Credit Markets Stabilizing After Fed Intervention

Credit Markets Stabilizing After Fed Intervention

Issue 13

04.06.20 - Key parts of the U.S. debt markets are functioning again, a sign the Federal Reserve’s extraordinary steps are easing a credit market crunch.

Investors say the Fed has reduced disruptions in the $17 trillion U.S. Treasurys market that had sent shock waves through the financial system. Large businesses such as Oracle Corp. and CVS Health Corp. CVS +1.67% are borrowing money at a breakneck pace.

Some lower-rated companies are beginning to issue bonds again. And increased demand for mortgage bonds is starting to pull mortgage rates lower after they rose last month.

Debt markets continue remain far shakier than they were about a month ago. Most new bond sales are still coming from well-established companies with higher credit ratings, reflecting a consensus that the coronavirus crisis will likely push the economy into a deep recession. Liquidity, or the ease with which investors can buy and sell securities at what they think are market prices, remains poor in some riskier corners of the market. Some worry conditions could quickly deteriorate again, if the economic outlook darkens further.

Still, investors and analysts say the Fed’s historic interventions have spurred a meaningful reduction in market stress. Those include announcing plans to buy unlimited amounts of government bonds and mortgage securities issued by government-supported entities and starting new programs to buy higher-rated corporate bonds. The Fed doesn’t even need to follow through on this announcement, the announcement alone was a strong enough signal to bolster market confidence.

“The liquidity side is being fixed,” said Michael Collins, a senior portfolio manager at PGIM Fixed Income.

Investors said the Fed’s main goal remains simple: to hold down borrowing costs across the economy, so individuals, businesses and communities are encouraged to borrow and spend money. But that has proved challenging in recent weeks, pushing the central bank to take ever-more-aggressive and creative actions.
Shortly after the central bank reduced the key interest rate it controls to near zero on March 15, yields on longer-term U.S. Treasurys shot upward, with the 10-year yield climbing to 1.259% from 0.5% the previous week. The extra yield, or spread, investors demand to hold ultrasafe mortgage bonds over Treasurys jumped to around 1.75 percentage points, according to Tradeweb. That is compared with 1.52 percentage points just before the rate cut and less than 0.3 percentage point a week earlier.

In both cases, investors said the moves were fueled by money managers rushing to raise cash by selling what they could: ultrasafe debt. That contributed to deteriorating liquidity, as dealers demanded more compensation to stand in the middle of trades.

One measure of the Fed’s recent success is that the 10-year Treasury yield has fallen back to 0.587%, as of Friday’s close. Another is that average mortgage spreads are back down to around 1 percentage point. Put together, the moves should push down mortgage rates and hand more money to homeowners who refinance their mortgages.

Source: Wall Street Journal