The Federal Reserve is buying corporate bonds for the first time in an attempt to curb the economic fallout of the coronavirus.
Fed Says It's Trying To Improve Liquidity
The central bank will begin to purchase $750 billion in corporate bonds Tuesday with its Secondary Market Corporate Credit Facility. The program will prioritize ETFs with investment-grade debt and some high-yield junk bonds. The Fed’s Primary Market Corporate Credit Facility, which involves direct acquisition of corporate debt, will follow “in the near future.”
“Purchases will be focused on reducing the broad-based deterioration of liquidity seen in March 2020 to levels that correspond more closely to prevailing economic conditions,” the Fed wrote in its investment management agreement.
BlackRock, Inc. (NYSE: BLK) is managing the bond-buying program, which requires $75 billion in Treasury equity leveraged 10-to-1. The loans are backed by $454 billion in Congressionally allocated equity.
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'We Are All Government-Sponsored Enterprises Now'
At the start of the pandemic, U.S. companies began to tap expensive bank credit lines — about $350 billion worth, according to JPMorgan strategists — to strengthen their balance sheets. The mere announcement of the Fed program in March helped curb this trend.
With the might of the Fed beside them, investors began to approach the credit market with more confidence. Fund managers focusing on investment-grade debt saw an influx of cash supporting their largest bullish position in three years, according to Bank of America.
The market conditions enabled companies to secure bonds at lower interest rates than revolving credit and to repay bank lines with long-term debt. PayPal Holdings Inc (NASDAQ: PYPL) issued $4 billion in such bonds, VF Corp (NYSE: VFC) and Dillard’s, Inc. (NYSE: DDS) each issued $3 billion, and Altria Group Inc (NYSE: MO) and Mondelez International Inc (NASDAQ: MDLZ) issued $2 billion and $1.5 billion, respectively.
Notably, the program is expected to skew risk and interest payouts in the bond market.
“We are all government-sponsored enterprises now,” Scott Minerd of Guggenheim Investments wrote in an investor letter. “At the margin some questionable credits will not only have lower risk of default, but they will also have lower risk of downgrade and pay lower rates of interest.”
What’s Next For The Fed
The Fed is rolling out eight other emergency lending programs as part of the $2-trillion stimulus package passed by Congress. Some economists expect the Fed to announce negative interest rates this year, which would further affect payouts in the bond markets.