When the Federal Reserve acts, the markets respond.
That typically applies to investor reaction when the central bank tightens or loosens the federal funds rate (giving rise to the investing maxim of “Don’t fight the Fed”), but it added a new twist last week after the Fed announced plans to buy corporate-bond exchange-traded funds as part of its efforts to bolster the nation’s economy during the COVID-19 epidemic.
The Fed launched a two-part program to support credit to large employers via the Primary Market Corporate Credit Facility (PMCCF) for new bond and loan issuance, coupled with the Secondary Market Corporate Credit Facility (SMCCF) to provide liquidity for outstanding corporate bonds.
The SMCCF will participate in the secondary market to buy individual investment-grade corporate bonds issued by U.S. companies and U.S.-listed ETFs that invest in U.S. investment-grade corporate bonds. Under this program, the Federal Reserve Bank of New York will lend to a special purpose vehicle, or SPV, to facilitate the purchases, and the U.S. Treasury Department will make an initial $10 billion equity investment in the SPV.
While the Bank of Japan has long bought ETFs in order to calm jittery markets and boost liquidity, this is the Fed’s first foray into the ETF market as part of its efforts to prime the economic pump in times of extreme financial stress.
Specifically, the Fed won’t buy more than 20% of the assets of any particular ETF as of March 22, 2020. And the Fed says it won’t buy eligible ETFs “when they trade at prices that materially exceed the estimated net asset value of the underlying portfolio.”
Unless circumstances merit an extension, the Fed plans to cease buying corporate bonds and eligible ETFs no later than September 30, 2020, and it will keep its holdings either until they mature or are sold.
Todd Rosenbluth, head of ETF and mutual fund research at CFRA, said the Fed will likely target the two largest investment-grade corporate bond ETFs—the $38.1 billion iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD) and $25.7 billion Vanguard Intermediate-Term Corporate Bond ETF (VCIT).
“They’re sizable enough to deal with the likely flows without impacting them,” he notes.
Other possible targets include the $22.4 billion Vanguard Short-Term Corporate Bond ETF (VCSH) and the $12.6 billion iShares Short-Term Corporate Bond ETF (IGSB).
According to XTF.com, all four funds jumped in price last week following the Fed’s Monday announcement regarding the SMCCF, with the upticks ranging from LQD’s 14.7% one-week gain to a 7.5% jump for VCSH. That said, the share price for all four funds are in the red year to date.