The Elephant in the Corporate Bond Market

Written by: Ken Frey

Last week the Federal Reserve announced an update to its Secondary Market Corporate Credit Facility (SMCCF), which as of June 15th can begin buying a broad and diversified portfolio of corporate bonds. Until this time, it only purchased corporate ETFs. The SMCCF is a $750 billion program meant to support market liquidity and the availability of credit for large employers.

The SMCCF was established on March 23rd, the day the corporate market credit spread (yield difference versus Treasury) hit a wide 373 basis points (bps). Since then the corporate market has rallied 228 bps even though the SMCCF has only purchased approximately $7.5 billion in ETFs – compared to a corporate market of over $8 trillion.

It appears the Fed’s announcement of support was what the market needed. In addition to massive tightening since the announcement on March 23rd, issuance of corporate bonds is double what it was last year. Currently any company can access the market in size - even cruise lines and oil companies.

This leads the market to question: “What is the Federal Reserve trying to do and what are they really accomplishing?”

We believe the Fed is trying to do just what they said. They set up and are testing a program that will be available if the corporate market seizes up and needs assistance. They are not trying to crowd out the natural buyers of corporate bonds through a massive buying program.

However, even small programs by the Fed can have large impacts.

The Fed is the elephant in the room and can move markets with the slightest turn. In fact, when Mr. Powell was answering questions about this program at his semi-annual testimony before Congress last week, he was quoted: "I don't see us wanting to run through the bond market like an elephant snuffing out price signals and things like that."

We do think having the elephant at your back helps support the corporate market, even if Fed purchases are not large. Perhaps more importantly, we are encouraged the US economy appears to be turning up from a very steep downturn, corporate spreads are still attractive from a historical perspective, and there is more real demand as foreign buyers are supported by attractive hedges and lower overseas yields.

Related: Municipal Bonds Come Roaring Back