Credit market popsicle

Despite its scale, the Federal Reserve's massive injection of financial liquidity of late and its announcement of a new facility that will purchase commercial paper are not registering with investors, who appear to be clamoring for interest rate cuts instead.

This was abundantly evident in the feeble response to news yesterday that the Fed was expanding its term auction facility, the facility the Fed created last December to auction loans to banks. The TAF was increased to a massive $900 billion from $150 billion just two weeks ago. The lack of a response of course also reflects the multitude of problems that exist in the financial system and the fact that financial shocks tend to resonate for a few months.

The TAF announcement and the subsequent deaf-eared response was made more important by the fact that the Fed had simultaneously announced that it would begin paying interest on bank reserves (money set aside by banks as margin against deposits held), an action that enables the Fed to add as much money into the banking system as it desires without the added money having any influence on the fed funds rate.

The combined actions amount to a quantitative easing of monetary policy, with the Fed expanding its balance sheet in order to place new money into the banking system, and the expansion has been dramatic, yet the market response has been feeble.

It is of course up to the banking system to expand the money the Fed injects in the financial system, and this is something that only banks can do, and they are not doing it yet, but it seems a sure bet that they eventually will, given the astronomical amount of money that the Fed has placed in the system. In the meantime, investors and the general public will clamor for what they understand most: interest rate cuts.

A cut of 75 to 100 basis points would do the trick for now. A large cut is the best choice, considering the gravity of the situation and because it is the surest route to a steeper yield curve, which would improve net interest margins and help banks. Moreover, as investors in banks, we the public have a vested interest in the profitability of the banking sector, now more than ever.

Meanwhile, key gauges of the credit market are mixed today, leaning toward slight improvement but so slight that almost no confidence can be gained from them. For example, swap rates, which are a good proxy for sentiment regarding credit spreads, are lower but only slightly lower.

The two-year swap rate, for example, which has been a good gauge of concerns about short-term credit conditions, is down just 2 basis points to 137 basis points over Treasuries. Importantly, the current level is higher than where it was just before the Fed announced it would create a facility to purchase commercial paper. At that time, the swap rate fell to 128 basis points over Treasuries. The current level is down from the cycle high of 165 basis points over Treasuries, set last Thursday.

T-bill rates are higher on the day, with 3-month bills at 0.97%, up 48 basis points, a good sign, but in light of the volatility seen in bill rates recently, and the fact that bill rates remain at least a half percentage point to three-quarters of a point below normal bill rates continues to reflect stress in the financial system.

The amount of basis points paid on credit default swaps for major commercial paper issuers fell after the Fed's announcement, but they remain high. Moreover, the improvement has an isolated feel to them, since the improvement has benefited commercial paper issuers disproportionately.

Eurodollar futures, which are a good gauge of expectations on three-month Libor, are barely changed, indicating that tomorrow's Libor setting won't show much improvement after having soared recently.

Euribor, which gauges euro-based inter-bank rates, are also little changed, also a sign of still-elevated inter-bank rates.

Lastly, no U.S. companies have sold bonds today, the third day with zero issuance. Only about $7 billion of company bonds have been issued over the past three-plus weeks.