FORCED MISALLOCATION
The Fed is propping up companies it had warned banks not to touch t.co/ldmmIBMCiP— Win Smart, CFA (@WinfieldSmart) May 5, 2020
For years, the Federal Reserve warned that too many highly risky companies were engaging in fuzzy accounting that bumped up their earnings — making it easier for them to obtain loans. The practice was driving up corporate debt to excessive and worrisome levels, regulators chastised.
But now, in its latest effort to keep credit flowing, the Fed has done a remarkable about-face. It essentially endorsed the dubious practice with a program that may serve to bail out some of America’s most leveraged companies.
No, the Fed can’t save the junk bond market, Goldman warns
Exchange-traded funds offering exposure to junk bonds may lack the full Federal Reserve safety-net that investors are betting on, warn analysts at Goldman Sachs.
The central bank announced in early April that it would buy ETFs that contained bonds with speculative, or “junk,” ratings in an effort to keep credit flowing through financial markets. An update Monday indicated that Fed purchases could start any day.
Investors responded to the historic move by pouring into the biggest junk bond ETFs, SPDR Bloomberg Barclays High Yield Bond ETF JNK, +0.79% and iShares iBoxx $ High Yield Corporate Bond ETF HYG, +0.78%, hoping to get ahead of the Fed’s purchases. From April 9, the day of the Fed’s announcement, through May 4, JNK took in $1.6 billion, while HYG has seen inflows of $4.71 billion, according to Refinitiv.
But a bigger tsunami of downgrades may lie ahead, Goldman cautions, and those risky bonds most likely to get marked down make up an outsize segment of those funds.
So far in the second quarter, downgrades of bonds rated “BB,” the highest rating on the below-investment-grade spectrum, has matched the number of downgrades in the first quarter, which was already an “elevated” level, Goldman analysts wrote. And ratings agencies have signaled more downgrades may lie ahead, through the use of “Negative Outlook” or “Negative Watch” designations.