There is focus today on the large amount of commercial paper held by the Federal Reserve that is scheduled to mature on Friday.
The Wall Street Journal on Tuesday put the number at $230 billion; Bloomberg put the figure at $245 billion. The tally represents a substantial portion of the $350 billion of commercial paper the Fed holds in its Commercial Paper Funding Facility. The idea that Friday represents a test, which is the way the Wall Street Journal angled it, substantially overstates the reality, which is that there is virtually no rollover risk on Friday. In other words, issuers that sold commercial paper to the Fed 90 days ago can ask the Fed to do so again if they want to and the Fed can purchase a quadrillion dollars worth of commercial paper if it chooses to.
Moreover, the idea that the Fed would leave issuers out to dry and at the mercy of dysfunctional capital markets is inconsistent with the Federal Reserve's efforts to support the financial system until such time that it can support itself.
The Fed will of course endeavor to shrink its balance sheet at some point, but that time certainly has not arrived.
Despite the above, misplaced anxiety is sure to surface in the week ahead regarding any contraction of the commercial paper market that takes place. It should not surprise that it contracts for two reasons in particular. First, it has become expensive for issuers to sell commercial paper to the Fed, with the Fed charging over 3% for certain types of issuance, more than 200 basis points above market interest rates for 90-day paper (the actual spread depends on the type of paper and the type of issuer, but the main point is held intact no matter how you slice it).
Second, many issuers simply don't need the money because of the weak economy. Commercial paper is used for "transactions purposes," as working capital for current output, for example, and output is shrinking. So, then, should the need for capital. It is normal for the CP market to shrink when the economy does.
If anything, Friday's rollover helps illustrate how it is that the Fed will shrink its balance sheet—the Fed will simply let its various programs expire. Friday's rollover also illustrates the ingenuity in the Fed's programs in that embedded in them are penalties that only appear as penalties when the cost of capital in the capital markets fall, as has been the case recently in the commercial paper market (90-day asset-backed commercial paper rates were 4.66% in October versus 1.27%, currently, a rate that is below the cost of selling paper to the Fed).
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Tony Crescenzi is the Chief Bond Market Strategist at Miller Tabak + Co., LLC where he advises many of the nation's top institutional investors on issues related to the bond market, the economy and other macro-related issues. Crescenzi makes regular appearances on financial television stations such as CNBC and Bloomberg, and is frequently quoted across the news media. He is also the author of the forthcoming book, "Investing from the Top Down," "The Strategic Bond Investor," and co-author of the 1200-page book "The Money Market."Crescenzi is a contributor to RealMoney.com."