By Selling $13.8 Billion in Corporate Bonds, the Fed Signals the End of Emergency Measures
As a measure to alleviate pandemic fears, the central bank bought corporate debt from hundreds of companies. Now, it is in the process of unleashing those corporate bonds and ETFs.
The Federal Reserve Went Beyond the Call After March’s Stock Crash
When the pandemic narrative heated up during March of 2020, the economic outlook was so dire that the Federal Reserve took an unprecedented step. For the first time, the central bank created the Secondary Market Corporate Credit Facility (SMCCF). Its purpose was singular – buying corporate bonds.
A business issues corporate bonds to be sold to investors as a way to shore up capital. In other words, corporate bonds serve as debt securities while investors who buy them gain an interest rate. Each corporate bond has a maturation period, expiring on the day interest payments repay the original price of the bond.
It was highly unusual for the Fed to intervene so directly in the private sector. In fact, it was borderline illegal, laying outside the Fed’s domain. However, the central bank creatively interpreted the provision of the CARES Act (Coronavirus Aid, Relief, and Economic Security Act), under section H.R.748, page 193.
The CARES Act allowed the Fed to buy ETFs – indexed securities – but the Fed expanded the meaning so it could create its own index and fill it up with corporate bonds. At the time, Steve Kellner, the executive of corporate bonds at PGIM Fixed Income, noted this abnormality to Bloomberg news.
“Yesterday showed that the Fed’s intent is not just to be a backstop, but to be an active participant in driving spreads back to pre-Covid levels…This was a game changer.”
Why Did the Fed Buy Corporate Bonds?
In total, since last year, the Fed acquired $13.8 billion in corporate bonds ($8.6 billion) and ETFs ($5.2 billion). The purpose of this debt-shopping spree was to inject liquidity into the corporate bond market, effectively shoring up all the bets made by America’s largest corporations. Put in a more direct way, the Fed propped up Wall Street, putting its weight on the side of the richest and most powerful corporate entities.
These include Apple, Microsoft, Visa, Goldman Sachs, Home Depot…among 800 other corporations, of which only 6 companies made up 10% of the SMCCF. By playing the inverted Robinhood role – propping up the richest – the Fed enabled highly profitable companies to sell their debt on the cheap. For example, Apple (AAPL) borrowed $8.5 billion by selling corporate bonds at a maturation period of 40 years with a 2.6% interest rate.
In contrast to such cheap debt, pension funds that rely on fixed income, which the Fed had driven down with its SMCCF, had to incur greater risk. This is just one of the reasons why the Fed is disliked so much across the political spectrum. It just goes to show that the Fed is perhaps the only sovereign entity in existence, which also explains why it can so easily reinterpret the law to suit its needs.
Does Corporate Bond Sell-Off Indicate Economic Recovery?
According to the central bank, the selling of corporate bonds itself can upset the fragile stock market. Therefore, the return to normal will have to be done gradually, as stated in the Fed’s press release on June 2nd:
“SMCCF portfolio sales will be gradual and orderly, and will aim to minimize the potential for any adverse impact on market functioning by taking into account daily liquidity and trading conditions for exchange traded funds and corporate bonds.”
However, considering that the world’s most profitable company in existence, Amazon, sold $18.5 billion in bonds for further investments last month, it doesn’t seem likely that meager $13.8 billion would have much of an impact. Rather, the Fed’s unwinding of corporate assets is a signal that emergency measures are no longer needed.
After all, the Primary Market Corporate Credit Facility (PMCCF), also established last March to issue credit via bonds, was left untouched. Its primary purpose was to signal that the Fed is ready to step in, and the selling off is now a signal that direct interventions won’t be necessary.
Do you think it is appropriate for the Fed to warp the market so significantly and one-sidedly? Or was the interference with market signals worth it? Let us know in the comments below.