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Federal Reserve takes steps to support US municipal bond market

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Via Financial Times

The Federal Reserve has stepped in to support the US municipal bond market in its latest effort this week to shield the economy and markets from the impact of the coronavirus pandemic.

Having already slashed interest rates, lined up an $700bn bond-buying programme and set up dollar swap lines with a clutch of central banks around the world, the Fed said on Friday that it would expand a programme to support local-government financing through a lending facility for money market mutual funds.

As US cities and states in stricken areas have taken on the brunt of immediate spending for the public health response to the coronavirus pandemic, the $3.9tn municipal bond market has been wracked by volatility in recent days. Investors dumped the debt in droves, pulling $12.2bn from municipal mutual funds in the week ending on Wednesday, according to data from Lipper.

Borrowing costs have surged as a result, with yields on municipal debt maturing in 10 years soaring nearly a full percentage point in the past week to 2.6 per cent.

According to a statement on Friday by the Fed’s Board of Governors, the central bank has “expanded its programme of support for the flow of credit to the economy by taking steps to enhance the liquidity and functioning of crucial state and municipal money markets”.

The Fed said that the Federal Reserve Bank of Boston would widen the money market mutual fund liquidity facility, which it set up on Wednesday to backstop money market funds facing redemptions, to provide loans secured by municipal debt with maturities of up to a year. It said it would accept “high-quality assets purchased from single state and other tax-exempt municipal money market mutual funds”.

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The Fed had faced calls to address the dislocations that have cropped up in the muni market. Earlier this week, Vikram Rai, head of municipal strategy at Citigroup, urged the central bank to buy municipal debt directly as part of its ongoing asset purchases programme.

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