The Reason Why the Fed is Buying Corporate Bonds

by OhioBaseball

I was surprised when the Fed announced it would be purchasing corporate bond markets, especially for non-investment grade issuers. “Why do they need to do this?” is a legitimate question. I believe there is a tactical reason why they did this and it makes sense.

Most banks provide large commitments often up to 5 years on revolving credit facilities that act as quick sources of cash if needed. A lot of companies never intend to use these but pay the expenses for them in case of a time when they really need the money. In March, a lot of companies drew on these revolving lines of credit to the max so they could get cash while it was still available. Banks have to put money out the door when these are drawn upon and everyone was doing it at the same time. This helps the liquidity of the companies borrowing, but clearly impairs the liquidity for banks as they have to put money out the door to meet the demands. This became a major problem for banks and it attributed to some major dislocations in various high quality fixed income products seen in March.

In April and May, corporate fixed income markets saw a TON of new bond issuance after the Fed announced it was purchasing. Some companies that issued new bonds were ones that drew their revolving credit facilities to the max in March (funded by banks), and some were companies that may have needed to do so in the future. The Fed supporting the corporate bond market took major pressure off bank liquidity and it effective transferred the funding sources to asset managers and other institutional investors that (1) are not as systemically important as the banks are to the economy and (2) in better position to fund at their discretion, as opposed to contractual funding commitments banks provide.

This is not meant to be a post supporting Fed’s actions, but I have previously questioned the need for a central bank to be purchasing corporate bonds and I believe this is the reason why they did it. It’s been successful. The future unintended consequences of the Fed’s actions are a separate topic.

 

Disclaimer: This information is only for educational purposes. Do not make any investment decisions based on the information in this article. Do you own due diligence.