The Fed in the Corporate Bond Market during the COVID-19 Pandemic ; The effect of corporate bond purchase announcements on corporate bond yields and CDX spreads
Tunkkari, Niko (2021-05-05)
Tunkkari, Niko
05.05.2021
Julkaisun pysyvä osoite on
https://urn.fi/URN:NBN:fi-fe2021050528876
https://urn.fi/URN:NBN:fi-fe2021050528876
Tiivistelmä
In mid-March 2020 market volatility soared abruptly, as the coronavirus pandemic-related stress gathered momentum. Particularly in the U.S. corporate bond market, where the selling pressure and dealers’ unwillingness to absorb corporate debt into their balance sheets caused wide dislocations and shortage of liquidity. With short-term nominal interest rates at zero lower bound, the Federal Reserve (Fed) expanded its unconventional monetary policy toolkit in an unprecedented manner and announced it takes on corporate credit risk by purchasing corporate bonds. To provide funding backstop for the U.S. corporations and to stabilize the disrupted corporate bond market, the Fed established two facilities, namely the Primary Market Corporate Credit Facility and the Secondary Market Corporate Credit Facility. The facilities were initially designed to cover investment-grade bonds but later extended to the high-yield corporate bond market.
This study examines the impact of those two facilities on the corporate bond market across the credit rating spectrum. In detail, the credit spread changes on the index level are studied on and around two different announcements. Further, the changes in perceived broad-based credit risk are studied by testing the announcement effects on credit default swap indices (CDX), both in investment-grade and high-yield space. The empirical analysis is conducted by a multiple regression-based event study, where explanatory variables are added to control for the changes in spreads. Before the regressions, unit root tests are conducted to confirm the stationarity of the time series.
The results show that by announcing the two corporate credit facilities, the Fed effectively relieved the stress in the corporate market. The effects are large and significant on both announcement days. The initial announcement effect is found to be more pronounced and persistent in the investment-grade space. Consistently, the high-yield credit spread narrows more on the latter announcement when the purchases were extended to the high-yield segment. Similar findings can be derived from CDX spreads, however, the announcement effects appear to be less persistent in forward markets. Overall, of examined explanatory variables, swap rate is found to have an inverse relationship with the credit spreads, while S&P500 and VIX can widely explain the changes in CDX spreads and credit spreads of lower-rated bonds.
The findings suggest that the corporate bond market is segmented across the credit ratings. Moreover, the findings support the safety premium, the default risk, and the portfolio rebalancing channels in monetary policy transmission. The effectiveness of the duration risk and the liquidity channels remain inconclusive, although interesting subject for further examining. Assessing these and longer-term effects of the central bank’s corporate bond purchases would require extending the methodology beyond the standard event study.
This study examines the impact of those two facilities on the corporate bond market across the credit rating spectrum. In detail, the credit spread changes on the index level are studied on and around two different announcements. Further, the changes in perceived broad-based credit risk are studied by testing the announcement effects on credit default swap indices (CDX), both in investment-grade and high-yield space. The empirical analysis is conducted by a multiple regression-based event study, where explanatory variables are added to control for the changes in spreads. Before the regressions, unit root tests are conducted to confirm the stationarity of the time series.
The results show that by announcing the two corporate credit facilities, the Fed effectively relieved the stress in the corporate market. The effects are large and significant on both announcement days. The initial announcement effect is found to be more pronounced and persistent in the investment-grade space. Consistently, the high-yield credit spread narrows more on the latter announcement when the purchases were extended to the high-yield segment. Similar findings can be derived from CDX spreads, however, the announcement effects appear to be less persistent in forward markets. Overall, of examined explanatory variables, swap rate is found to have an inverse relationship with the credit spreads, while S&P500 and VIX can widely explain the changes in CDX spreads and credit spreads of lower-rated bonds.
The findings suggest that the corporate bond market is segmented across the credit ratings. Moreover, the findings support the safety premium, the default risk, and the portfolio rebalancing channels in monetary policy transmission. The effectiveness of the duration risk and the liquidity channels remain inconclusive, although interesting subject for further examining. Assessing these and longer-term effects of the central bank’s corporate bond purchases would require extending the methodology beyond the standard event study.