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The world's Central Banks get some control over bond markets

The Fed, the Bank of Japan and the Bank of England have all showed their concerns and support for markets.

Golden Law scales with thousands dollars cash money

by
John Redwood

in Features

25.03.2020

As expected, the Federal Reserve Board put everything into rallying the Treasury market, and did a great deal to boost the Investment grade corporate bond market. As we hoped on Friday, this seems to be working. "Safe" assets have been stabilised, have great support behind them, and are possible investments again.

The Fed simply erased the large sums it had promised for Quantitative Easing and said, in an historic announcement:

"The FOMC will purchase Treasury securities and agency mortgage-backed securities in the amounts needed to support smooth market functioning and effective transmission of monetary policy to broader financial conditions and the economy."

This is as important as Mr Draghi's "do whatever it takes" statement and the Bank of Japan's commitment to buy as many Japanese government bonds as necessary to keep the 10-year interest rate at zero. It takes much of the price risk out of holding US Treasuries. It more than matches the Bank of England's strong interventions this week to keep the gilt market working and to keep prices up.

The Fed has gone a lot further to ensure the supply of credit to large companies, businesses generally, to consumers and the municipalities. It announced three major Special Purpose Vehicles, the Primary Market Corporate Credit Facility, the Secondary Market Corporate Credit Facility and the Term Asset Backed Securities Loan Facility. Each will have lending supplied by the Fed backed by an equity stake injected by the Treasury. The first is to give large companies better access to the primary bond market for their virus linked financing needs. Investment grade companies can borrow up to 4 years with no interest accruing having to be paid for the first sixth months. The second is designed to create liquidity and a bit more confidence in the secondary market for Investment grade bonds.  The third lends to those owning portfolios of car loans, student debt, credit card loans and small business loans.

The Money Market Mutual Fund Liquidity Facility will now cover a wider range of securities to help municipalities, whilst the Commercial Paper Fund is also available.  This means the Fed recognised that the whole range of financing activities in US markets were under threat, from insufficient liquidity and a lack of buying interest. The Fed is committing substantial resource, backed by modest equity holdings in the SPVs by the Treasury, to seeing Investment grade credits through. There is no support for High Yield or distressed credit, and no guarantees that substantial numbers of BBB credits will not be downgraded by the independent rating agencies to Junk status. This leaves open the question whether these Fed funds will be cautious about the strength of existing covenant they buy or will come back to the issue of loss of status with new proposals.

The Bank of Japan earlier this month also showed its concerns about financing companies. It announced a 63% increase in its Commercial Paper buying programme for March/April, and a doubling of its purchases of Corporate Bonds for the same period. The Bank is also presumed to be buying ETFs of shares but has made no recent statement about the quantities.

All this is welcome support for fixed income markets. For share markets, we await with impatience the US Congress reaching an agreement about a big package of direct cash support for companies and people which will be needed to avoid large damage to balance sheets and family budgets.  When this comes it should boost share markets generally. It does not, however, solve the many problems besetting most businesses. The duration of the shutdowns matters a lot, as this will determine how big the losses are in the period of interruption, and how big the crater will be in output and employment. Our current best estimate is to expect at least two months of severely impaired working.  This means expect dividend cuts, capital expenditure cancellations, the termination of share buy back programmes and poor earnings from many shares. We identified some areas that will do well in these difficult conditions yesterday, which are led by food and medical-based businesses. These fall a long way short of making up for the big losses of turnover and profit elsewhere.

As we approach the quarter end the need for funds to rebalance towards equities where market values have taken their holdings below target levels, may combine with better news of a US fiscal package. Anyone buying shares at this juncture will still be well advised to avoid the many sectors that are going to be hit very badly by the shutdowns.

Nothing on this website should be construed as personal advice based on your circumstances. No news or research item is a personal recommendation to deal.

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