(Bloomberg opinion) – The Federal Reserve leaves no corner of the US bond market in this crisis.
There is no other way to interpret the drastic measures announced by the central bank on Thursday, which together provide up to $ 2.3 trillion in loans to support the economy. It will enter the US municipal bond market at $ 3.9 trillion to an unprecedented degree, will now be able to buy “fallen angels” bonds from companies that have recently lost their investment grade ratings and extended its asset-backed securities loan facility to include commercial mortgage-backed securities and secured loan obligations.
Details matter. Here’s what’s new and important to the bond markets:
Municipal liquidity facility
It is new and close to what I have supported over the past year. The Fed Facility will purchase municipal debt directly from issuers sold for cash flow and will mature no later than 24 months after the date of issue. I thought for the sake of simplicity, the central bank would only make this available to states, but the Fed decided that in addition to the states and Washington, DC, it would also buy tickets in more cities of a million inhabitants and counties of more than 2 million.
The Treasury Department makes an initial investment of $ 35 billion in shares, and the vehicle can recover up to $ 500 billion in eligible debt.
At first glance, this seems well done. The parameters are probably enough not to break the munitions market, when they should lower borrowing costs in the short term and allow states and large communities to raise liquidity quickly. This is what we need as much as anything during the coronavirus pandemic.
Credit facilities for companies in the primary / secondary market
I said that the Fed should never buy unwanted bonds. My colleague from Bloomberg Opinion, Noah Smith, said that speculative quality borrowers also needed a lifeline.
The central bank shared the difference. He changed the parameters of his two business credit facilities to include fallen angels who were top quality a few weeks ago but lost those notes due to the intentional economic shutdown. The specific wording is as follows: “Issuers which have been rated at least BBB- / Baa3 as of March 22, 2020, but which are subsequently downgraded, must be rated at least BB- / Ba3 at the time the facility makes a purchase . “
This is a potential boon for companies like Ford Motor Co., which became the biggest fallen angel on March 25 after Moody’s Investors Service and S&P Global ratings brought its $ 35.8 billion debt down. speculative. Overall, the yield differential between double B and triple B rated debt increased to 290 basis points from as little as 38 basis points in December.
This gap will likely narrow if high-yield investors don’t have to worry about declines causing a glut. In fact, the largest exchange traded fund that tracks the high yield market has jumped the most since January 2009 on Thursday. This did not detract from the fact that the Fed also said it could buy a small amount of ETFs “whose primary investment objective is exposure to high yield US corporate bonds”.
The two facilities combined could reach up to $ 750 billion – a huge bite out of the corporate bond market.
Lending facility for asset-backed securities
The Fed’s TALF has even more rigid parameters than municipal and corporate facilities. The most notable cancellation of Thursday’s announcement appears to be for mortgage-backed securities.
All eligible securities for this vehicle must be rated triple-A and were issued on or after March 23, with the exception of CMBS. On the contrary, the Fed can only buy legacy CMBS issued before that date that are linked to real estate in the United States or its territories. CMBS investors and even a group of bipartisan lawmakers hammered the table for inclusion in TALF after the commercial real estate market was inundated with margin calls and forced to sell late last month.
The Fed can now also buy the highest rated tranches of new CLOs. This market was already showing signs of thawing, with Apollo Global Management Inc. marketing a $ 500 million CLO just this week. This announcement should also contain spreads on triple-A CLOs. TALF will initially provide up to $ 100 billion in available loans, fully secured by asset-backed securities.
All of this, of course, comes on top of the Fed’s relentless purchases of US treasury bills and mortgage-backed securities. BlackRock Inc. said on Wednesday that the central bank’s balance sheet will most likely grow to more than $ 10 trillion in the coming year, up from $ 4.2 trillion in early 2020 and potentially exceed 50% of the proceeds. nominal US gross domestic.
“Our emergency measures are reserved for truly rare circumstances such as those we face today,” Fed President Jerome Powell said on Thursday. “When the economy is on the road to recovery and private markets and institutions are once again able to perform their vital functions of channeling credit and supporting economic growth, we will set aside these tools for ’emergency.”
To call the Fed’s actions “throwing the kitchen sink” into the bond markets seems like a huge understatement. It extends its reach to everything, which is probably good for now. The tricky part will be knowing when and how to let go.
This column does not necessarily reflect the opinion of Bloomberg LP and its owners.
Brian Chappatta is a Bloomberg Opinion columnist covering the debt markets. He previously covered bonds for Bloomberg News. He is also the holder of the CFA charter.
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