The Fed doesn’t need to buy corporate bonds

The Federal Reserve realises that it doesn’t have to buy US corporate bonds, right? I ask this question only somewhat in jest. In a surprise move, the central bank announced that it would start to buy individual company bonds under its $250 billion Secondary Market Corporate Credit Facility, specifically by following a diversified index of US corporate bonds created expressly for its program. “This index is made up of all the bonds in the secondary market that have been issued by US companies that satisfy the facility’s minimum rating, maximum maturity and other criteria,” the Fed
said in a statement. Notably, issuers of bonds acquired through this program don’t need to provide certifications, unlike the stipulations for individual debt purchases.
It’s not immediately clear why this is necessary, nor how this will impact markets any differently than the facility’s current purchases of exchange-traded funds. So far, the secondary-market vehicle has bought about $5.5 billion of ETFs.
Predictably, the largest investment-grade bond ETF, ticker LQD, surged in the wake of the announcement to its biggest intraday gain since April 9. That was the day the Fed changed the parameters of its credit facilities to allow for purchases of high-yield ETFs and debt from fallen angels that were investment grade as of March 22.
The most surprising part of this is there is virtually no evidence that the corporate-bond market needs this kind of intervention — it has been working nearly flawlessly for months. Sure, the credit ratings of several brand-name companies have been lowered since Covid-19 started to spread across America in March. Some even fell into junk, like Ford Motor Corp., Kraft Heinz Co and Macy’s Inc. For countless others, their business model has radically changed for at least the next several months, if not years.
And yet the average yield demanded by investors for investment grade debt fell last week to just 2.23%. On March 6, the rate was 2.22%, the lowest ever in Bloomberg Barclays data going back to 1972. On that day, the benchmark 10-year Treasury yield tumbled as much as 25 basis points to a record low and closed at 0.76%, while investment-grade bond spreads widened to 144 basis points in what was the credit market’s worst day in a decade. By contrast to those volatile bouts, the move lower in corporate yields during the past few weeks could be described as nothing short of orderly, with average all-in rates falling or staying constant for 21 consecutive trading sessions through June 10 and never dropping by more than 9 basis points at a time.
One reason for this type of indexed buying might be that the central bank is worried about the overall leverage levels of corporate America. A Fed report released showed US nonfinancial business debt, which includes bank loans and corporate bonds, increased in the first quarter by the most in records dating back to 1952. Firms added $754.8 billion of debt, equivalent to an 18.8% annualised rate, in the first three months of the year. Now with $16.8 trillion of borrowing, nonfinancial corporations have more debt outstanding than all American households.
At first glance, that seems rather obvious. That time frame roughly coincides with companies rushing to raise cash and stave off imminent liquidity problems as the coronavirus crisis reached a zenith. But the first quarter also included a period of about two weeks in late February and early March in which the US corporate bond markets were closed in the primary market’s longest drought since July 2018.

—Bloomberg