NY Fed Blogs on Dealers During March
The Federal Reserve Bank of New York's Liberty Street Economics blog asks, "Did Dealers Fail to Make Markets during the Pandemic?" They write, "In March 2020, as the COVID-19 pandemic disrupted a range of financial markets, the ability of dealers to maintain liquid conditions in these markets was questioned. Reflecting these concerns, authorities took numerous steps, including providing regulatory relief to dealers. In this post, we examine liquidity provision by dealers in several financial markets during the pandemic: how much was provided, possible causes of any shortfalls, and the effects of the Federal Reserve's actions." The piece tells us, "Dealers support market liquidity by intermediating customer trades -- for example, by taking customer sell orders into inventory when buyers are absent. Hence, changes in the size of their inventory positions can indicate whether dealers are performing intermediation activities. The chart below shows that primary dealer net positions in commercial paper (CP) and investment-grade (IG) corporate bonds ... fall starting the week of February 26 and bottom out in the week of March 18 (for CP) and March 25 (for IG bonds) before recovering in April. By comparison, dealer net positions in U.S. Treasury bills, Treasury notes and bonds, and agency residential mortgage-backed securities (RMBS) ... are generally higher or similar in March as compared to their prior levels–although net positions in bills fell sharply in the week of March 25. Overall, dealers cut inventory in some markets but increased or maintained it in others in March." It adds, "In CP and corporate bond markets, limited dealer intermediation and heightened market illiquidity went hand in hand, and improved only after the Fed's actions. For example, the Commercial Paper Funding Facility (CPFF) was announced on March 17, and dealer net positions recovered the week of March 25. Similarly, two corporate bond facilities were announced on March 23 to support IG bonds. Liquidity in the corporate bond market improved on the announcement, and dealer net positions recovered in the week of April 1. In contrast, even as dealers maintained intermediation, market dysfunction continued apace in U.S. Treasury and agency MBS markets in March 2020. What accounts for this disjunction? One possibility is that the amount of liquidity provided by dealers was insufficient to meet the volume of customer selling, as shown for the agency MBS markets. Ultimately, the Fed's massive purchases of Treasury and agency MBS securities helped to accommodate the selling pressure."
