NEW YORK – The credit markets saw some slight easing Tuesday after the Federal Reserve said it would buy commercial paper, the unsecured short-term debt that companies sell for their short-term cash needs.
In the eyes of many market participants, the move to grease the commercial paper market could do more to get people lending again than the $700 billion bailout plan passed by Congress.
“It's the most effective move the Fed has done to date,” said Axel Merk, portfolio manager at Merk Funds. “When that market seizes up, the economy stops working.”
Still, the let-up in the credit markets – where companies go to borrow and lend – was tentative. Some investors were skeptical that the central bank's decision still might take a while to restore confidence among potential lenders.
“It's another psychological boon to Wall Street, but Main Street is going to have to still wait for the trickle-down effects,” said John Atkins, a fixed-income analyst at IDEAGlobal.com.
The three-month Treasury bill – the ultimate safe asset to which big investors, like money market funds, have been flocking – saw its yield rise to 0.89 percent from 0.49 percent late Monday. That increase suggested a decrease in demand for government debt; still, a yield below 1 percent is very low in historical terms.
And lending between banks remains extremely expensive.
The London Interbank Offered Rate, or LIBOR, for overnight dollar loans jumped to 3.94 percent on Tuesday from 2.25 percent Monday. LIBOR for three-month dollar loans rose at 4.32 percent, near its nearly nine-month high.
Both rates are well above the Fed's target rate for overnight loans of 2 percent. LIBOR is important not only because it indicates how willing banks are to lend, but also because many consumer rates are tied to it, including adjustable-rate mortgages.
On Monday, to address the rise in LIBOR, the Federal Reserve doubled its one-month loan and three-month loan offerings. Those moves and others brought the total amount of credit potentially outstanding through year end to $900 billion, the Fed said.
If the Fed buys commercial paper, it will help keep many companies operating more normally than they have been.
Commercial paper is a common way for large companies to maintain their cash flow. Demand for commercial paper has plummeted in recent weeks, as most investors have gotten too scared to put their money in anything but government debt. A big reason was that a money market fund “broke the buck” – or lost too many assets to cover each dollar invested – because it was exposed to the now-bankrupt Lehman Brothers Holdings Inc.
In the week ended Oct. 1, commercial paper outstanding fell to $1.61 trillion, seasonally adjusted, from $1.70 billion in the previous week. Since the summer of 2007, the market has shrunk from more than $2.2 trillion. Recently, it's been hard for many companies to issue commercial paper for more than overnight or a couple days, market participants say.
Money market funds are typically the largest holders of commercial paper, accounting for about one-third of outstanding commercial paper, according to Standard & Poors.
One source of concern is that the Fed only plans to buy the safest, top-tier commercial paper.
The riskier, lower-tier commercial paper is a smaller portion of the market, but has seen particularly low demand. The rate spread between top-tier and lower-tier commercial paper is typically 0.10 to 0.20 percentage points, Atkins said – and right now, it's about 3 percentage points, indicating a massive aversion to the lower-tier debt.
The biggest sellers of top-tier commercial paper are financial companies. The paper sold by companies outside the financial sector is usually lower-tier.
“Those guys are still kind of left in the cold. The dislocations in that sector of commercial paper don't figure to improve materially directly as a result of this plan,” Atkins said.
