Federal Reserve to support credit markets by buying corporate bond ETFs

Mar 24th, 2020 | By | Category: Fixed Income

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The Federal Reserve has announced it will support US credit markets by extending its asset purchase program to corporate bonds and ETFs that hold them.

Federal Reserve to support credit markets by buying corporate bond ETFs

The U.S. Federal Reserve has vowed to support credit markets by buying corporate bond ETFs.

Corporate bond markets have been in freefall recently as the extent of the coronavirus’s impact on economic growth has cast doubt on the financing ability of even the most creditworthy issuers.

The $30.3bn iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD US), the largest US-listed ETF to track USD investment-grade credit, slumped 18.8% between 9 March and 20 March 2020.

In Europe, the $4.5bn iShares $ Corp Bond UCITS ETF (LQDE LN), which shares the same underlying reference, the Markit iBoxx USD Liquid Investment Grade Index, suffered a similar fate.

Liquidity in the corporate bond market has also tightened severely causing a dislocation in pricing between ETFs and their underlying indices and holdings.

Due to the uncertainty and liquidity issues in the market, the Federal Reserve has taken the decision to step up its market intervention following a move to slash interest rates to almost zero last week.

Two new facilities will be established to manage the Central Bank’s program – the Primary Market Corporate Credit Facility (PMCCF) and the Secondary Market Corporate Credit Facility (SMCCF).

The former will purchase newly issued corporate debt directly from firms in primary markets, while the latter will focus on bonds and credit ETFs trading in secondary markets. Each program has been allocated an initial $100 billion mandate.

The Federal Reserve has not explicitly indicated which ETFs it will purchase but noted in a statement that these funds will include “US-listed exchange-traded funds whose investment objective is to provide broad exposure to the market for US investment-grade corporate bonds”.

The bank will not extend the program to high-yield bonds or their ETFs.

Some analysts have labeled the scope of the intervention as modest, considering the $8 trillion market capitalization of the entire corporate bond markets. However, investors reacted positively to the news, encouraged by the Federal Reserve’s willingness to take unprecedented steps to support the economy.

The iShares iBoxx $ Investment Grade Corporate Bond ETF has rallied 3.6% so far this week, as of the market’s close on Tuesday. It has also seen over $1bn in net inflows.

In a further indication of its dedication to markets, the Federal Reserve also announced it has removed the limit on its purchases of Treasuries and agency mortgage-backed securities, previously set at $500bn and $200bn respectively.

The yield on ten-year Treasuries fell 0.2%, while the broad market iShares US Treasury Bond ETF (GOVT US) gained 1.4%.

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