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Fed Support for Fixed Income Eases Liquidity Concerns

1 June 2020BondsUS
  • As part of the US central banks Secondary Market Corporate Credit Facility (SMCFF), the Federal Reserve (Fed) has purchased US$3 billion in corporate bond exchange traded funds (ETFs) as of May 26. This was put in place to support credit market conditions and corporations struggling from the COVID-19 pandemic. Actual purchases began on May 12.
  • In the most heavily traded investment-grade (IG) and high yield (HY) corporate ETFs, shares outstanding have reached historical levels and premiums to net asset value (NAV) have also moved meaningfully higher.
  • As an active buyer of ETFs, the Fed removes some future liquidity concerns that created sharp price declines and wide discounts to NAV during the March-April sell-off. Similarly, this could also add additional liquidity to secondary corporate trading. Since the Fed announced their support for IG and HY corporate bonds and ETFs, index spreads have tightened meaningfully.

    Fed Support for Fixed Income Eases Liquidity Concerns
    Past performance is no guarantee of future results. Real results may vary.
  • Citi analysts prefer a high quality bias to global fixed income and favour US IG credits. Credit curves have also shifted in recent weeks. After briefly reaching its flattest level in over ten years, IG corporate yield curves have followed US Treasury curves steeper. However, BBB-rated spreads have not rallied as much as higher quality corporates. This has left BBB spreads 100bps wider than A-rated bonds, or about 40bps above its 10-year relationship. Downgrade risks remain prominent in BBBs, though Fed policy to support "fallen angels" may help provide some stability in spreads.
  • Despite the improvement in markets, lingering uncertainties over the economic impact of COVID-19 has left some parts of the market behind. Defaults in HY markets are rising and are likely to continue to do so. It may be possible to see HY default rates rise to 10% later this year, and Citi analysts are neutral on the HY segment.

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