The vast and currently dysfunctional markets for US Treasuries, mortgages and corporate credit now have the ultimate buyer of last resort – the Federal Reserve.
Since the major stock market crash of 1987, investors have become dependent on the US central bank’s decision to help the financial markets when they went wrong. Now, the central bank is indeed “all in”, announcing a series of new initiatives on Monday aimed at saving time for a weakened financial system. So far, the Fed has suggested that the system has been unable to withstand a growing pandemic that has made the U.S. economy the most affected by growth since the 1930s.
Having not eased the nerves in the past week with the expansion of its quantitative easing program, the Fed has increased the bet Buzz Lightning territory. QE infinity, in the form of unlimited purchases of treasury and mortgage-backed securities, is only one aspect of the new approach.
Another notable measure is the entry of the Fed into the world of investment grade credit, the central bank launching a facility that will allow the purchase of debts of companies already sold with a maturity of less than five years, as well as transactions on the stock market funds that follow the sector. Yet another facility will support new sales of bonds and corporate loans with high-quality credit ratings. One way to look at this is to note that the Fed has joined the Bank of Japan, the European Central Bank and the Bank of England to support the credit markets. Seen from another angle, it complicates any future exit strategy and extends Lehman’s long post-crisis legacy of distorted risk premiums on the markets.
But this may not be the time to quibble about the legacy when the pandemic is raging. The Fed’s purchase of corporate debt is aimed at preventing a deeper and prolonged collapse in the face of an economy that has been placed in suspended animation. A highly indebted US business sector, fueled by Fed policy objectives since the last crisis, is deprived of earnings and cash flow growth for an indefinite period. It is led by companies active in the travel, leisure, restaurant and retail sectors, and opens the way to a deepening of the current macroeconomic shock.
Credit risk premiums have widened significantly in recent weeks, catching up with many investors, while preventing lower quality borrowers from refinancing their maturing debts in the form of commercial paper and corporate bonds. The losses of many fund managers are increasing, while exchange traded funds have become very volatile and dysfunctional. In the US treasury market, meanwhile, when liquidity dries up, business credit conditions become even more tense, intensifying an inflammatory sales environment as investors rush for exits and seek to cash in. all cost.
An aggressive expansion of QE by the Fed has emerged since the market turmoil erupted just over a month ago. Some have long argued that unlimited quantitative easing was a likely final step, after policy appeared to become a permanent feature of the Fed’s toolbox following the financial crisis.
The policy of suppressing long-term treasury bill yields – and by extension, broader market volatility – was billed as a temporary measure when it was introduced in 2009. However, it has remained virtually unchanged since then. Fed and other major central banks. The Fed’s efforts to raise interest rates by modest amounts and to reduce the balance sheet were halted after severe market turmoil erupted in late 2018, casting a long shadow over business and consumer confidence. A debt-filled financial system was unable to handle a slight increase in Treasury yields at the time.
Today, an even more indebted business sector faces intense pressure – until a spike in the spread of infections allows the economy to start to rebound, unlock cash flow, and increase profits to some extent. The ultra-low cost of borrowing in recent years has allowed companies to tap into credit markets to finance large share buyback programs that have benefited executives. The inability to save for a rainy day means that many businesses are now waiting for taxpayer help.
The new Fed package also means that the central bank’s balance sheet will increase significantly in size as it becomes a buyer of last resort in the fixed income markets. Investors should not expect a contraction anytime soon, given the scale of the debt frenzy since 2009.
And they should not rule out further support measures if the markets remain unfair and difficult to negotiate. While Fed intervention boosted parts of the US credit market on Monday, stocks were stifled, reflecting the other game in town – negotiations on a $ 2 billion budget response to the economic effects of the crisis sanitary.