(Bloomberg Opinion) -- The Federal Reserve realizes that it doesn’t have to buy U.S. corporate bonds, right?
I ask this question only somewhat in jest. In a surprise move, the central bank announced Monday 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 U.S. 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 U.S. 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. As my Bloomberg Opinion colleague Tim Duy quipped on Twitter, it’s as if policy makers said “we want to expand beyond ETFs, so we will purchase individual bonds such that we mimic an ETF.”
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 last week showed U.S. 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% annualized 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 U.S. corporate bond markets were closed in the primary market’s longest drought since July 2018. In total, investment-grade companies borrowed about $479 billion in the first three months of the year, according to data compiled by Bloomberg. In April and May alone, they combined to issue more than $528 billion of debt. While this month isn’t shaping up to be quite as busy, companies reeling from the pandemic like Delta Air Lines Inc. and Royal Caribbean Cruises Ltd. have been lured back to the bond market, given the favorable conditions.
All this has happened, of course, without the Fed’s credit facilities purchasing a single bond. Private investors have been more than willing to pick up the slack, pouring $14.6 billion into funds that buy U.S. investment-grade debt, high-yield bonds and leveraged loans in the week that ended June 10, the second-highest inflow on record behind the $15.6 billion added in the week ended June 3, according to data from Refinitiv Lipper.
The weeks of record inflows make the Fed’s rush into corporate bonds all the more puzzling. As it stands, the facility will stop purchases no later than Sept. 30, “unless the Facility is extended” by the Fed and Treasury Department. That’s a huge caveat. Why not save the firepower for when — or if — it’s needed? Especially with so much extra room to go in buying ETFs?
According to Bloomberg News’s Christopher Condon and Craig Torres, the Fed built the index internally, and a spokesman couldn’t immediately say whether its details would be made public. The central bank added that it could slow or even pause purchases if market functioning showed sustained improvement.
I’m not sure what more the Fed wants to see. Obviously, corporate executives have been happily reaping the benefits from the wide-open primary market and locking in rock-bottom interest rates. Now with the central bank in play as well, expect investment-grade yields to soon set record lows.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Brian Chappatta is a Bloomberg Opinion columnist covering debt markets. He previously covered bonds for Bloomberg News. He is also a CFA charterholder.
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