Yesterday, the Fed announced a liquidity ‘bazooka’ to ease coronavirus-related liquidity strains within the banking system and US Treasuries (normally the most liquid assets in the world).
The measures offered up to $3.5tn of liquidity into the financial system this month. It involved: two 3-month $500bn repo operations (one conducted yesterday and another today) and an additional 1-month operation (also conducted today). Furthermore, weekly 1-month and 3-month operations will continue for the rest of the month.
The Fed cited “highly unusual disruptions in Treasury financing markets associated with the coronavirus outbreak” for the decision. Banks, dealers, corporate treasurers and other investors had begun hoarding liquidity by fully drawing down revolving debt facilities. This tightened liquidity in the banking system and caused trading costs in off-the-run Treasuries to widen substantially.
In our view, this is not reflective of the health of the US banking system – which we believe is in robust shape overall. Given the Fed’s essentially unlimited ability to do repo operations, we also believe that it has all tools at its disposal to prevent a liquidity crisis, and it is signaling that it will use them to prevent one. We expect the measures will significantly reduce the strain on bank balance sheets and help trading normalize in Treasuries.
QE has also essentially returned
The other announcement was that the Fed’s existing liquidity program ($60bn in monthly T-bill purchases) will change. Now it will be used to purchase bonds across the entire Treasury curve “to roughly match the maturity composition of Treasury securities outstanding”.
Although it was not explicitly presented as such yet – this is essentially a resumption of quantitative easing.
All eyes on next week's Fed meeting
Although liquidity will likely normalize, wider asset markets responded with no more than a momentary ‘sigh of relief’. The S&P 500 and the Dow later suffered their lowest daily returns since the infamous ‘Black Monday’ of 1987 (albeit that was twice as severe).
As uncertainty around the coronavirus impacts both the real economy and the financial system, the global policy response – both monetary and fiscal – is gaining more attention.
Next week’s FOMC meeting will offer greater clarity on the future of US rates, QE and liquidity operations. Markets are now close to pricing in an entire 100bp cut, which would take the lower bound of the Fed’s target range all the way to 0%. For now, an accompanying fiscal ‘bazooka’ maybe further off.
Stay diligent, and keep an eye on emerging opportunities
We believe investors can best navigate the current market by keeping sight of their long-term objectives, remaining calm as they prepare for more potential volatility.
From a credit strategy perspective, investors should closely monitor companies’ liquidity positions and financial flexibility, which can offer a buffer against further volatility and/or economic downturns. Some names may be relatively insulated from the economic impact (consider, for example, a robust cable provider that may benefit from fewer public gatherings), so we would carefully consider fundamentals and seek to avoid forced selling.
Furthermore, the market sell-off is creating potential value in certain areas. Once greater clarity arrives and the dust settles, compelling opportunities may present themselves.
Please note: any forecasts or opinions expressed herein are Insight Investment's own as of March 13, 2020 and subject to change without notice. This information may contain, include or is based upon forward-looking statements. Past performance is not indicative of future results.