Why the Fed’s stunning move to buy Corporate America’s junk bonds is so significant

April 9, 2020, 4:19 PM UTC

Fears that the Federal Reserve had run out of ammunition are proving entirely premature.

The central bank astounded markets on Thursday when it announced an historic move to buy risky corporate debt as part of a larger $2.3 trillion rescue package for businesses and municipalities hit hardest by the coronavirus pandemic. Just two weeks ago, the Fed drew a line in its whatever-it-takes playbook, saying it would only consider the purchase of investment-grade corporate debt as part of any efforts to pump liquidity into the credit markets. 

Under the newly expanded Fed program, the Fed will now buy what many pension funds will not: speculative grade corporate bonds. Junk.

There’s a caveat: for a so-called “fallen angel” to qualify, it would have had to be rated “at least BBB-/Baa3 by two or more [credit agencies] as of March 22, 2020,” the Fed explains. And, that firm “must be rated at least BB-/Ba3” at the time of issuance.

Still, that’s significant.

“They are going into uncharted territory,” says Shanawaz Bhimji, a fixed-income strategist at ABN Amro Bank NV. “The high-yield market is really taking off on this.”

Exchange-rated funds specializing in high-yield corporate debt popped on the news Thursday, as did the shares of companies that were recently downgraded. Investors sent Ford Motor Company up 12.7% at the open. Moody’s and S&P Global last month downgraded Ford and its $36 billion debt pile into junk territory as the automaker struggles with shuttered factories and cratering demand, fallout from the globe-spanning coronavirus lockdown. 

The Fed move is seen as its strongest yet to keep some of America’s most highly indebted companies—to be sure, these are big employers—from going insolvent should the coronavirus crisis extend into the summer.

While significant, Bhimji reckons the Fed bond-buying program won’t be extended carte blanche. The central bank will almost certainly hold onto the securities until maturity, he notes, and so “will likely stick to the safer rung of high-yield debt, no lower than the double Bs.”

“They’re in it for the long-term. They don’t want to do any write-downs,” he added.

After today’s aggressive moves by the Fed, all eyes are now on how other central banks will respond. During the 2008-2009 financial crisis, central banks around the world acted often in a coordinated fashion to minimize some of negative fallout of the credit crisis that was spilling across borders.

“Now that the Fed is doing this, I wouldn’t be surprised to see the ECB do something similar,” said Bhimji. “There are hot spots like Italy and Spain that aren’t out of the doldrums yet.”

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