Fed Starts to Experiment with the Corporate Bonds Market

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The Fed has finally lent a helping hand to the corporate bond market as $ 305 million of investment and junk bonds were added to its asset portfolio, showed weekly balance sheet update of the Fed, released on Thursday:

ETF and direct bond purchases apparently began on Tuesday. They are part of an emergency asset purchase program designed to mitigate the effects of coronavirus shock on the US economy and financial markets. The idea of ​​introducing this credit mechanism is quite simple: commercial banks will be more willing to lend to companies if they know that there is demand in the secondary debt market (i.e., a guaranteed buyer represented by the Central Bank). It suggests that the main asset of this program (especially at initial stages of its functioning) is a signaling function, i.e. potential of purchases when the market starts to feel strains.

Also, low interest rates in the past decade sharply stimulated massive inflation of corporate debt, and since there is the second side of this debt (i.e. holders of this huge debt with their own balance sheets), an increase in interest rates on corporate market will cause depreciation of the holders’ balance sheets (for example, banks). And this is an increase in systemic risk, which the Fed is also trying to contain:

The growth of corporate debt for the period from 2009 to 2019 exceeded the growth for the period from 2001 to 2008 by more than 3.5 times.

The fact that guaranteed demand will exist on the corporate debt market probably had a strong stimulating effect during the announcement, which probably explains the recent divergence of the stock market with the real state of the economy.

Purchases made on Wednesday were not included in the report, since the data is published with a one-day delay. Data about them will be available in the report next week. In addition, the Federal Reserve will not disclose specific company names in weekly updates but will do so once a month.

In the week ending Wednesday, assets on the balance sheet of the Central Bank rose to $ 6.93 trillion.

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