Why the Fed says the financial markets are functioning well
Review of the financial situation
The Fed noted that over the intermeeting period, the S&P 500 increased and bonds rallied, presumably on the back of the decision not to taper at the September meeting. It said the market pushed out its estimate for the first taper. It gets this information from primary dealers through its Desk Survey. Primary dealers trade Treasuries in the primary market, which means they trade directly with the Fed. This is a lucrative business.
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It discussed the government shutdown’s effects on the short-term debt markets, specifically Treasury bills and the repurchase market. We saw a big increase in the yield on the one-month T-bill during October, where the yield spiked from 2 basis points to 34 basis points. You can see the move on the chart above. The reason for the spike was the market pricing in possible delays in getting paid on the one-month bill.
The Fed noted that credit availability generally increased and even went as far as describing leveraged loan issuance as “robust.” While the shutdown did slow down corporate issuance a bit, the market is still very strong and many large firms have taken advantage of the low interest rates to refinance long-term debt at very attractive rates. The Fed watches this like a hawk and is very sensitive to investors “reaching for yield.” “Reaching for yield” is code for being a little too reckless and not taking into account risk. The Fed is understandably gun-shy about this after the financial crisis.
On the household front, it said non-mortgage debt was increasing at a “robust” pace again. Mortgage rates fell from the September FOMC meeting to the October FOMC meeting. The Fed discussed the drop in refinance activity and noted that purchase activity was more robust. Banks are easing credit standards on mortgages, especially for prime borrowers.
So to sum it up, the credit markets are functioning well, aside from the few hiccups we saw related to the government shutdown. Both corporations and households are finding themselves able to access the credit markets.