The coronavirus crisis has introduced a whirlwind of sweeping financial maneuvers by global central banks. And the U.S. Federal Reserve is at the center of this.
This past week, the Fed announced its plan to give liquidity to the U.S. bond market in new ways investors have never seen before by making outright purchases of bond exchange-traded funds.
“The multiple stimulus actions taken by the Federal Reserve over the last few days is intended to provide market stability as well as inject liquidity at a time of stress,” said Matthew Bartolini, head of SPDR Americas Research at State Street Global Advisors.“The Fed’s inclusion of the purchase of broad investment-grade corporate bond ETFs within the Secondary Market Corporate Credit Facility (SMCCF) speaks to the benefits the ETF structure can provide in terms of the movement of capital.”
The Fed said it would limit purchases U.S.-listed ETFs that provide broad exposure to U.S. corporate debt that is investment grade. Popular ETFs that match this description include the iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD) and Vanguard Intermediate-Term Corporate Bond ETF (VCIT). These are the two largest investment-grade corporate bond ETFs by assets and hold combined assets of around $55 billion. LQD and VCT have had year-to-date declines of 8.1% and 8.3% respectively.
Exchange-traded products linked to other parts of the credit market such as high-yield corporate bonds and mortgage REITs have fared much worse. The ETRACS Monthly Pay 2x Leveraged Mortgage REIT ETN (MORL) has collapsed 98.25%, the iShares Mortgage Real Estate ETF (REM) has sunk 63.40% and the SPDR Barclays High Yield Bond ETF (JNK) has fallen 18.99%.
While the Fed’s move into the U.S. ETF market is big, it’s not unlimited—at least not yet. The Fed announced purchases would not exceed 20% of the assets of any particular ETF and prices of eligible ETFs cannot have their prices trading at a steep premium to their underlying net asset value. Moreover, the bond ETF purchase program is expected to stop on September 30, 2020, according to the Fed’s timeline.
Could the Fed buying ETFs be the precursor of it becoming the next Bank of Japan?
Since 2010, the BOJ has been buying REITs along with ETFs and is now a top-10 shareholder in nearly 40% of listed stocks in Japan. As of March 24, the BOJ held $261.6 billion in index-linked ETFs.
Might we see a scenario whereby the Fed starts acquiring U.S. equity ETFs?
“Buying any form of equities is a risky idea for a central bank,” says Andrew Martin, president at 7Twelve Advisors in Nashville, Tenn. “All central banks buy bonds, but bonds come due—these are called loans. Buying equities is ownership. There is no reason in a free-market economy for government to own equities unless the objective is to nationalize industry.”