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How the Fed Saved the Corporate Bond Market

federal-reserve

As America responded to COVID-19 by issuing stay-at-home orders in every state, the economy was left in shambles. Millions lost their jobs and companies were struggling to keep their heads above water.

The Federal Reserve typically takes action to protect the markets in times of recession, as it is their responsibility to keep the economy stable. When the corporate bond market started to struggle, the Fed jumped in to encourage lending to continue.

What Happened to the Corporate Bond Market?

Corporate bond yields skyrocketed as the world was in turmoil, making it hard for companies to issue debt and find lenders. The likelihood of defaulting startled lenders, and borrowers could not afford such high interest rates during a period of economic uncertainty. The market froze in mid-March as its liquidity practically disappeared.

This halt in lending hurt companies’ financial health as many lacked the cash to maintain workers and continue normal operations. A frozen corporate bond market is obstructive to businesses, and therefore the overall economy.

How Did the Fed Respond?

Historically, when the overall credit market loses liquidity, the Fed slashes interest rates and buys back munis. 

However, COVID-19 triggered the highest spread between corporate and treasury yields since 2009, so the Fed felt the need to take additional action to help the corporate sector of the credit market. They vowed to purchase investment-grade corporate bonds for the first time in history. 

Market Reaction

The Fed’s plan to buy corporate debt was revealed on March 23 and fostered an immediate market boom. The market jumped higher in April after the Fed announced they’d add some high-yield/junk bonds to the program, and again when they started buying the securities in May.

The March announcement encouraged short-term lending between companies to continue. Without the promised backstop, the corporate bond market may have remained frozen and the financial crisis could’ve spiraled further out of control.

With the help of the Federal Reserve, corporate bonds were back to trading around pre-COVID prices by the end of May.

PIMCO Investment Grade Corporate Bond Index ETF

As the coronavirus pandemic sunk the corporate bond market, the Fed took steps to protect it. They bought corporate debt for the first time ever, which stimulated lending and helped the market recover quickly.

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