The Fed Will Be Building A Corporate Bond Portfolio. Or Didn’t You Believe Them?

Capital markets are supposed to be efficient, but they sure don’t act like it sometimes.

Monday was a case in point.

To paraphrase The Brain from the film “Brick” (an absurdly underrated neo-noir masterpiece), I bet if you got every trader in town together and said ‘Show your hands’ if any of them didn’t know the Fed would soon announce details around purchases of individual corporate bonds, you’d get a crowd of full pockets.

In other words: It’s not exactly a secret that the Fed is poised to buy corporate bonds in addition to the credit ETF purchases which started last month. In fact, the only reason some investors are even in corporate credit in the first place is to frontrun the Fed. Here’s how BofA put it a month ago:

Note to Fed: A lot of investors (including non-credit ones) have bought IG corporate bonds the past two months on the expectation they can sell to you. So it would be helpful if you soon began buying in size.

Given that, you wouldn’t think the formal announcement of corporate bond buying on top of ETFs would cause much of a stir, but it did. In fact, it pulled equities out of the red on Monday afternoon, and pushed the dollar lower.

You can, if you’re so inclined, sign up for real time e-mail alerts from The New York Fed to keep yourself apprised of what’s going on with the various emergency facilities on any given day. Below, for example, is the alert sent out Monday afternoon announcing the next steps for the secondary corporate credit facility.

As specified in the revised term sheet, the SMCCF will begin purchases of corporate bonds to create a portfolio that tracks a broad, diversified market index of U.S. corporate bonds. This index is made up of bonds trading in the secondary markets that have been issued by companies created or organized in the United States or under the laws of the United States that satisfy the criteria detailed in the revised term sheet.  Issuers must have been rated investment grade as of March 22, 2020, and still be rated at least BB-/Ba3 on the date of purchase by the SMCCF.  Issuers also cannot be an insured depository institution, depository institution holding company, or subsidiary of a depository institution holding company. Finally, the bonds must have a remaining maturity of no more than five years. The SMCCF will begin purchasing bonds from Eligible Sellers on June 16.  These purchases follow the start of purchases by the SMCCF of exchange-traded funds (ETFs) on May 12. 

So, that’s that, then. There’s a longer version embedded below, but there doesn’t appear to be anything surprising about this, although news that the Fed will follow an index created specifically for the facility is a wrinkle.

“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 remarked. “This indexing approach will complement the facility’s current purchases of exchange-traded funds”.

The announcement briefly turned the tide decidedly in favor of risk assets late in the US session, and perhaps more importantly, cut the legs out from beneath the dollar. CDX IG spreads dropped 9bps.

Flows into corporate credit have been robust lately, to say the least. Investment grade funds just took in more than $9 billion for the second straight week, the latest Lipper data showed.

Inflows into high yield have been similarly impressive. In fact, 2020 has seen a number of record weeks for junk inflows, according to Lipper.

EPFR data for last week showed the second largest IG inflow ever at $18.6 billion.

(BofA, EPFR)

You get the idea – the market isn’t just anticipating this, investors have already traded it. They’ve been trading it for months or, in other words, since the Fed first announced it would backstop the corporate credit market (the announcement on fallen angels came just days later).

As noted above, credit ETF purchases began almost exactly a month ago.

Issuance has approximated a flood. Powell’s promise to support the market kicked open the door for borrowers, who took the opportunity to raise as much money as possible. IG supply is running so far ahead of the usual pace that one can only chuckle in amusement (and amazement).

“While the Fed’s corporate bond ETF purchases took longer to materialize, they have reinforced the announcement effect by strengthening demand in recent weeks”, JPMorgan said earlier this month.

“There is little doubt the original announcement of the Fed’s corporate credit facilities helped facilitate demand by providing an implicit backstop”, the bank went on to say, adding that liquidity metrics for the largest ETFs have improved dramatically, recovering to pre-crisis levels.


Within an hour, equities had given back gains logged in the wake of the Fed’s announcement, perhaps proving that while markets are not, in fact, always very efficient, they do come to their senses once carbon-based lifeforms have a chance to “correct” moves attributable to headline-scanning machines.

And yet, by the time the closing bell sounded, stocks were higher, because… well, just because.

I suppose now there’s just one question…

More from the Fed


Leave a Reply

This site uses Akismet to reduce spam. Learn how your comment data is processed.

12 thoughts on “The Fed Will Be Building A Corporate Bond Portfolio. Or Didn’t You Believe Them?

  1. I can’t help but to think about your recent post on Kocic’s state of exception, the Fed buying individual corporate bonds is another way to cement the state of exception as the new normal, will this cause further atrophy in the markets transmission mechanism? Even if it does will it matter? I guess only time will tell, I know you have detailed in exhaustion how the measures by the Fed have had the intended result, I cannot disagree with the fact the backstop has worked and I have little interest in joining the moral hazard crew, but to the extend the Fed feeds the market dependency loop we move further away from a market where price discovery is the main driver. Distressed debt investors are in a win win situation, they can gorge in high yielding junk and if things turn sour just sell their junk to Jerome. Central Banks have created a monster that needs to be managed constantly to maintain an illusion of control and functionality, we give the addict more and stronger drugs in the hope that some day it may simply cure itself, there is no exit plan so this better works.

  2. The moral hazard problem (and free riding and adverse selection) is/are a real problems that do raise transaction costs and misallocate capital in the long run whether it’s hip to believe in it or not. Consciously deferring addressing those problems is one thing but denying they present real danger is quite another. The Austrian leeches and bleeding prescription is obviously fatal for the patient, but that doesn’t mean that “Oh taking one made you feel better? Great let’s double the dose” is good for the patient either.

  3. I am starting to wonder what exactly markets are any more. MMT at the consumer level at least makes sense as market participants need to compete to capture the money as it gets spent. MMT at the corporate level basically turns corporations into shell companies to syphon wealth from the US population. Is that where we are now, the vulture funds out of other targets are simply going to withdraw the full value of the USA then close up shop and skip town? You can complain about the looting in the streets but this is the real show.

  4. I’m not much of a reader of Fed tea leaves.

    On its face, there appears to be no need for the Fed to buy corporate bonds. Credit conditions are fine, at least for larger companies. Is it possible that the Fed is flexing its muscles in anticipation of much worse credit conditions ahead?

    If so, should we expect a similar program for munis?

  5. Will be interesting to see the political pressure on the rating agencies and the MMT for corps when the fundamentals for some of these companies degrade to untenable situations.

    We’ll all be hearing a lot about “extend and pretend” in the future.

    Socialism Trump style. Rs must be loving it.

  6. This is not amoral Hazard issue at all……This is a human failing in if this solution does not work we go up the ladder looking for a more drastic remedy… Capitalist based systems do not operate well in reverse… You might liken this to prehistoric Brontosaurus who ate all the low leaves on the trees…and did not survive the ice ago ..(as the fable goes) ..Time for some selective adaptation me thinks….

  7. Ignoring moral hazard arguments (for now), pragmatically speaking we have functioning credit markets and high flying equities so shouldn’t the Fed be hinting at an exit strategy so the market digests it early?

    Everything I heard in Powell’s overcommunicative “plain speech” model was “we’re really worried, lots of uncertainty, I guess we’ll save the US if the Congress won’t” which to me indicates they’re ok with unintended consequences as long as the bigger hammer “solves” economic problems… except the problem is a virus?
    (Is Powell committing to trickle-down-middle-man funding until a widespread vaccine?)

NEWSROOM crewneck & prints