Flatten the Curve? The Fed’s Trying to Get Ahead of It - OZY | A Modern Media Company
The expansion of the Fed’s crisis-fighting toolkit to encompass riskier debt will be controversial.


The U.S. central bank is going beyond its traditional approach to try to prop up the markets.

By Joe Rennison and Colby Smith and Robin Wigglesworth

The Federal Reserve has jolted credit markets by expanding the scope of its support measures, announcing plans to buy debt issued by riskier companies in a radical addition to its crisis-fighting toolkit.

The Fed will not purchase high-yield bonds directly, but will buy shares in exchange-traded funds (ETFs) that own the debt and seek to track the market. Its Thursday announcement has since sparked the biggest rally in the asset class since the 2008 financial crisis.

The move adds a new dimension to the central bank’s efforts to buttress the U.S. economy, which already include buying more highly rated corporate bonds and ETFs. But it also means stepping into riskier corners of a market that most investors thought would remain off-limits to the U.S. central bank, reflecting the scale of the coronavirus threat to markets and economies.

It is both shocking and almost amazing.

Peter Tchir, Academy Securities

“It is both shocking and almost amazing,” says Peter Tchir, chief macro strategist at Academy Securities. “I like it a lot because they are getting ahead of the curve.”

The high-yield market, often referred to as “junk,” encompasses the debt issued by lower-rated, riskier companies that are more exposed to deteriorating economic conditions stemming from the viral outbreak and the collapse in oil prices.

In response to the Fed’s move on Thursday, the biggest high-yield bond ETF — run by BlackRock, which is also administering the Fed’s bond purchases — jumped by more than 7 percent, on course for its largest one-day move since 2008. 

The U.S. central bank has also expanded its existing credit facilities, which include the purchases of bonds and ETFs, from a combined $200 billion to $750 billion. A separate facility will now accept highly rated bonds backed by commercial real estate loans, as well as the safest slice of instruments backed by leveraged loans. 

Under the program, the central bank will buy corporate bonds that were rated BBB– or above — the threshold for a company’s debt to be considered investment-grade — on March 22. That still includes bonds from recently downgraded companies such as Ford, known as “fallen angels” when they lose their coveted investment-grade ratings. 

Seema Shah, chief strategist at Principal Global Investors, says the Fed’s intervention would provide some “welcome relief” to the still-stressed market. The yield on Ford’s $1.8 billion bond maturing in 2031 dropped from almost 13 percent to 9.3 percent after the announcement, as its price recovered.

“Fears about how the high-yield market would absorb the wave of oncoming fallen angels have been weighing heavily on the market,” says Shah.

Rear View Of Businesswoman With Colleague Discussing Graph On Desktop Pc At Office

The Fed will not purchase high-yield bonds directly, but will buy shares in exchange-traded funds that own the debt and seek to track the market.

Source Getty

Some analysts, bankers and private equity executives had been pushing for the Fed to throw a lifeline to corporate debt rated below investment grade, arguing that without the central bank’s support, many large employers could go bust

Nonetheless, the expansion of the Fed’s attempts to encompass riskier debt — including debt issued by companies owned by private equity firms — will be controversial. One investment industry insider argues it’s tantamount to an indirect bailout of the private equity industry. 

“If you think people were upset about bailing out banks where the CEOs were making $50 million a year, how are they going to feel about bailing out private equity firms where the CEOs make $500 million a year?” wonders an investor. 

Some investors in the municipal bond market are chafing at the Fed’s initiative, saying the central bank has not yet gone far enough to support states and cities.

The Fed has said it will purchase up to $500 billion of short-term notes from states and some counties and cities in an attempt to shore up their funding, but has stopped short of supporting longer-dated municipal bonds.

“To buy high-yield bonds and not [longer-dated] munis is not fair,” says Vikram Rai, head of municipal strategy at Citigroup. The Fed’s expanded effort to aid the muni market is “a huge disappointment,” he says, adding that the central bank needs to consider buying muni bonds with longer maturities.

By Joe Rennison and Colby Smith and Robin Wigglesworth

OZY partners with the U.K.'s Financial Times to bring you premium analysis and features. © The Financial Times Limited 2020.

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