Liquidity Event, Not a Credit Event – Yet
A Perspective from Invesco Fixed Income
As the coronavirus made its presence known across the globe, governments, companies and individuals struggled to ascertain what the real impact would, and should, mean to their respective businesses and lives. Uncertainty led to volatile markets, with equity and fixed income markets showing signs of stress as early as mid-February, ultimately leading the US Federal Reserve (Fed) to implement an inter-meeting interest rate cut of 50 basis points on March 3. At that time, the Fed stated that the economy was “strong” but wanted to limit downside risk due to the virus. Unfortunately, the risk-off tone continued, leading to elevated demand for cash and US dollars. Companies needed more cash on hand to meet payroll and other obligations while their businesses were put on hold. Governments (local, state and federal) needed more cash on hand to pay for new fiscal policies launched to offset the economic impact of the virus. And individuals withdrew from risk markets as volatility increased and their risk appetite waned.
Through March, the Fed continued to pull all the levers at its disposal, including repurchase agreement (repo) operations and open market purchases, to try to add liquidity to the system and stabilize what was becoming a volatile and illiquid US Treasury market. The Fed also announced a large-scale asset purchase program, enhanced US dollar swap lines with foreign central banks, including a reduced rate charged to access these lines, and implemented other measures to encourage banks to use their capital and liquidity buffers to help restore market functioning.
Despite the Fed’s willingness and ability to pump trillions into the market, it struggled to get liquidity into the hands of those who needed it. The Fed’s traditional counterparties are banks and broker dealers, but their balance sheets are much smaller now due to post-global financial crisis regulations put in place to make them stronger. These regulations have worked, but banks and broker-dealers have become a kink in the liquidity supply chain – working through them was not enough to disperse the needed liquidity through the system. The Fed and the US Treasury had to act quickly to create new facilities and bring back old ones from 2008.
Learn more about:
- Special facilities to support investment grade debt markets
- Improving credit markets
- Banks’ stronger capital positions