Interest Rate Outlook: Bond Market Liquidity

FOMC Meeting

The Federal Reserve has taken extraordinary steps over the past six weeks to shield the economy from the massive fallout of the virus pandemic, including emergency interest rate cuts, massive bond purchases and the opening of multiple lending facilities to provide liquidity and backstops to the fixed income markets. Following their regularly scheduled meeting last week, Fed Chair Jerome Powell pledged that the Fed “is committed to using its full range of tools to support the U.S. economy in this challenging time”. He also warned that “the ongoing public health crisis will weigh heavily on economic activity, employment, and inflation in the near term, and poses considerable risks to the economic outlook over the medium term.”

Signs of Economic Damage

The first reading of Q1 GDP revealed that the US economy contracted by 4.8%, the worst reading since Q4 of 2008. However, the negative data is likely to be just the tip of the iceberg as the country’s economic shutdown only started at the end of the quarter. Of note, consumers slashed their spending by 7.6% and investment by businesses contracted by 8.6%. The damage to the labor market also continues to mount – over the past six weeks, more than 30 million Americans have filed for initial jobless claims and economists warn that the true totals are underrepresented due to systemic filing problems. As we move into May, more and more states are taking initial steps towards easing quarantine restrictions and reopening businesses, but it remains to be seen whether these early actions will help to stave off economic disaster or instead backfire by leading to a second wave of infections.

Bond Market Liquidity

Conditions continue to normalize in the short end of the fixed income markets following the restoration of the balance between buyers and sellers. Corporate-to-government spreads have tightened in and yields for high-quality short-term credits continue the downward trend that we’ve observed since late March. One-month LIBOR has fallen by roughly 20 basis points in the last five business days and three-month LIBOR is down by more than 35 basis points over the same short period.

Source: Bloomberg

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