A woman passes by the United States Federal Reserve Building in Washington DC on May 21, 2020.
Ting Shen | Xinhua News Agency | fake pictures
As the Federal Reserve deepens its purchases of corporate debt, it faces more questions about the consequences of its unprecedented market interventions.
Disclosures released this week around its lines of credit show that the Fed is not only buying the bonds of struggling companies affected by the coronavirus pandemic, but also some of the stalwarts of the US industry: Microsoft, Visa and Home Depot. just to name three companies whose Fed debt they directly hold.
The Fed has an expansive list of other companies indirectly, including names like Apple and Goldman Sachs, through exchange-traded funds it has purchased.
Additionally, he has bought bonds in speculative grade companies as well as ETFs including the SPDR Bloomberg Barclays High Yield Bond, a fund in which the Fed has a $ 412 billion position.
When the Fed expressed its intention to buy corporate bonds, it was an important moment for both the institution and the bond market, which had frozen amid fear of the damage the coronavirus would cause to the economy. But with that decision questions also arose about the probity of such a movement in the functioning of free markets, and the role of what is supposed to be an independent central bank.
“In a way, you wonder if it makes sense for them to buy Apple bonds. The spreads are so tight and the stocks are so good. I wouldn’t think they would need the support of the Fed,” said Kathy Jones. fixed income director at Charles Schwab. “I suppose the reasoning makes sense. But when you look at the result, you scratch your head and wonder if this is where we need the money.”
Undoubtedly, purchases so far have been modest.
Revelations that the Fed released over the weekend show it owns nearly $ 430 million in individual bonds and $ 6.8 billion in ETFs. That’s just a splinter in a corporate bond market worth more than $ 10 trillion and fixed-income ETFs with assets of $ 961 billion.
The Fed has created its own diversified bond index, with a 42% tilt toward higher-rated debt and the remainder toward mid-to-low variable grades and a slight tilt toward speculation. In sector terms, the bonds are weighted towards consumer and technology companies.
Those purchases so far have come on the secondary market, or bonds already issued. The Fed announced Monday that it would soon open its primary market facility, which it will buy directly from the companies.
“They accomplished a couple of things. They managed to move on while having little impact on how those bonds are actually trading,” said Tom Graff, head of fixed income at Brown Advisory. “This literally says that we are going to follow the movements of doing what we said we were going to do, but we are going to do the least and have the least possible impact beyond what we have already created by recognizing that the program will come out at all.”
Still, Jones said one of the reasons the Fed is buying some of the higher-profile companies is that they are big employers at a time when nearly 20 million Americans are collecting unemployment benefits. However, that will not stop concerns that the Fed is overshooting.
“I think it is a moral hazard,” said Jones. “I think it is something they will have to deal with when things calm down. There will be allegations that they committed money in ways that made no sense and did not help the average Joe.”
It is not a permanent solution
Goldman Sachs sees the potential for moral hazard plus two other problems: misallocation of capital and a diminished appearance of independence for the Federal Reserve.
Some of those concerns are well known and were voiced during the Fed’s last aggressive foray into markets in the financial crisis.
However, Goldman says most of those concerns should be allayed.
As the Fed continues to steer markets properly, the ideas of moral hazard and loss of independence will disappear as conditions improve. On the misallocation of capital, mentioned primarily with respect to the Fed’s purchase of junk debt, Goldman says that market capital could have gone wrong if the Fed had not stepped in and stabilized the weaker parts of corporate debt. .
However, Goldman’s David Choi and David Mericle warn that the Fed may not want to make such interventions part of their normal set of crisis tools.
“Cost-benefit compensation is unlikely to be as favorable in the next recession,” they said in a note. “If the Federal Reserve were to use these tools more routinely in the future, markets could expect Federal Reserve credit intervention in all future recessions. Such concerns have made policymakers hitherto reluctant to adopt the credit policy as a tool for the future, despite its contribution to the Fed’s remarkable success in preventing financial markets from amplifying the initial shock of the virus in recent months. “
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