As the Federal Reserve moves deeper into its purchases of corporate debt, it faces more questions about the consequences of its unprecedented market interventions.
Disclosures filed this week surrounding its credit facilities show the Fed is not only buying the bonds of struggling companies hit hard by the coronavirus pandemic but also some of the stalwarts of American industry — Microsoft, Visaand Home Depot just to name three companies whose debt the Fed holds directly.
The Fed holds an expansive list of other companies indirectly, including names like Apple and Goldman Sachs, through exchange-traded funds it has purchased.
In addition, it has purchased bonds in speculative-grade companies as well as ETFs, including the SPDR Bloomberg Barclays High Yield Bond, a fund in which the Fed holds a $412 billion position.
When the Fed expressed its intent to buy corporate bonds, it was a major moment both for the institution and the bond market, which had frozen up amid fears of the damage the coronavirus would cause to the economy. But with that decision also came questions over the probity of such a move into the functioning of free markets, and the role of what is supposed to be an independent central bank.
“It does sort of make you wonder if it makes sense for them to be buying bonds of Apple. Spreads are so tight and stocks are doing so well. You wouldn’t think they would need support from the Fed,” said Kathy Jones, director of fixed income at Charles Schwab. “The reasoning I guess makes sense. But when you look at the outcome, you scratch your head and wonder whether this is where we need the money to go.”
To be sure, the purchases thus far have been modest.
Disclosures the Fed filed over the weekend show it owning nearly $430 million in individual bonds and $6.8 billion in ETFs. That’s barely a sliver in a corporate bond market worth more than $10 trillion and fixed income ETFs with assets of $961 billion.
The Fed has created its own index of diversified bonds, tilted 42% toward higher-rated debt and the rest toward varying degrees of lower-medium grade and a slight tilt toward speculative. Sector-wise, the bonds are weighted toward consumer and tech companies.
Those purchases thus far have come in the secondary market, or bonds already issued. The Fed announced Monday it soon would open its primary market facility, which will buy directly from companies.
“They’ve achieved a couple things. They’ve managed to follow through while having very little impact on how those bonds actually trade,” said Tom Graff, head of fixed income at Brown Advisory. “This is literally saying we’re going to go through the motions of doing what we said we were going to do, but we’re going to do the bare minimum and have as minimal impact as possible beyond what we’ve already created by acknowledging the program will exit at all.”
Still, Jones said one reason the Fed is buying some of the higher-profile companies is they are huge employers at a time when nearly 20 million Americans are collecting unemployment benefits. That won’t, however, halt concerns that the Fed is overstepping.
“I do think it’s moral hazard,” Jones said. “I think it’s something they’re going to have to deal with when things settle down. There will be accusations that they committed money in ways that didn’t make sense and didn’t help the average Joe.”
Goldman Sachs sees the potential for moral hazard plus two other issues: misallocation of capital and a diminishing appearance of independence for the Fed.
Some of those concerns are by know well known and were expressed during the Fed’s last aggressive foray into the markets in the financial crisis.
Goldman, though, says the bulk of those concerns should be allayed.
So long as the Fed continues to steer the markets properly, the ideas of moral hazard and loss of independence will go away as conditions improve. On capital misallocation, brought up mostly in regard to the Fed buying junk debt, Goldman says market capital could have gone awry had the Fed not stepped in and stabilized the shakier parts of corporate debt.
Goldman’s David Choi and David Mericle do warn, however, that the Fed may not want to make such interventions part of their normal crisis toolkit.
“It is unlikely that the cost-benefit tradeoff will be quite as favorable in the next recession,” they said in a note. “If the Fed were to use these tools more routinely in the future, markets might come to expect Fed credit intervention in all future downturns. Such concerns have made policymakers reluctant so far to embrace credit policy as a tool for the future, despite its contribution to the Fed’s remarkable success in preventing financial markets from amplifying the initial virus shock in recent months.”