Will the End of Fed Lending Programs Hurt the Bond Market? | Lord Abbett
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Fixed-Income Insights

We don’t think so. The two lending facilities designed to backstop U.S. corporate credit markets appear to have accomplished their objectives.

Read time: 3 minutes

A quiet announcement by U.S. Treasury Secretary Steven Mnuchin on November 20 has grabbed a considerable amount of investor attention.  Mnuchin said that the Primary Market Corporate Credit Facility (PMCCF) and the Secondary Market Corporate Credit Facility (SMCCF), put in place in March 2020 through a joint effort by the U.S. Federal Reserve (Fed) and the Treasury department, would be unwound. (We explained these facilities in detail in an earlier commentary.)  These programs rightly seized the spotlight as a major part of the Fed’s and Treasury’s efforts to stabilize markets in March; both were critical in restoring investor confidence during a period of deep uncertainty.

It is understandable that investors may be alarmed that such a significant backstop for fixed-income markets would be eliminated, even as COVID-19 case counts are hitting all-time highs amid ongoing electoral uncertainty.  However, we do not view this announcement to be of significant concern for several reasons.

The primary impact of these facilities was not in the actual deployment of capital, but rather as a signal of government support for U.S. corporate borrowers.  Of the combined $750 billion in purchasing and lending power for the two facilities, only $15 billion was invested at the time of Mnuchin’s November 20 announcement, and the facilities never exceeded $25 billion in size at any point in time.  That implicit support still exists, even as the need for it has significantly diminished.

Putting a Floor Under Valuations

The major reason that these facilities had such a dramatic impact at the time they were unveiled is that they brought a sense to the market that there was a floor for valuations during a period of deep uncertainty.   Since the volatility of March, markets have stabilized.  Even though the spread of COVID-19, and the length of time it has affected lives around the world, has exceeded many forecasts when markets collapsed in March 2020, valuations of virtually every risk asset have improved substantially.

Periods of deep uncertainty can lead to extreme market stress.  The lending facilities appeared to be successful in mitigating concerns around the functioning of credit markets at an unsettled time.

Although statistics from the pandemic may have deteriorated from many forecasts, investors have seen what the world looks like during COVID-19 and appear to be more comfortable with pricing risk. We think it is extremely unlikely that a further weakening of economic indicators, due to the spread of the virus, would cause a market collapse similar to the events of March 2020, even without the Fed to backstop prices. Simply put, the factors of panic and uncertainty that dogged the market earlier in the year have greatly diminished.

This stabilization of markets also leads to a last, and extremely important reason that we do not view the Treasury’s withdrawal of support for the PMCCF and SMCCF as likely to have an impact on either valuations or default rates. Over the past six months, companies have taken advantage of abundant liquidity to achieve both present and future borrowing needs.

 

Figure 1. Strong Debt Issuance in 2020 Has Shored Up Balance Sheets of U.S. Investment-Grade Issuers
Data (quarterly) for U.S. non-financial, investment-grade companies for the period January 1, 2007–September 30, 2020

Source: FactSet and Barclays Research. Data as of September 30, 2020. Year-over-year change calculated using current-quarter cash balance versus the same quarter one year ago.

 

As noted earlier, the two Fed facilities were launched in March with a massive $750 billion in lending power.  Since that time, corporate borrowers have raised many multiples of that number, at lower rates than the Fed had offered.  Importantly, borrowers have used the market to address any potential cash needs to weather future periods of uncertainty.  Even if markets deteriorate significantly from here, many companies that tapped credit markets in 2020 have pushed their borrowing needs out many years. Thus, it appears there is no longer a material risk of default simply because companies cannot access capital markets.

A Final Word

There are doubtless many reasons why the Treasury chose to wind this program down, and at a minimum, this episode illustrates that Fed and Treasury are not coordinating nearly as closely as they were in March 2020.  It is hard to view such lack of coordination as a positive; however, it is at most a very small negative, in our view, and need not be cause for alarm.  In fact, Mnuchin’s comments around this action should also give investors some level of additional assurance—specifically, that it is easy for any future Treasury secretary to relaunch the programs.  The plumbing that took several months to set up following the initial announcement (i.e., the creation of the legal facilities, buying agents, protocols, etc.) is already in place now, and the Fed is still clearly focused on acting aggressively in the face of any alarming new risks.

 

The value of investments in fixed-income securities will change as interest rates fluctuate and in response to market movements. Generally, when interest rates rise, the prices of debt securities fall, and when interest rates fall, prices generally rise. U.S. Treasuries are debt obligations issued and backed by the full faith and credit of the U.S. government. Income from Treasury securities is exempt from state and local taxes. Although Treasuries are considered to have low credit risk, they are affected by other types of risk—mainly interest-rate risk (when interest rates rise, the market value of debt obligations tends to drop) and inflation risk. The value of investments in equity securities will fluctuate in response to general economic conditions and to changes in the prospects of particular companies and/or sectors in the economy.                                                                                           

Forecasts and projections are based on current market conditions and are subject to change without notice. Projections should not be considered a guarantee.

This article may contain assumptions that are “forward-looking statements,” which are based on certain assumptions of future events. Actual events are difficult to predict and may differ from those assumed. There can be no assurance that forward-looking statements will materialize or that actual returns or results will not be materially different from those described here.

Fed refers to the U.S. Federal Reserve.

Risk asset generally refers to assets that have a significant degree of price volatility, such as equities, commodities, high-yield bonds, real estate, and currencies.

The information provided herein is not directed at any investor or category of investors and is provided solely as general information about our products and services and to otherwise provide general investment education.  No information contained herein should be regarded as a suggestion to engage in or refrain from any investment-related course of action as Lord, Abbett & Co LLC (and its affiliates, “Lord Abbett”) is not undertaking to provide impartial investment advice, act as an impartial adviser, or give advice in a fiduciary capacity with respect to the materials presented herein.   If you are an individual retirement investor, contact your financial advisor or other non-Lord Abbett fiduciary about whether any given investment idea, strategy, product, or service described herein may be appropriate for your circumstances.

The opinions in the preceding commentary are as of the date of publication and are subject to change. Additionally, the opinions may not represent the opinions of the firm as a whole. The document is not intended for use as forecast, research or investment advice concerning any particular investment or the markets in general, and it is not intended to be legal advice or tax advice. This document is prepared based on information Lord Abbett deems reliable; however, Lord Abbett does not warrant the accuracy and completeness of the information.

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