Some will call it an astounding feat in light of the economic circumstances and evidence of smashing success for a Fed determined to avert systemic credit events in a crisis.
Others will invariably characterize it as a dubious milestone, indicative of the moral hazard the central bank has unleashed with its corporate bond-buying programs.
Whatever you want to call it, US investment grade issuance topped the $1 trillion mark on Thursday for 2020. That is a record for the first 149 days of any year. Normally, the mark isn’t hit until the fourth quarter.
“The previous quickest pace came in 2017, when sales flew past the $1 trillion milestone in August, pushed by deal financing from the likes of AT&T, British American Tobacco and Amazon”, Bloomberg writes. “Supply reached $1.4 trillion by year-end, setting an annual record”.
Headed into the pandemic, corporate America was already sitting on a large debt pile after years of accommodative monetary policy pushed investors out the risk curve and down the quality ladder, creating insatiable appetite for corporate supply. The low cost of debt and the temptation to use the proceeds for EPS-inflating buybacks left balance sheets highly levered.
Now, companies are tapping the market not for the purposes of financial engineering (buybacks are expected to plunge by around half in 2020), but to ensure they have the liquidity they need to ride out the worst storm since the Great Depression. Sensing that all but the most pristine of corporates would lose market access as spreads ballooned wider during March’s chaos, the Fed stepped in with a backstop for investment grade credit. Shortly thereafter, the central bank opened its doors to fallen angels.
As discussed in these pages at great length, the Fed didn’t deploy a single dime in the corporate credit market until earlier this month. Rather, the mere promise of future purchases was enough to compress spreads and turn the tide on fund flows. Indeed, it’s possible to argue that the Fed’s pledge to backstop the market was itself enough to help Boeing avert a $60 billion taxpayer bailout.
The risk, though, is clear. Piling debt on top of debt at a time when cash flows are choked by a deep recession means companies who borrow now could find themselves unable to service that debt down the road, leading to a second wave of defaults and credit events following the initial bankruptcy tsunami catalyzed by the COVID lockdowns.
Some critics argue that the Fed is simply creating corporate “zombies” whose debt will now be seen as carrying an implicit guarantee from the US government.
In any event, another consequence of the Fed’s pledge to support corporate credit was a turning of the tide in fund flows. I’ve documented this on a weekly basis, and the latest data from Lipper (out Thursday afternoon) shows IG funds took in $7.5 billion in the week to May 27. That is the second-largest haul on record.
It also marks the seventh straight inflow into IG funds, which experienced a veritable exodus during March’s darkest days.
Meanwhile, high yield funds took in $6.3 billion last week. It was the ninth straight week of inflows.
The total (nearly $14 billion between high-grade and high yield funds) looks to be a record, and the inflow into junk funds was the third-largest ever. Note how many of the biggest weeks for high yield inflows have occurred in 2020.
Analysts see the pace of issuance tailing off from here, now that companies have raised enough cash to get them through the worst of the crisis.
No matter how much you may disagree with the Fed’s decision to buy corporate bonds, it’s hard to see this as anything other than a “mission accomplished” situation for Jerome Powell. The Fed has bought a relatively minuscule amount of corporate credit ETFs over the two weeks the secondary market facility has been operational and the primary market program isn’t even truly off the ground yet.
In other words, the Fed has engineered a record in blue chip corporate bond issuance and triggered a wave of inflows into credit ETFs, essentially by doing nothing other than making the market aware of its intention to buy. All of that in the midst of a modern day depression.
“Flows into HY and IG are rising at the same time as supply is booming”, Jefferies’ Sean Darby said this week. “[That’s] the perfect answer for a central bank dealing with a credit crunch”.