Stocks surged Tuesday afternoon, after a muted morning session. The surge came just after the Federal Reserve announced it would do something it hasn’t done since the financial crisis: provide a credit facility in the commercial paper market.
First, here’s what stocks did.
All three major indexes in the U.S. rose more than 4% in the afternoon, after having exhibited gains of 1% in the morning. By midday, the S&P 500 was up more than 5% and the Nasdaq more than 6%.
Secondly, the commercial paper market is the market between companies and lenders, who provide very short-term and low interest loans to businesses purchasing inventories and paying down short-term liabilities like accounts payable. Companies want to remain as liquid as possible, even in the short-term.
With the coronavirus raging and revenues likely falling hard from previous exceptions, credit quality is worsening and there have been murmurs that the commercial paper market is drying up.
The Federal Reserve announced Tuesday that it will support the commercial paper market, using a fund with billions of dollars allocated for this special purpose. That fund will extend commercial paper to companies. The Federal Reserve has special authority to invoke this action and it is supported by $10 billion sent from the treasury department, which protects the Fed against poor credit.
The Fed has been spending trillions on liquidity for the banking system and must watch its own financial position.
Here’s what the Fed said about the situation:
"The commercial paper market has been under considerable strain in recent days as businesses and households face greater uncertainty in light of the coronavirus outbreak. By eliminating much of the risk that eligible issuers will not be able to repay investors by rolling over their maturing commercial paper obligations, this facility should encourage investors to once again engage in term lending in the commercial paper market. An improved commercial paper market will enhance the ability of businesses to maintain employment and investment as the nation deals with the coronavirus outbreak."
This new form of liquidity from the Fed is pressuring short-term rates and bringing long-term rates higher, as incremental optimism on the economy kicks in. The 3 month treasury yield fell to 0.22%, wit the 10 year yield up to 0.87%.
This combination is a clear positive for bank stocks, which are outperforming the market Tuesday. Bank of America (BAC) - Get Report, Wells Fargo (WFC) - Get Report and JPMorgan (JPM) - Get Report were all up 8%, 11% and 8%, respectively, while the broader market had its previously mentioned swing.
The market then moderate some.