An End to the Fed’s Interventionist Role?

Thursday’s CPI 7.7% report hinted at some slowing of inflationary pressures. Stock and bond markets had a huge party celebrating the release but none of it matters until Fed Chairman Jerome Powell offers his take on the situation and what it means for downstream policy. Overall, markets remain challenging. New issue transactions are getting done in both the public and private markets but at higher levels and with different—more challenging—levels of investor engagement.

SIFMA reset this week at 2.19%, which is approximately 57% of 1-Month LIBOR and represents a -5 basis point adjustment versus the October 26, 2022, reset.

Resource Positioning and Changing Fed Policy

A central thesis over the past two years has been that each healthcare organization is a portfolio of operating, credit, and investment resources in which every isolated action—from performance improvement to merger or partnership to debt financing to asset allocation—combines to reposition the total portfolio in ways that define the enterprise’s ability to independently advance its mission. Integrated resource management needs to be a hallmark of your organization—silos are dangerous.

One of the ingredients to effective resource management is having a point of view—one that captures both the specifics of component resources but also how things knit together to move your portfolio to the right point on the return versus resiliency continuum. This is always a dynamic process that must respond to changing internal and external factors, and for healthcare providers the job has never been more complicated, more nuanced, or more fluid.

Earlier this week I was asked to share my point of view about the capital structure impact and actions embedded in three market scenarios:

1. Interest rates continue to increase
2. Inflation remains high or potentially settles at 4.0%
3. A deep recession occurs in calendar 2023

For each scenario, my first thought was what Fed policy might correspond to the situation; my second thought was how investors would respond to that Fed policy; and my last thought was how investors might respond to the potential economic environment itself. What comes through is a baseline point of view that everything keys off the Fed. This is logical, from either a backward- or forward-looking perspective; if inflation is a monetary phenomenon that isn’t yet under control, then it makes sense that the Fed is going to drive the bus. But there is another thread worth considering, which is whether the Fed’s playbook is changing and, if so, what that might mean.

The Fed reached superstar status by transforming itself from being an influencer (via the Fed Funds Rate) to being an interventionist (via Quantitative Easing). The below graph tracks 30-year investment grade corporate funding rates during the Fed’s transformation; between June 2009 and year-end 2021, Bloomberg’s 30Y generic Investment Grade corporate rate fell 370 basis points from 6.76% to 3.06% (with a low of 2.48% during those 12+ years). While the Fed Funds rate was near zero for much of this stretch, this 30Y yield reset would never have happened without the Fed expanding its balance sheet from a little over $2.0 trillion to $8.8 trillion. While the most tangible result of the Fed as interventionist was low benchmark rates, the powerful corollary was the transformation of credit markets into rates markets—liquidity exploded, credit access exploded, and spreads tightened materially across and between rating cohorts.

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One of the interesting post-inflation outcomes may be the Fed migrating back into an influencer only role. In an inflation construct, the interventionist lever would take the form of a more aggressive liquidation of the Fed’s balance sheet, which would likely be highly disruptive and only used if their influencer efforts prove ineffective. The Fed is aggressively pushing its influencer buttons now, and the response is higher benchmark rates (although maybe not as much as the Fed would want), wider credit spreads, and investors even choosing not to participate in certain transactions because of credit. To a lot of people this feels new and uncomfortable, to others this is just a place we haven’t seen for a long time, and for everyone the question is what comes after inflation moderates—what will be the “new normal” for both markets and the Fed?

Unless there is some new liquidity crisis—and a recession is not a liquidity crisis—it doesn’t seem likely that the Fed could tame inflation and then reintroduce quantitative easing without losing credibility. Put differently, it seems like we’re off the Red Bull and Cocoa Puffs monetary diet. If correct, this could have huge downstream implications. The Fed monetized major amounts of federal spending, so a no quantitative easing scenario means markets alone would determine the clearing rate for financing U.S. deficits. The Fed was a major buyer of mortgage-backed securities, so a no quantitative easing scenario means markets alone would determine mortgage debt access and pricing.

The important leap here is saying “markets alone would determine.” This is a 180-degree shift from the construct that was in place for much of the time from 2008 until inflation wrecked the party, and the impact will ripple across hospital financing and investing activities; but it may very well bleed into operations, especially the part about markets having to absorb the full amount of U.S. budget deficits. On January 1, 2008, the Fed’s balance sheet was $0.875 trillion; it reached a peak of $8.965 trillion in April of 2022—that is approximately $8.1 trillion of mostly federal debt that global markets will have to absorb. Unless supply collapses, it’s hard to think that removing all that liquidity will support 3.06% 30-year corporate debt, but it also seems logical that it may not facilitate continued super-sized U.S. deficits—which escalates the probability of higher taxes or declining spending or both.

The Fed’s transition from interventionist back to influencer will impact every corner of the modern healthcare enterprise and should be on the list as you reassess post-inflation resource positioning.