Short-term corporate debt markets are “frozen,” and Wall Street strategists have called for U.S. central bankers to intervene.
The Federal Reserve used most of its monetary-policy toolkit in a comprehensive stimulus effort Sunday, cutting rates to a range of 0% to 0.25% and unveiling $700 billion of Treasury and mortgage bond purchases to combat the potential economic fallout from the coronavirus pandemic.
But Wall Street seems to have doubts about the efficacy of the central bank’s attempted shock-and-awe stimulus. S&P 500 futures fell the maximum 5% at the open of overnight trading.
A closer look at markets’ response to previous Fed rate cuts shows there is good reason for investors’ concern.
For the highest-rated companies, the Fed’s prior rate cuts reduced short-term interest costs significantly. But even with the Fed’s surprise March 3 cuts and last week’s interventions, borrowing became far pricier last week for companies rated just one notch below that. Interest rates have soared on those companies’ three-month cash loans, climbing to nearly 2.5% on March 12 from 1.4% on March 6, according to Fed data.
That prompted Bank of America strategists to call on the Fed to expand its stimulus efforts to create a facility to help “liquefy” the market for commercial paper, where companies borrow from money-market funds and other institutional investors short term, mostly for one to 90 days.
Here’s what is causing the commercial-paper crunch: Companies know they will need cash to keep operating while Americans halt travel, work remotely, and cancel plans to avoid spreading the virus, and they know that will require cash. They just don’t know exactly how much those adaptations will affect their cash flow, or how much other companies’ layoffs or furloughs will hurt the income of their customers.
One way companies such as Boeing (ticker: BA) and Hilton Worldwide Holdings (HLT) are preparing for potential liquidity needs is by drawing on their credit lines with banks. Investors worried last week that a cash grab could stress banks’ balance sheets, and those fears helped fuel moderate declines in bank bonds last week. (The ICE BofA U.S. Banking Corporate Index lost 5.6%.)
But the reason most companies turn to bank credit lines in the first place is that they find it too expensive or difficult to borrow in commercial paper markets, wrote Bank of America’s strategists.
The strategists say it has become more difficult for companies (other than banks) to issue short-term debt to raise cash. As uncertainty grows around the outlook for companies’ cash flow, investors are demanding higher interest rates on commercial paper, or are just staying out of the market altogether.
There is another important reason institutional investors are reluctant to lend: They don’t know themselves how much cash they will need to fulfill withdrawal requests from their customers.
Money-market funds—specifically the nearly $800 billion of “prime” funds that invest in commercial paper—have to take extra care with their cash. That is because they are required to impose fees and have the option to temporarily suspend withdrawals if their cash levels fall to less than 30% of the fund’s net asset value.
If cash levels do start to fall, investors may race to withdraw their money while they still can, starting a run on those funds until (or after) a withdrawal “gate” is put in place. Money-market funds are allowed to suspend redemptions for only up to 10 business days every three months.
The Fed almost certainly wants to avoid any run on money-market funds, since that would make it even more difficult for companies to borrow in a “frozen” commercial-paper market, as Bank of America points out. In fact, many large multinational companies invest a significant portion of their cash reserves in money-market funds, and may need to withdraw cash themselves.
That is why Bank of America’s Mark Cabana and Olivia Lima initially predicted that the U.S. central bank would create special facilities for commercial-paper purchases on Sunday night, in their March 13 note.
In a Sunday call with the press, Fed Chairman Jerome Powell didn’t rule out such an intervention, but didn’t say the Fed was planning on it, either.
“We have nothing to announce on [using emergency powers to introduce more lending facilities] but of course it’s a part of our playbook in any situation like this,” Powell said. “So as I’ve said we’re prepared to use our authority as is appropriate to support borrowing and lending in the economy, and hence to support the availability of credit to households and businesses.”
Here’s what the new commercial-paper market interventions could look like, according to the Bank of America strategists.
First, the Fed could reintroduce a facility it created during the financial crisis to buy short-term commercial paper and hold it to maturity, so companies can have easier access to cash financing. The facility was called the “Commercial Paper Funding Facility” or CPFF.
The second would be a new facility created to buy commercial-paper securities from banks’ bond-trading desks. The facility would be created to buy the commercial paper that banks’ bond traders already hold on their balance sheets, Bank of America says, along with commercial paper that “prime” money-market funds might need to sell to raise cash for customer withdrawals. That facility would probably “only” need to be around $30 billion to $50 billion, the strategists wrote.
Of course, a total $30 billion to $50 billion doesn’t sound like much compared to the New York Fed’s recent $1.5 trillion liquidity injection, or the $37 billion of Treasury purchases it made in a single day.
The two new facilities would need approval from the Treasury secretary, Bank of America’s strategists say. And in general, the central bank must meet higher standards before taking action than it did before the financial crisis, since Congress passed provisions limiting the Fed’s power in the Dodd-Frank Act of 2010.
The strategists think that the central bank can meet those standards easily, however.
And that is a good thing—the batteryof actions the Fed is taking to relieve the pressure within the Treasury market may not offset the cracks spreading through corporate debt markets. A commercial-paper facility is one step that authorities could take to help mend them.
Write to Alexandra Scaggs at alexandra.scaggs@barrons.com
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March 16, 2020 at 08:24AM
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The Fed Should Step In to Fix ‘Frozen’ Short-Term Credit Markets, BofA Says - Barron's
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