March 17, 2020 / 10:27 PM / 14 days ago

Investors worry Fed's commercial paper facility will not be enough

NEW YORK (Reuters) - The Federal Reserve’s plan to ease strains in short-term funding markets received mixed reviews from investors on Tuesday, with some saying further relief may be needed from the liquidity issues plaguing that corner of the financial system.

Prices for high-grade commercial paper - short-term loans that companies use to meet financing needs for things like payrolls, accounts payable and inventories - improved after the Fed announced the reintroduction of its Commercial Paper Funding Facility (CPFF), said Nick Maroutsos, co-head of global bonds at Janus Henderson Investors, and an active investor in commercial paper.

The spread between interest rates on lower- and higher-rated overnight commercial paper had increased on Monday to the widest level since 2008, signaling investors were demanding a hefty premium to hold riskier debt.

Still, some investors worried whether the CPFF - and other recent measures aimed at bolstering liquidity - would be enough to keep the plumbing of the financial system running amid broad asset market volatility in the face of the coronavirus pandemic’s uncertain trajectory.

Lower-rated paper, issued by companies with riskier credit profiles will largely be left out of the operations, a concern for some market participants. Citi analysts also suggested the cost for these issuers to borrow from the Fed may be significantly higher than it is for high-grade paper.

“Our concern is that this channel will not be fast enough to deal with a problem that gets worse over time,” wrote analyst at Citi.

On the cost side, the price being offered by the Fed is 200 basis points over the Overnight Interest Swap rate - steeper than some had expected.

That suggests the facility is intended to function more as a backstop for the market rather than an easy source of funding, some said Kevin Giddis, chief fixed income strategist at Raymond James.

“It’s a steep price to pay for liquidity,” he said.

The FRA-OIS spread, a proxy for risk in the banking sector, widened by more than 15 basis points on Tuesday following the Fed announcement as investors bet that companies will continue to draw on existing lines of credit at banks, potentially putting them under stress.

“Directionally that’s the opposite of what (the Fed) wants to see,” said Jon Hill, U.S. rates strategist at BMO Capital Markets.

Last week Boeing Co (BA.N), Hilton Worldwide Holdings (HLT.N) and SeaWorld Entertainment Inc (SEAS.N) among others drew down on bank loans to shore up their liquidity.

The rate for AA-rated paper US1DCP= was 0.76% versus 3.05% for lower-rated debt US1DCP22=, according to data posted on the Federal Reserve’s website on Tuesday.

On Tuesday, prior to the Fed’s announcement, the cost for companies to borrow commercial paper was higher than on Monday.

“Quoted rates have gone up from where they were yesterday,” said Giddis. He noted that the direct issue market is virtually shut by 9 a.m. EDT (1300 GMT), so the effects of Tuesday morning’s announcement would not be seen until Wednesday.

Reporting by Kate Duguid, additional reporting by Megan Davies; Editing by Ira Iosebashvili; Chris Reese and Tom Brown

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