Coronavirus Turmoil Takes Toll on Short-Term Lending - The Wall Street Journal

Fed Chairman Jerome Powell. Investors and bankers are studying options the central bank potentially could take to ease jumpy markets.

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By

Julia-Ambra Verlaine

Julia-Ambra Verlaine
The Wall Street Journal
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• julia.verlaine@wsj.com

March 8, 2020 10:33 am ET

Banks and other firms are growing cautious operating in short-term markets, a sign of the financial stress brought on by the coronavirus epidemic.

Short-term lending markets are the plumbing of the financial system, moving large volumes of cash from those who have it to those who need it. Confidence in their ability to function smoothly is integral to the performance of the wider financial system. Hiccups can lead to increased volatility and strain.

One area of recent note is the market in which firms borrow and lend cash through agreements to repurchase Treasury securities. Rates in the so-called repo market are measured against the Federal Reserve’s key short-term benchmark. Last week the difference between the two, or the spread, widened to levels not seen since November.

The repo market is where firms such as hedge funds borrow to finance their investments and money-market funds earn returns on piles of cash. It also supports bank operations that include extending near-term loans to corporate clients.

At the same time, a measure of the premium investors will pay for U.S. dollars—known as the cross-currency basis—increased for the first time in years. Traders and salespeople at Barclays PLC, UBS Group AG and Morgan Stanley said such a move usually reflects a shortage of dollars available, a circumstance that was last acute when a sovereign-debt crisis gripped Europe in 2011.

“Dollar funding is always the orphaned child of crises as the regions where the pressures flare up have no control over it,” said Credit Suisse Group AG analyst Zoltan Pozsar. Investors often use U.S. dollars to fund foreign investments.

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Additionally, traders at large asset-management firms said they are having more trouble trading a variety of financial instruments, from corporate bonds to derivatives. One said the difference between what buyers wanted to pay and what sellers were willing to receive for investment-grade bonds is widening, with banks less willing to take on risk. Some are even beginning to “fade” trades—industry parlance for backpedaling from agreed-upon deals.

The pain is also being felt in the Treasury market, where high-frequency trading algorithms have pulled back as volatility increased. According to Priya Misra, head of rates strategy at TD Securities, liquidity in the Treasury market is bifurcated and stressed because of this phenomenon.

“When volatility picks up, the high-frequency traders step away,” said Ms. Misra. “It’s not a deep market."

Investors and bankers are concerned enough that they are studying options the Fed could take to ease jumpy markets that go beyond rate cuts. Many traders believe such cuts are an inadequate tool to fix a problem rooted in short-term supply chain shocks that could leave companies short of cash to make payments on debt and other obligations.

“During the financial crisis, the Fed didn’t employ the same cookie-cutter responses that central banks in the 1980s used,” said Rick Rieder, chief investment officer of global fixed-income at BlackRock Inc. “The market will react to innovative ideas that are targeted at stabilizing the near-term problem.”

Mr. Rieder said the Fed could purchase longer-dated assets as it did in some post-financial-crisis operations, or buy municipal bonds, mortgages, and other unconventional assets.

“I don’t think they need to execute that sort of option today, but overall the Fed has tremendous leeway to operate in,” he said.

Such possibilities aren’t just idle trader talk. Federal Reserve Bank of Boston President Eric Rosengren said Friday that to provide stimulus, the Fed may need the power to buy a broader array of bonds beyond Treasurys and mortgage-backed securities.

Operational risks posed by the coronavirus are an additional source of worry. Banks and investment firms could be forced to close central trading hubs and scatter employees to remote locations, some of which hadn’t been tested for some time until last week.

If financial institutions begin implementing contingency plans that make trading more difficult because traders are working remotely or from multiple backup locations, “the possibility for some kind of operational slowdown or malfunction gets high,” said Nellie Liang, a former senior Fed economist who is now at the Brookings Institution.

Some smaller broker-dealers already are extending overnight repo trades into the future, as evidenced by an esoteric measure called the general collateral term structure. This is presumably to reduce risks associated with large dealers asking employees to work elsewhere, said Josh Younger, head of interest rate derivatives strategy at JPMorgan Chase & Co.

Banks spent the past week ratcheting up plans to prevent the coronavirus from rapidly spreading among employees. Morgan Stanley, UBS and JPMorgan are among banks splitting global markets workforces into groups working out of locations spanning from Stamford, Conn., to Edison, N.J.,—or remotely from home.

At Goldman Sachs Group Inc., a group of traders would remain in the firm’s downtown Manhattan headquarters—but scattered between empty desks to avoid contamination—while others would move to remote locations, a person familiar with the matter said.

—Matt Wirz contributed to this article.

Write to Julia-Ambra Verlaine at Julia.Verlaine@wsj.com

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