I hope this helps to ease some of the stress caused by today’s very bad employment news.
There’s a corner of the US financial system that gets little to no attention. I’m talking about the credit markets, that place where companies buy and sell bonds from those with a duration of 30-days to 30-years. This is a boring, stodgy market that moves at a glacial pace — until there’s a financial crisis. And then, usually just like that, the entire market seizes up, making it nearly impossible to get any credit.
Why is this important? Because this provides companies with cash needs for all time frames. For example, suppose your company needs $1.5 million in the short-run. You also have a ton of receivables due in 90 days and a strong sales pipeline; you just happen to be short now. You can sell commercial paper — a corporate bond with a 30-90 day maturity — to get the cash. When the receivables are collected, you pay off the bond. This happens all the time. And, much like spice in the book Dune, “the credit must flow.”
Starting a few weeks ago, this market started to seize up — big time. No one could trade anything. There were some articles that to financial folks were really scary because they more or less implied the entire system was about to lock-up. If this had happened the entire financial system could have come down — and quickly.
In stepped the Federal Reserve, which created a ton of programs that back-stopped the entire market. It’s already starting to show some impressive and much-needed positive results.
Let’s start with a look at overall financial stress as measured by the St. Louis Federal Reserve’s Financial Stress Index.
The index spiked sharply higher. However …
… I=in the latest reading, it’s come down a tick. Also note on the longer chart that the index is below levels reached during the Great Recession (at least so far).
The good news doesn’t stop there. The entire corporate market’s yields are lower.
AAA yields (the best-rated credit; in blue) are already back down to near their lowest levels of the last five years. BBB yields (second-best credit rating; in red) are also down.
CCC yields (junk bonds) have also stabilized.
Compare recent price activity with that which preceded the pandemic: previously, yields moved slowly. When the pandemic hit, they spiked sharply higher. And in some cases (see the AAA yields), they moved lower just as sharply. In others (BBB) they’re lower while in the riskier markets, yields have potentially stabilized below previous levels.
And, the entire corporate credit market’s yields have now moved lower.
The short-end of the corporate curve (1-10 years) has dropped, as has …
… the longer end of the curve.
Now — we are nowhere near out of the woods with this situation. As I understand current projections, we should write-off the 2Q20 due to the virus. But the above information shows that the Fed’s policy response is calming markets. Should this trend continue, recovery will be a tad easier.
Please take care of yourselves during this difficult time.