Fed to stay full throttle with credit support despite debt rally

There are also worries that the economy could drag as double-digit unemployment punches holes in consumer demand and corporate revenue growth
The Federal Reserve may have stoked one of the strongest corporate debt market rallies in decades, but it’s too soon to declare an all-clear for credit with the economy facing a potentially rocky road ahead.

Sure, US investment-grade borrowing costs have retreated to near all-time lows, and companies have sold $1 trillion of bonds at the fastest pace on record — evidence that merely announcing a plan to pump liquidity into corporate debt markets has helped ease strains before barely a dollar of central bank money was deployed.

But the Fed’s emergency pandemic lending programs are just getting started. Chairman Jerome Powell is expected to repeat that the Fed will deploy its full suite of liquidity backstops when he addresses reporters Wednesday after a two-day policy meeting — even if there is little need for some at the moment.

There are also worries that the economy could drag as double-digit unemployment punches holes in consumer demand and corporate revenue growth. Even though the labor market performed better than expected in May, unemployment at 13.3per cent is well above the peak of the last recession.

Central bankers are likely to remain undeterred in both their credit and monetary policy support until the jobless rate gets closer to their full employment estimate of 4.1per cent. Fed officials will publish new forecasts this week.

Not time

“What the Fed has done is prevented an economic crisis from becoming a financial crisis,” said Julia Coronado, founding partner of MacroPolicy Perspectives LLC and a former Fed economist. “They won’t say it is time to start pulling back. They won’t take it for granted when they see the playbook worked.”

The Fed still has to roll out key components of its corporate credit programs, and officials could stoke the rally further if they announce a decision to ramp up Treasury purchases.

Current Fed government bond buying is to ensure market functioning. But officials could shift purchases toward deliberately stimulating demand in the economy, compressing returns on risk-free Treasuries and sending investors scurrying into higher-yielding debt.

‘Belt and suspenders’

“The programs are doing a lot of work on the credit spreads, but the total cost of finance includes the spread on the risk-free rate,” said Michael Feroli, chief US economist at JPMorgan Chase & Co. He said the Fed will adopt a “belt and suspenders” approach to continued credit easing policies and announce a program of $80 billion per month in longer-term Treasury purchases sometime over its next two meetings.

The Fed announced two corporate credit facilities March 23 of up to $750 billion, taking a radical step into direct finance of large companies. Since then, investment-grade and high-yield companies have gone on a record-breaking borrowing spree, taking advantage of robust investor demand that the Fed also encouraged.

The Primary Market Corporate Credit facility will buy bonds directly from companies, as well as slices of syndicated loans. That program is expected to launch in the next couple of weeks, according to people familiar with the matter.

ETF buying

The Secondary Market facility buys exchange-traded funds of investment grade and high-risk, high-yield junk bonds, in addition to bonds already trading in the market. Only the ETF purchases are underway with $4.3 billion in the Fed’s portfolio as of June 2.

“Before they bought a single bond or ETF, the liquidity crisis was over,” said Hans Mikkelsen, head of high-grade credit strategy at Bank of America Corp. “The Fed doesn’t need to do more. It’s a done deal.”

One reason other components of the programs have been slower to get off the ground is they are complicated. For example, a company must be able to show that it has significant operations and a majority of its employees based in the U.S. for its bonds to be eligible. To obtain a direct loan, the company must also certify that it couldn’t get “adequate credit” in private markets at a normal rate.

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