Because it can’t just let the free markets be free, the Federal Reserve will now begin buying individual corporate bonds. It will do so to apparently keep the financial markets from ever going down.
The announcement came yesterday in the midst of a 760-point selloff in the Dow Jones Industrial Average. This, however, quickly reversed and saw the index close the day up 157 points.
Capitalism and the idea of free markets have become even more threatened. With this, the Fed will begin “to create a corporate bond portfolio that is based on a broad, diversified market index of U.S. corporate bonds” to go along with the $5.5 billion in corporate bond ETFs and junk bonds that it is already buying.
“This index is made up of all the bonds in the secondary market that have been issued by U.S. companies that satisfy the facility’s minimum rating, maximum maturity, and other criteria. This indexing approach will complement the facility’s current purchases of exchange-traded funds,” the official statement said.
The Fed’s Plan
The Fed will run the purchases through its Secondary Market Corporate Credit Facility. The facility serves as the same one used to buy up the corporate bond ETF and junk bonds. The Fed also has a Primary Market Corporate Credit Facility. It will use the said facility to buy bonds directly from the issuer.
Both credit facilities will use about $75 billion of equity from the US Treasury to make the purchases. Although, the amount could balloon as high as $750 billion if needed. The funding pushed through as part of the CARES Act. Lawmakers passed the said act in March as the country grappled with the coronavirus pandemic.
The goal of the latest bond purchases is to “support market liquidity and the availability of credit for large employers” according to the Fed. This will require that any bonds purchased carry an investment-grade rating and mature in five years or less. There is a carve-out, however, that would grant eligibility to “fallen angels” that were investment-grade prior to March 22. However, these have since been re-rated to junk status.
Economists and Investors React
Steven Friedman, senior macroeconomist at MacKay Shields, says the move “to buy a broad portfolio of corporate bonds represents a shift to a more active strategy for the secondary market corporate credit facility, rather than the passive approach originally envisioned.”
Friedman added the latest initiative “may also reflect the Committee’s view that the economic recovery from the ongoing COVID-19 crisis will be an extended and challenging one, with credit markets requiring extensive support.”
In other words, the Fed sees the recovery from the pandemic to be a much tougher slog than the equity markets are currently pricing in. Also, it is preemptively going to take action to keep credit markets from freezing up.
At least one investor says the Fed has really stepped over the line with its latest plan.
Christopher Whalen, a former investment banker and now head of Whalen Global Advisors says, “I think [the bond purchases are] a mistake, because they already achieved their objective. The Fed doesn’t need to get distracted. What they care about is that markets work and spreads don’t go crazy. The Fed has to realize that other than assuring that market conditions are acceptable, they really shouldn’t go diving into this stuff.”