Jay Powell says bond-buying launch shows Fed resolve to meet promises

Jay Powell says the launch of the Federal Reserve’s corporate bond-buying programme shows it is serious on following through on promises made to financial markets, but the chairman of the US central bank swore it did not want to be an “elephant” trampling signals from the $10tn market.

The Fed kicked off a long-awaited programme to buy corporate bonds on Tuesday, more than two months after it was unveiled, stepping in to buy individual bonds for the first time to fulfil a pledge that boosted market prices and tempered expectations of defaults.

The scheme prompted the Fed to create a new index to determine which bonds to buy. But in testimony to Congress, Mr Powell said it was important for the Fed to find a way to make the initiative work.

“We feel we need to follow through and do what we said we’d do,” the Fed chairman said. “I don’t see us as wanting to run through the bond market like an elephant or snuff out price signals.”

The announcement of a series of support programmes in March and April helped to shore up credit markets, with borrowing costs for US companies steadily falling from a big spike at the height of fears over the spread of coronavirus. That recovery prompted scrutiny from US senator Pat Toomey, who asked on Tuesday whether bond-buying from the Fed would warp market prices to the point that it “starts to look a lot like fiscal policy”.

Line chart of Yield on investment grade US corporate debt (%) showing Corporate borrowing costs have tumbled over past three months

Analysts and investors said it was crucial that the Fed followed through on its pledge to launch the programme, particularly after a sharp slide in asset prices toward the end of last week. “The market was on the verge of cracking,” said Andrew Brenner, head of international fixed income at National Alliance Securities. “If the Fed hadn’t come in I think corporate bonds and equities would have broken down. The Fed has clearly put a floor under the market.”

The Fed had already begun buying corporate bonds in the form of ETFs, but had taken longer than expected to roll out its direct purchases of individual bonds. 

To carry out the scheme, the Fed plans to create a new index of corporate bonds that meet its eligibility criteria. The bonds included will have a maturity of less than five years and will be from US-based companies that were rated investment-grade as of March 22. The index will exclude bonds issued by banks.

“It’s a historic day to see the Federal Reserve coming into the corporate bond market,” said Nicholas Elfner, co-head of research at Breckinridge Capital Advisors. “The Fed is trying to put shock and awe into the investment grade market in the US.”

The announcement confirms a shift from the Fed’s original plan to buy bonds only once companies self-certified that they were eligible under the central bank’s rules, which include a stipulation that participating companies must not have received support from the US government’s $2tn coronavirus relief package.

Analysts and investors had warned that this condition could result in few companies signing up for the new facility because they would not want to signal that they were in distress and needed the Fed’s help — especially when the corporate bond market has been rallying.

Daniel Sorid, a strategist at Citigroup, said that the Fed would now have “greater headroom” to buy bonds. “Lifting the certification requirement empowers the Fed to gear the facility toward specific sectors if localised strains emerge,” he wrote in a recent note.

Corporate bond purchases are just one facet of the Fed’s broader plans to ensure the smooth functioning of financial markets following a period of elevated volatility as a result of the global pandemic. The Fed has so far unveiled 11 emergency facilities under powers that allow it to make asset purchases in “unusual and exigent circumstances”. 

Several of these facilities are not yet online, including one aimed at buying corporate debt directly from issuers. In a statement on Monday, the Fed said the programme should launch “in the near future”.

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