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By Sam Goldfarb and Anna Hirtenstein 

Key parts of the U.S. debt markets are functioning again, a sign the Federal Reserve's extraordinary steps are easing a credit market crunch.

Investors say the Fed has reduced disruptions in the $17 trillion U.S. Treasurys market that had sent shock waves through the financial system. Large businesses such as Oracle Corp. and CVS Health Corp. are borrowing money at a record pace. Some lower-rated companies are issuing bonds again. And increased demand for mortgage bonds is starting to pull mortgage rates lower after they unexpectedly rose last month.

Debt markets remain far shakier than they were about a month ago. Most new bond sales are still coming from well-established companies with higher credit ratings, reflecting a consensus that the coronavirus crisis will push the economy into a deep recession. Liquidity, or the ease with which investors can buy and sell securities at what they think are market prices, remains poor in some riskier corners of the market. Some worry conditions could quickly deteriorate again, if the economic outlook darkens further.

Still, investors and analysts say the Fed's historic interventions have spurred a meaningful reduction in market stress. Those include announcing plans to buy unlimited amounts of government bonds and mortgage securities issued by government-supported entities and starting new programs to buy higher-rated corporate bonds.

"The liquidity side is being fixed," said Michael Collins, a senior portfolio manager at PGIM Fixed Income.

Investors said the Fed's main goal remains simple: to hold down borrowing costs across the economy, so individuals, businesses and communities are encouraged to borrow and spend money. But that has proved challenging in recent weeks, pushing the central bank to take ever-more-aggressive and creative actions.

Shortly after the central bank reduced the key interest rate it controls to near zero on March 15, yields on longer-term U.S. Treasurys shot upward, with the 10-year yield climbing to 1.259% from 0.5% the previous week. The extra yield, or spread, investors demand to hold ultrasafe mortgage bonds over Treasurys jumped to around 1.75 percentage points, according to Tradeweb. That is compared with 1.52 percentage points just before the rate cut and less than 0.3 percentage point a week earlier.

In both cases, investors said the moves were fueled by money managers rushing to raise cash by selling what they could: ultrasafe debt. That contributed to deteriorating liquidity, as dealers demanded more compensation to stand in the middle of trades.

One measure of the Fed's recent success is that the 10-year Treasury yield has fallen back to 0.587%, as of Friday's close. Another is that average mortgage spreads are back down to around 1 percentage point. Put together, the moves should push down mortgage rates and hand more money to homeowners who refinance their mortgages.

The Fed hasn't even started buying corporate bonds yet, but just its promise to do so has already provided a lift to larger businesses.

Last week, companies outside the financial sector, including Oracle, Dollar General Corp. and General Mills Inc. sold a record $104 billion of investment-grade bonds, beating the previous record of $73 billion set the previous week. In many cases, companies have been selling bonds at yields that were barely above those on their existing bonds, a sign of strong demand from investors. Five companies also issued speculative-grade bonds, kicked off by Pizza Hut owner Yum Brands Inc., with the first high-yield bond sale since March 4. In addition, cruise operator Carnival Corp. & PLC -- which is investment-grade but facing urgent liquidity pressures after it shut down operations -- sold $4 billion of secured bonds at a hefty 11.9% yield.

The recovery has been more mixed in other areas of the credit market. The amount of extra yield investors demand to hold securitized debt -- backed by everything from student loans to aircraft leases -- instead of Treasurys has generally declined in the last two weeks. But investors say there are large variations even within sectors, depending on how vulnerable specific borrowers are to the economic downturn. And sales of new asset-backed securities are likely to be on hold until the Fed starts up a program to buy the highest-rated debt in the asset class.

Central-bank support for some short-term municipal bond prices helped pull the market out of a major liquidity crunch that brought state and local government borrowing to a standstill in mid-March. Also helping: congressional endorsement of a program that would provide liquidity for longer-dated maturities. Prices rebounded sharply, though they later fell again. Issuance of new bonds has increased slightly but remains around 10% of February levels, according to Refinitiv.

A series of ratings-firm downgrades over the course of the past week reminded investors of many issuers' vulnerability. S&P Global on Wednesday reset its outlook to negative on all U.S. public-finance sectors. New York's Metropolitan Transportation Authority has frozen new projects despite billions of dollars in planned aid.

Some investors say there is still more pain to come, regardless of what the Fed can do to calm markets.

In many cases, companies are issuing bonds to build up their cash reserves and try to improve their ability to weather the crisis, said Rupert Lewis, head of European syndicate at BNP Paribas. Companies have also been drawing down on their credit lines en masse, putting pressure on lenders.

"There's very few companies that will be operating anywhere close to their usual level," said James Athey, an investment manager at Aberdeen Standard Investments. "Short term, medium term, long term, there should be huge concerns about balance sheets and people's ability to pay back their debt."

Heather Gillers contributed to this article.

Write to Sam Goldfarb at sam.goldfarb@wsj.com and Anna Hirtenstein at anna.hirtenstein@wsj.com

(END) Dow Jones Newswires

April 06, 2020 05:44 ET (09:44 GMT)

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