Investor demand for commercial paper backed by mortgages – a key source of short-term funding for companies and financial institutions – has plunged in recent weeks, according to Federal Reserve data that helps explain recent turbulence in short-term debt markets, reports the FT on Friday.Volumes of asset-backed commercial paper have fallen more than 10 per cent over the past two weeks as money market investors have shunned any exposure to the troubled mortgage market in favour of the safest and most liquid short-term government securities.That shift in portfolio allocation helped push the yields on Treasury bills dramatically lower last week, prompting Fed intervention last Friday as the yield on the one-month Treasury bill dropped below 2 per cent.The total amount of commercial paper outstanding shrank by $90.2bn in the week ending August 22, versus a $91bn decline the previous week. But last week’s decline was heavily concentrated in the asset-backed category, which fell $77bn versus a $48bn decline the prior week.

Sharp drops in the value of mortgage-related securities have rattled commercial paper investors, following losses at hedge funds and other investment groups that owned bonds backed by subprime mortgages. Commercial paper is also used to fund portfolios of securities backed by mortgages and other consumer loans – with such paper representing around half of the outstanding debt in the $2,000bn market.
The problems have had a serious knock-on effect for companies that rely on the commercial paper markets to fund their operations, as investors have refused to roll existing holdings into new commercial paper issues, except at very high rates. Asset-backed commercial paper rates have risen by 100 basis points in recent days to above 6 per cent.

There are signs, however, that companies could be staving off liquidity problems with short-term measures. According to analysts at Wrightson ICAP, while the stock of asset-backed commercial paper has fallen, the volume that must be rolled over each day was still rising in the early part of this week as issuers have been forced to rely on very short-term maturities rather than longer-dated paper.