Corporate bond ETFs soared on Monday after the Federal Reserve announced that it would expand its asset purchases to include them.
The $29 billion iShares iBoxx Investment Grade Corporate Bond ETF (LQD) and the $26 billion Vanguard Intermediate-Term Corporate Bond ETF (VCIT) gained 7.4% and 5.4%, respectively, on the session.
The Fed announced that it would be starting two new facilities to support credit to large employers: the Primary Market Corporate Credit Facility (PMCCF) for new bond and loan issuance, and the Secondary Market Corporate Credit Facility (SMCCF), to provide liquidity for outstanding corporate bonds.
The SMCCF “will purchase in the secondary market corporate bonds issued by investment grade U.S. companies and U.S.-listed exchange-traded funds whose investment objective is to provide broad exposure to the market for U.S. investment grade corporate bonds,” wrote the Fed.
The Fed's entrance into the ETF market, while a first for the U.S. central bank, isn’t without precedent. The Bank of Japan has been buying ETFs for years. The BoJ’s program, which focuses on equity ETFs, has resulted in the central bank owning upward of 80% of the country’s entire ETF market.
LQD Spikes On Fed Announcement
As the largest and most liquid broad-based corporate bond ETFs on the market, LQD and VCIT will likely be targeted for purchase by the Fed.
Importantly, the Fed’s new facilities only extend to investment-grade bonds. High yield bonds, like those held in the iShares iBoxx USD High Yield Corporate Bond ETF (HYG) and the SPDR Bloomberg Barclays High Yield Bond ETF (JNK), are not included.
Those ETFs were last trading down by less than 1% on the session, close to 11-year lows.
The Fed’s foray into exchange-traded funds follows turmoil in the corporate bond markets. Bond prices cratered in the past two weeks as the extent of the coronavirus-related economic hit became increasingly clear. Wide swaths of the economy have been effectively shut down due to the virus, raising concerns that even well-capitalized companies will struggle to pay their bills.
Panic selling and a lack of liquidity in underlying bond markets also pressured prices and created unusual dislocations, such as large discounts for bond ETFs.
The Fed’s plan to buy corporate bond ETFs wasn’t the only new measure revealed on Monday. The central bank unveiled a host of programs to support the severely strained economy and financial markets.
Headlining its list of moves was the promise to purchase unlimited amounts of Treasuries and agency mortgage-backed securities “to support smooth market functioning and effective transmission of monetary policy to broader financial conditions and the economy.”
The Fed had previously pledged to buy $500 billion of Treasuries and $200 billion of mortgage-backed securities, but it purchased $275 billion of Treasuries last week alone.
Meanwhile, the central bank also said that it would be establishing new programs that would provide up to $300 billion in financing to employers, consumers and businesses; it would expand its Money Market Mutual Fund Liquidity Facility (MMLF) “to include a wider range of securities, including municipal variable rate demand notes and bank certificates of deposit;” and it would broaden its Commercial Paper Funding Facility (CPFF) to include high-quality munis as eligible securities.