Make no mistake in your thinking. Both the bond and the equity markets are being led by the Fed. We are in a time, because of the pandemic, when both Congress and the Fed are doing whatever they think is necessary to get the American economy back on track. The Congress is tossing money up into the air and while it is earmarked, it is the American currency flung about, in various directions, which is valuable for Main Street but it takes a second seat to the actions of the Fed who are now in buying corporate bonds and ETFs and putting a floor under both markets.
The Fed is also keeping interest rates at very low levels which is a dual bump. First, they are helping U.S. corporations borrow money at yields so low that there balance sheets will be positively affected by the levels they are getting which is why we are seeing such a sizable amount of new issues. More than that, they are keeping rates low, so the U.S. government is not constrained by the rates that they have to pay on Treasuries. To be quite blunt, the American government could not afford “normal” yields and so the Fed has moved to make sure they don’t have to pay them.
Total government debt has jumped $2.2 trillion since just before the crisis began, which is an increase of 9.4%. Even with the Federal IOU at $25.6 trillion and counting, many of the central bank officials have said there’s still plenty of room to maneuver, if needed.
I don’t think we’re anywhere near the limit to that…The U.S. government is issuing a lot of debt right now, and global investors are gobbling it up.
– New York Fed President, John Williams
The Fed said the “preponderance” of those holdings would be in funds whose primary investment objective was in the market for debts with investment-grade ratings, but officials said they would allow for some purchases of ETFs with exposure to high yield bonds. The Fed has disclosed 158 transactions made between May 12 and 18. Of the Fed’s $1.3 billion in ETF holdings as of May 19, around 17% were in funds that invest primarily in high yield debt. The Fed has said it would purchase up to $250 billion in outstanding corporate debt and up to $500 billion in newly issued debt, as well. The Fed’s largest ETF purchases:
iShares iBoxx US Dollar Investment Grade Corporate Bond ETF
Vanguard Intermediate-Term Corporate Bond ETF
Vanguard Short-Term Corporate Bond ETF
iShares iBoxx High Yield Corporate Bond ETF
SPDR Bloomberg Barclays High Yield Bond ETF
iShares Short-Term Corporate Bond ETF
SPDR Portfolio Intermediate Term Corporate Bond ETF
iShares Intermediate-Term Corporate Bond ETF
SPDR Portfolio Short Term Corporate Bond ETF
iShares Broad US Dollar Investment Grade Corporate Bond ETF
There is a play here. It will be far easier for the Fed to buy more of what their investment committee has already approved than to buy new names. This is just the way of it in large institutional accounts. Consequently, if you get in between the first and second purchases it may work out to your advantage.
Soon the Fed is going to start buying single issuer corporate bonds. This is the companion program to the ETF program which is named the “Primary Market Corporate Credit Facility.” This facility will also buy syndicated loans. It will be quite interesting to see what they buy here but my guess is very large credits with lots of liquidity.
With the Fed stepping into the arena I also have a warning for my trader friends. You all have longs and shorts based upon relative value and the ingenuity of your algos. Allow me to suggest that you be more than careful about your shorts now. If the Fed steps in and buys some credit that you are short, and as the word floats around the Street, that credit could be up points and points in the blink of an eye. You have a new dynamic to deal with now.
Lastly, there is the compression issue. With the “Leader of the Pack” in buying bonds the spreads of risk assets are going to tighten further against Treasuries, in my estimation. Corporate bonds, and all of the other risk assets, will be edging up in price and this is also a play for those wishing to participate. I point out that we are now in a highly controlled market where the actions of the Fed will take precedence over market data. Make no mistake here, you cannot beat the folks that make the money and spend it as they see fit.
Editor’s Note: The summary bullets for this article were chosen by Seeking Alpha editors.