It’s hard to believe it was less than two months ago when the US corporate debt market was pushed to the brink by a combination of the COVID crisis and the onset of a short-lived oil price war between the Saudis and the Russians.
To be sure, there’s a sense in which the dark days of late March feel like just yesterday. Epochal shocks and the multi-standard deviation market events they often produce aren’t easily forgotten. This crisis will be enshrined in the history books, and the anomalous price action it engendered will always stick out like a sore thumb on a chart of virtually any asset you care to consult.
So, it’s not that March feels like a long time ago. Rather, it’s that the swiftness and ferocity of the snapback in various measures of corporate credit stress means that 60 days on, you’d never know anything happened if all you were consulting were today’s levels.
As a reminder, there was a point in March when LQD – the most popular investment grade credit ETF – was trading as wide (or wider) to NAV as it did during the financial crisis. In the days following the Fed’s historic announcement that high-grade debt would be backstopped, the product flipped back to trading at a steep premium (green arrow).
That was indicative of the U-turn to come in pretty much every conceivable measure of stress or disruption in IG credit.
Last week, the Fed made its first purchases of credit ETFs to the tune of $305 million in a day. LQD is widely seen as the most logical target, and fund flows data for the product pretty clearly indicates folks have attempted to front-run Powell at various intervals.
But everyone has seen those visuals. I wanted to take a few minutes to highlight updated versions of a few charts from JPMorgan you might not have seen, just to underscore how successful the Fed has been at tamping down panic and normalizing market functioning with nothing more than a verbal pledge.
Remember, last week’s initial purchases were the first time the Fed actually did any buying via the corporate credit facilities. In other words, the Fed engineered the bounce shown in the following chart without spending a single dime to support the corporate credit market.
“The Fed chose to start with ETFs rather than bonds as significant hurdles remain on the latter”, JPMorgan’s Nikolaos Panigirtzoglou writes, in a new note, adding that “given a number of weeks have passed… the start of corporate bond ETF purchases should alleviate concerns that these hurdles could hamper the starting of the Fed’s corporate credit facilities”.
Panigirtzoglou looks at short interest and liquidity metrics to illustrate the improvement in market conditions catalyzed by the Fed’s forthcoming foray.
I’ve mentioned this before, but at this point, the collapse is so dramatic that it certainly bears repeating. Panigirtzoglou writes that the quantity on loan as a share of outstanding for LQD “was rapidly unwound” after the Fed announced its intention to venture into corporate credit. Suffice to say “rapidly unwound” is wholly insufficient to describe the almost comical decline shown in the left pane below.
The picture isn’t nearly as dramatic for HYG (right pane) but as you might recall, IG credit was actually the locus of the pain in March, due in part to worries that the COVID crisis would finally trigger the dreaded “BBB apocalypse” that many market participants have been warning about for years.
As for liquidity, JPMorgan uses the Hui-Heubel ratio from the academic literature. This will be familiar to readers of the bank’s “Flows & Liquidity” series – Panigirtzoglou uses it all the time. Basically, it shows the price impact of volumes on prices or market breadth.
“The ratio for LQD retraced around 80% of its previous rise from late February to its mid-March peak by early April, before settling at new levels”, Panigirtzoglou writes. Do note from the visual on the left that on this measure, liquidity for LQD was severely (and I do mean severely) impaired two months ago.
On the right, JPMorgan takes a look at the absolute deviation to NAV – i.e., the same thing illustrated in the first visual above, only using both premiums and discounts and using a five-day moving average.
“During the intense pace of the risky market sell-off during March, the absolute deviations from NAV rose sharply for both IG and HY bond ETFs”, Panigirtzoglou says, briefly recapping the dramatics. “While the ETF liquidity metric in Figure 9 has fully normalized for IG ETFs, the equivalent metric for HY ETFs has yet to return to pre-virus levels”.
There’s nothing particularly novel about any of the above, but given the attention afforded the Fed’s corporate debt purchases, it’s worth highlighting the short interest and liquidity proxies, as they give you a more nuanced look at the situation than you’d get from simply pulling up a “V-shaped” chart of LQD.
At the end of the day, though, the takeaway is the same – namely that the Fed found what transpired in late March to be wholly distasteful. And Jerome Powell’s exhortation for the market to mind its manners was heard loud and clear.