell stock you own at a stop limit of $67. If the stock drops to $67 or less, the trade becomes a limit order and your trade will only be executed at $67 or better. Glossary All or None (AON) A stipulation of a buy or sell order which instructs the broker to either fill the whole order or don't fill it at all; but in the latter case, don't cancel it, as the broker would if the order were filled or killed. Day Order A buy or sell order that automatically expires if it is not executed during that trading session. Fill or Kill An order placed that must immediately be filled in its entirety or, if this is not possible, totally canceled. Good Til Canceled (GTC) An order to buy or sell which remains in effect until it is either executed or canceled (WellsTrade® accounts have set a limit of 60 days, after which we will automatically cancel the order). Immediate or Cancel An order condition that requires all or part of an order to be executed immediately. The part of the order that cannot be executed immediately is canceled. Limit Order An order to buy or sell a stated quantity of a security at a specified price or at a better price (higher for sales or lower for purchases). Maintenance Call A call from a broker demanding the deposit of cash or marginable securities to satisfy Regulation T requirements and/or the House Maintenance Requirement. This may happen when the customer's margin account balance falls below the minimum requirements due to market fluctuations or other activity. Margin Requirement Minimum amount that a client must deposit in the form of cash or eligible securities in a margin account as spelled out in Regulation T of the Federal Reserve Board. Reg. T requires a minimum of $2,000 or 50% of the purchase price of eligible securities bought on margin or 50% of the proceeds of short sales. Market Makers NASD member firms that buy and sell NASDAQ securities, at prices they display in NASDAQ, for their own account. There are currently over 500 firms that act as NASDAQ Market Makers. One of the major differences between the NASDAQ Stock Market and other major markets in the U.S. is NASDAQ's structure of competing Market Makers. Each Market Maker competes for customer order flow by displaying buy and sell quotations for a guaranteed number of shares. Once an order is received, the Market Maker will immediately purchase for or sell from its own inventory, or seek the other side of the trade until it is executed, often in a matter of seconds. Market Order An order to buy or sell a stated amount of a security at the best price available at the time the order is received in the trading marketplace. Specialists Specialist firms are those securities firms which hold seats on national securities exchanges and are charged with maintaining orderly markets in the securities in which they have exclusive franchises. They buy securities from investors who want to sell and sell when investors want to buy. Stop An order that becomes a market order once the security has traded through the designated stop price. Buy stops are entered above the current ask price. If the price moves to or above the stop price, the order becomes a market order and will be executed at the current market price. This price may be higher or lower than the stop price. Sell stops are entered below the current market price. If the price moves to or below the stop price, the order becomes a market order and will be executed at the current market price. Stop Limit An order that becomes a limit order once the security trades at the designated stop price. A stop limit order instructs a broker to buy or sell at a specific price or better, but only after a given stop price has been reached or passed. It is a combination of a stop order and a limit order. These articles are for information and education purposes only. You will need to evaluate the merits and risks associated with relying on any information provided. Although this article may provide information relating to approaches to investing or types of securities and investments you might buy or sell, Wells Fargo and its affiliates are not providing investment recommendations, advice, or endorsements. Data have been obtained from what are considered to be reliable sources; however, their accuracy, completeness, or reliability cannot be guaranteed. Wells Fargo makes no warranties and bears no liability for your use of this information. The information made available to you is not intended, and should not be construed as legal, tax, or investment advice, or a legal opinion.
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