Is the Fed's next move in the secondary?

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The Federal Reserve has acted aggressively in the face of the coronavirus pandemic to help financial markets but its next move may be an assistance program for the secondary market.

“We believe that the Fed will move forward with the secondary market credit facility in the coming weeks, starting with investments in corporate bond ETFs that meet the investment criteria,” said Pri de Silva, senior corporate credit research analyst at Aware Asset Management. “For extra credit, we believe that the Fed’s actions served to reduce contagion risk (i.e. the risk that the economic crisis spills into the banking system) as well.”

The Fed's dual mandate is to maintain stable prices and maximum employment. How do the Fed's actions in the credit market relate?

Federal Reserve building

“The short answer is jobs," said de Silva. "The efficient functioning of credit markets is for all intents and purposes a requisite for maintaining maximum employment.” Since companies often need to borrow money, they can "be viewed as the piston that keeps the employment engine humming.”

De Silva noted, "when the health crisis rapidly morphed into an economic one in mid-to-late March," with non-essential businesses being forced to shutter, "financial markets went into freefall and access to credit markets were frozen."

The Fed had no option but to do something.

“At this point, the Fed had to step in forcefully to signal to financial markets that it 1) had more bullets left in its arsenal, and 2) was willing to do whatever it takes to serve its dual mandate,” de Silva said. “Simply put, if the Fed did not act in the way it did, it would have made a very challenging employment picture even worse."

But since this was a different type of crisis than the ones the Fed normally responds to, monetary policy easing and quantitative easing needed to be augmented by "a new tool from its toolkit — direct support to the corporate bond market, reflecting both the severity of the market disruption and targeting a specific pressure point,” he said.

And to get the employment market back, it will need to act in both the primary and secondary markets.

“The primary market credit facility and the secondary market credit facility were to target the supply and the demand sides, respectively, of the corporate bond market," de Silva said. "Fast forward one month, due in part to the Fed’s willingness and ability to act, most companies are able to borrow again at relatively reasonable levels and the primary market credit facility may not even get used.”

ADP national employment report
Private-sector employment fell by 20,236,000 in April, after 149,000 were lost in March, ADP reported. That was an upward revision from the 27,000 jobs it first estimated were lost in March.

Economists polled by IFR Markets expected 20 million jobs to be lost in April.

The decline topped the previous record of "834,665 in February 2009 during the Great Recession," said Scott Anderson, chief economist at Bank of the West. “Nearly 80% of the job losses were in service industries most directly impacted by the rapid closure of all non-essential businesses. Job losses occurred in most industries with the largest declines in leisure & hospitality, trade, transportation & utilities and construction," he said. "This is just a preview of the ugly numbers we expect from Friday’s official BLS jobs report.”

“Job losses of this scale are unprecedented and the total number of job losses for the month of April alone was more than double the total jobs lost during the Great Recession,” said Ahu Yildirmaz, co-head of the ADP Research Institute.

"Ironically, the massive jobs loss is good news in that it is a reflection of how serious we have become in limiting the death of Americans and saving the country from completely overwhelming and eventually decimating the healthcare system," said Bryce Doty, senior vice president and senior portfolio manager at Sit Fixed Income. "As investors, we see this Friday’s employment report, which will show a job loss of 21 million people, as marking the bottom for terrible economic news."

He also commented on the Treasury's plans to borrow almost $3 trillion this quarter, including $20 billion of 20-year bonds. "We need to hear the Fed’s announcement of how many of the Treasury bonds they intend to buy," Doty said. "Investors won’t swallow $3 trillion of Treasury bonds at current yields but I can’t imagine the Fed will tolerate higher yields."

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