The Federal Reserve is finally kicking off its purchases of corporate bond exchange-traded funds on Tuesday, marking the beginning of its historic intervention into a market that sits traditionally outside of the central bank’s influence.
The Fed’s purchases are aimed at supporting the flow of credit as corporations look to survive the hit from the COVID-19 pandemic, which has upended supply chains, hammered consumer spending and put millions out of work. Since large U.S. businesses often rely more heavily on corporate bond markets than banks to borrow money during times of crises, the Fed’s action looks to arrest financial turmoil that reared up in mid-March and limit the economic fallout from the coronavirus.
Under the emergency lending programs authorized by Congress, the Treasury Department is allocating $75 billion of equity to the Fed, which in turn will lever up this capital on a 10 to 1 ratio, parlaying it into $750 billion of funds.
It’s akin to borrowing $10 dollars for every $1 dollar invested.
A chunk of these funds will be dedicated to purchasing exchange-traded funds focused on the investment-grade corporate bond market, with the rest of the funds left for ETFs in so-called junk bonds, or debt rated below investment-grade.
Fund management giant BlackRock was tapped to run the emergency lending facility on the behalf of the Fed.
The Fed’s ETF purchases aims to give support to the broader U.S. corporate debt market in a way that doesn’t favor a single issuer, said analysts.
In addition, ETFs are considered an important source of liquidity for traders in corporate bonds, which change hands less frequently than government debt. Buying ETFs, thus, aims to be a powerful way for the central bank to stimulate trading in the U.S. corporate debt markets.
Investors have said the Fed’s mid-March announcement about its plans to deploy lending programs to a broad swath of the U.S. financial markets provided a strong signal about the central bank’s willingness to bolster corporate credit markets.
Soon thereafter, Boeing Co. BA, -1.25%, Hyatt Hotels Corp. H, -3.74% and even Carnival Corp CCL, -3.24% were able to tap capital markets and source funds needed to help see through the weeks and months of dwindling cash flow.
“Things were pretty dire back in March. Since then, issuance has been at record levels,” said Marc Kremer, portfolio manager at Franklin Templeton, told MarketWatch. “There’s a question of whether the Fed purchases are really necessary. My feeling is they’re just trying to follow through on their commitments.”
In Wall Street, the S&P 500 SPX, -0.60% and Dow Jones Industrial Average DJIA, -0.47% were giving up ground, following a sharp rally on Monday. The yield for the 10-year U.S. government bond TMUBMUSD10Y, 0.687% fell 4 basis points to 0.68% after a solid auction for the benchmark note.