Macaskill on markets: Hedging – is it safe?
The Federal Reserve’s expanded bond buying commitment underscores that the safest hedge at the moment is a security that can be sold to a government.
The Federal Reserve on Monday announced that it will buy Treasury and mortgage-backed securities “in the amounts needed” to support markets and the economy. The commitment to unlimited buying was new and so was a related extension of support for the corporate credit and municipal bond markets.
European and Asian central banks have seen mixed results from previous attempts to boost lending with purchases of corporate bonds – and even equities in the case of the Bank of Japan – but the Federal Reserve’s measures should help to ensure that core hedging markets at least remain functional.
Treasury liquidity may be improved, but the broader market for risk management by offsetting trades and use of derivatives is still precarious. Basis relations between similar instruments such as bonds and swaps are being tested by a sharp rise in volatility across asset classes, as well as uncertainty about the ability to close or value different legs of hedges.
A dislocation between Treasuries and futures in the approach to the Fed move alarmed interest rate traders and fuelled concern that asset managers were trying to dump liquid holdings in a desperate dash for cash.