Federal Reserve: Backstop doubts and high intervention bar – BNY

BNY’s David Tam asserts that the Federal Reserve, while legally capable of supporting corporate credit, is unlikely to mimic the extensive interventions seen during the Covid era. He notes that investors should not rely on dealers or the Fed to swiftly curb sharp increases in credit spreads during future sell-offs. The Federal Reserve has the authority and capacity to step in, as evidenced by the Primary Market Corporate Credit Facility (PMCCF) and Secondary Market Corporate Credit Facility (SMCCF) during the early Covid days.

These programs saw limited use, but were credited with narrowing spreads through an announcement effect. Critics argue that these interventions created a moral hazard. The current Warsh Fed is perceived as more cautious, likely viewing such events as localized crises or opportunities to impose discipline in a market that has thrived for nearly two decades under a more interventionist Fed.

Investors are currently seeing tight spreads, dealers being structurally short on investment grade credit, and strong investor demand. While no immediate alarm is raised, the possibility of a selloff could see circuit breakers like dealers, investors, or the Fed less willing or able to intervene. Dealers should monitor net positioning and total fails, as movements toward neutrality or net long could signal balance sheet constraints and rising intermediation frictions.

Additionally, monitoring credit spreads and long-end yields is advised. A widening in credit spreads might indicate cooling investor sentiment, while a decline in long-end yields could make the value proposition less appealing.