This week Fed Chairman Powell set out to offer a explanation for the complicated steps he is taking to relieve dire stresses in the global financial system.
“Many places in the capital markets, which support borrowing by households and businesses. I am talking about mortgages and car loans and things like that have just stopped working,” the Fed Chairman said in a rare TV interview. “So we can step in and replace that lending under our emergency lending powers.”
His mild-mannered delivery misrepresented the historic actions underway to put out fires raging in the financial system because of the novel coronavirus pandemic.
The system is still far away from normal, and stress points remain. But, this week it became clear that the rapid response alleviated a variety of issues that threatened to worsen economic damage being inflicted by attempts to halt the spread of the virus.
If there is 1 thing I’ve learned in my 40 yrs in this business is that you do not fight the Fed. And now the Fed is the buyer that is going to buy unlimited amounts.
The Fed added more than $1-T to the system recently, with untold trillions to come. The effort underscores the main lesson policy makers learned from the Y 2008 experience: Act fast and go big.
Unlike that crisis, in which the Fed focused solely on propping up the banking system, the central bank’s support is much more widespread this time around, as almost every sector of fixed income, from Treasuries to municipal bonds to money-market mutual funds, has come under stress this month.
In the last 2 wks alone, the central bank has purchased $942-B in Treasuries and mortgage-backed securities, dwarfing its previous efforts and restoring a semblance of order to those markets. The Fed this week also provided more than $50-B in cheap loans to banks through its discount window.
Its Primary Dealer Credit Facility, which takes as collateral investment-grade corporate bonds, municipal debt and mortgage- and asset-backed securities in exchange for cash loans, provided $27.7-B as of Wednesday. Its Money Market Mutual Fund Liquidity Facility, which finances purchases of assets from US money market funds, added another $30.6-B. Borrowing by foreign central banks soared to $206-B the highest since Y 2009.
The most-obvious sign of success in easing financial stresses can be seen simply in exchange rates for the dollar itself. Intercontinental Exchange Inc.’s(NYSE:ICE) US Dollar (.DXY) Index, a measure of the US currency Vs peer counterparts, ended last week at a 3-year high in a reflection of the overwhelming global demand for dollars from corporations and investors. This week it sank 4.3%, the most since Y 1985, as the Fed’s liquidity flowed around the world.
The market for high-grade corporate bond saw a massive turnaround, especially in shorter-dated securities that the Fed has pledged to buy in essentially unlimited quantities.
Credit risk, as measured by derivatives indexes, eased nearly all week and encouraged a rush of issuance that was met with strong demand.
US investment-grade supply this week surpassed $109-B, breaking a prior record set in September. Massive investor orders helped drive down borrowing costs and secondary spreads, which compressed 71 bpts through Thursday from Monday’s highs. ETFs that buy shorter-dated bonds have also been trading better since the Fed stepped in.
The tools are in place, now you need to run the machine, time is needed for system to heal, and it is healing.
It has not happened smoothly.
The Fed’s announcement Friday afternoon that it will slow the pace at which it buys Treasuries was blamed by some for extending losses in stocks that afternoon, with the Standard & Poor’s 500 Index trimming its best weekly advance since Y 2009 to 10%. The equity benchmark is down 25% from its last record high in February.
And the Fed’s efforts are not a cure all for the system’s ills. It has had to take the US Treasury in to its organization, effectively making President Trump the de facto Fed Chairman.
The crucial US commercial paper market, which many businesses turn to for short-term funding sourced from money market funds, remains stressed. The spreads between commercial paper interest rates and overnight index swaps aka risk-free rate, are at records. A program meant to aid that market will not become operational until early of April.
“There are very encouraging signs of a thaw but we’re not quite there yet,” head of U.S. interest rates strategy at Bank of America Corp. “As soon as money funds become more comfortable on where their asset base is, then they can start spending. This is the 1st step on getting the wholesale funding market started again. We are still far from normal but a lot of the illiquidity has already come out.”
It is unclear to what extent the Fed’s efforts will help riskier areas of debt markets like high-yield bonds and leveraged loans, which the Fed is not buying. Those parts of leveraged finance could see default rates rise to 15% this year and next, according to Fitch Ratings. The biggest buyers of leveraged loans, collateralized-loan obligations, are struggling too, further delaying a recovery to the underlying asset class.
The Fed’s move to buy an unlimited amount of mortgage-backed securities with government backing has helped support that market, but the program doesn’t apply to the smaller market for private-label MBS that is not sponsored by government-linked agencies. Those bonds, which include debt issued even before the Y 2008 financial crisis, have been under pressure amid concerns that millions of borrowers could fall behind on payments as the economy grinds to a halt.
The revival of the Fed’s Term Asset-Backed Securities Loan Facility may help support the market for asset-backed securities backed by consumer debt. In that program, the Fed will purchase top-rated newly issued notes backed by debt like small business loans, credit card debt and auto loans. Risk premiums on those bonds have widened to near Y 2008 crisis levels as investors sell to meet redemptions and fret over borrowers’ ability to pay.
Investors in riskier debt products may see more of an impact from Congress’s $2-T fiscal-stimulus package that’s meant to bolster the real economy. The hope is that as governments take action and rates are slashed across the world, investors will gradually return to put money into funds that buy riskier debt. But so far, it has been consistent weeks of outflows, even in higher-quality investment-grade funds.
“You need the plumbing of the credit markets to work and the Fed has helped significantly on that front,” said co-head of Wells Fargo Asset Management’s US high yield fixed income team. “But we need a functioning economy.”
Have a healthy weekend, stay home!