On Wednesday, the Federal Reserve announced plans to begin winding down its $13.8 billion portfolio of corporate bond holdings purchased during the market dislocation caused by the COVID pandemic and the shutdowns implemented to mitigate it.
The Secondary Market Corporate Credit Facility (SMCCF) was launched in March 2020 to support financing for hundreds of large employers, and it became a buyer of last resort in secondary markets. While relatively small, the Fed backstop brought buyers back into the market and allowed companies to finance billions of dollars in credit.
The wind-down of the Fed’s corporate bond holdings and ETFs should have a limited effect on the market. It was important at the time, but the purchases did not last for long or amount to that much.
We think that spreads could widen slightly, but the market will not have that much difficulty absorbing the wind-down. Year-to-date corporate bond issuance is $685 billion so relative to that the $13.8B isn’t a very large amount. It probably accounts for about 10% or less of what we see issued monthly. Prior to the announcement, we were at 14-year tights in investment-grade corporate spreads, so some minor widening in the space would create some relative attractiveness versus taxable munis.
The market seems to agree with us: At the end of the week, corporate bond spreads were +85.
We are also comfortable that the wind-down will cause little disruption, as the Fed has announced that the portfolio sales will be gradual 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.
The market, however, is seeking clarity about the trajectory of interest rates and inflation and looking to the Fed’s actions and words to get information on potential changes in outlook or in policy.
Some worried that this unwinding of corporate bond holdings could be a signal that the Fed sees indications of trending inflation rather than transitory inflation and that this action could spur a taper tantrum similar to the dislocation that occurred in 2013. The Fed holds almost $8 trillion in Treasury bonds and mortgage-backed securities.
The Fed has noted that it will stay the course and remain data dependent. Friday’s jobs report showed the economy had added 599,000 new jobs; and while that number did not rise to expectations of 675,000, it was much better than the meager 266,000 increase last month. The economy will not advance on a straight trajectory as we emerge from the ravages of the pandemic, and it may take some more data points to have a better picture of what the recovery will look like. Wages rose more than expected. They were up 0.5%, compared with expectations of 0.2%, while workforce participation rate declined after increasing last month. Without a doubt, there will be fits in starts in other data points, too, as we return to normalcy.
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