Posted on 04/12/2020 6:21:12 PM PDT by NRx
On Thursday, knowing that a three-day Easter weekend was coming and the attention of the public would be elsewhere, the Federal Reserve announced that it would allow two of its emergency lending programs to begin buying junk bonds. Those are bonds with less than an investment-grade credit rating, meaning they have a greater likelihood of defaulting. The Fed is not simply accepting junk bonds as collateral for loans, it will actually be buying junk bonds — potentially hundreds of billions of dollars of them.
Two of the popular junk bond ETFs, iShares iBoxx High Yield Corporate Bond ETF (symbol HYG) and SPDR Bloomberg Barclays High Yield Bond ETF (symbol JNK) closed the trading day on Thursday up 6.55 and 6.71 percent, respectively, on the announcement. Those ETFs had been plunging in price for most of the month of March.
For years now, prudent investors have been forgoing risky investments like junk bond ETFs and accepting a much tinier yield on U.S. Treasury securities. Now, high rollers like hedge funds that bought junk bonds and junk bond ETFs and received the higher yields, are getting bailed out of these risky bets. The markets will now, going forward, price junk bonds on a closer plane with Treasury securities, assuming the Fed will not let them fail.
This is effectively killing the pricing mechanism of Wall Street. A U.S. Treasury note has the unconditional guarantee of the U.S. government to make the timely payment of interest every six months and pay the principal at maturity. Junk bonds are backed by nothing more than deeply-indebted corporations, which can, and do, frequently file for bankruptcy protection, making their bonds sometimes sell for pennies on the dollar. Going forward, junk bond ETFs will be priced on the premise that the Fed may ride to the rescue.
(Excerpt) Read more at wallstreetonparade.com ...
I’ve got some junk stocks. Are they interested in those??
While I don’t disagree with the sentiment, it’s a bit different when the government is forcing the shutdowns than if they just made poor investment decisions. Besides, we saw in the last downturn that “ investment grade” didn’t hold up so well, especially mortgages.
This article is bogus and misleading.
In a crisis market the bond market is so huge, wide, that unless the fed did some underlying buying, mark to market would turn the entire system into a dumpster fire.
-28 yr finance vet
Re: The Fed Is Killing the Two Main Functions of Wall Street: Price Discovery and Prudent Capital Allocation
Agreed. The economy has largely become a man-made illusion, created and sustained by trillions of dollars-from-thin-air.
Kung Flu has proven the illusions have moved heavily into man-made: delusions. Reality, projected out of internet devices into the masses brains.
Fed nationalized the entire bond market because Fed created a massive bond bubble to paper over the Fed created housing bubble. Only thing left for them to destroy is the currency.
Quite true. To avert a cascade of defaults, panic, and then market collapse, the Fed has to buy widely. Distortions of price are a lesser evil than losing market function entirely and suspending the ability of credit worthy cities and states to finance their capital needs and of bond holders to sell to willing buyers.
Sorry. If the system can’t withstand junk debt defaulting, then the system sucks. There has to be at least some heavy regulation on debt issuance if this is the game now. Maybe ban stock buybacks for junk rated corporations?
The credit rating agencies and analysts effectively deny or limit market access to issuers with bad finances. Buying already issued debt that is suddenly distressed due to the COVID-19 economic crisis bails out investors, not the issuers.
Fair enough. Seems to me high yield should be wild west risk. Never thought I’d see that level of debt monetized. Guess the game will forever be just gaming the Fed, imagine they’ll be buying stocks soon.
“suspending the ability of credit worthy cities..”
Credit worthy like Chicago and Detroit?
L
See my comment #9, above, as for how Chicago and Detroit and other spendthrift cities and states experience market discipline.
A basic problem is that the US tax code advantages the issuance of corporate debt over equity. The result is that US companies tend to be over-leveraged, which makes the productive sector of the US economy prone to instability and debt crisis. Similarly, local and state public debt has been abetted by lax accounting rules, especially as to pensions. Finally, even after the SarBox reforms, SEC enforcement remains weak, especially as to public issuers. Fix those problems and the markets will function better.
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