The Fed Pulled Off a Masterful Manipulation of the Junk Bond Market
The Federal Reserve pulled off a magnificent manipulation of the junk bond market, facilitated a massive wealth transfer from savers to speculators, pocketed millions of dollars, and then washed its hands of the matter.
In March 2020, as governments shut down the economy for coronavirus, the Fed slashed interest rates and launched a massive quantitative easing program. But that wasn’t enough, so the central bank took the unprecedented step of announcing it would purchase $750 billion in corporate bonds, junk bonds, bond exchange-traded funds (ETFs), and junk-bond ETFs.
This triggered a huge rally in the junk bond market. With the Fed putting its big fat thumb on the market, investors dove in. Prices skyrocketed and junk bond yields fell to their lowest levels ever.
But as it turns out, this was just another Federal Reserve “open mouth operation.” The central bank did a lot of talking, but it never bought very many corporate bonds.
The Federal Reserve can’t legally buy corporate bonds, so it set up a “Special Purpose Vehicle” (SPV). In effect, this was a separate legal entity called the Secondary Market Corporate Credit Facility (SMCCF). The Fed lent money to this Special Purpose Vehicle while the US Treasury provided equity capital. The SPV bought the bonds.
BlackRock was involved and then State Street, and a whole bunch of bond funds from which it bought the bonds, and everyone and their dog began front-running the Fed, and a huge rally in corporate bonds, junk bonds, and bond ETFs ensued because, you know, the Fed would be buying $750 billion of this stuff.”
The Fed stopped buying corporate bonds in July 2020. At the peak, the SPV only held $13 billion in ETFs and corporate bonds — far short of the $750 billion that the Fed and mainstream media hyped. That compares with the Fed’s purchase of $8.5 trillion in US Treasury bonds.
Last June, the Fed announced it would sell off its corporate bond holdings. It was good timing because it was the hottest bond market ever. The Fed had completely divested itself of its corporate bond holdings by the end of August.
Last week, the Fed announced it had earned $513 million in interest and capital gains on those deals. It sent 90% of its earnings to the US Treasury and held on to 10%. The SPV will be dissolved.
Interestingly, the junk bond market peaked in September, with yields at record lows. The average BB-rated junk-bond yield plummeted to 3.01% with inflation over 5%. Since then, we’ve seen a reversal in the market with prices falling and yields rising.
This was textbook market manipulation by the central bank. As Wolfstreet put it, “Its words were enough to manipulate markets higher and cause fantastic gains for speculators in junk bonds.”
The junk bond rally triggered by the Fed’s announcement that it would buy junk bonds via junk-bond ETFs had a huge impact on the market, though the Fed ended up buying very little in the end. The Fed enriched these speculators, while at the same time, it crushed the savers, first through its interest rate repression, and then since early this year, with the worst inflation in three decades. It was a massive wealth transfer, from savers to bondholders, accomplished in two slick steps. But OK. The savers, who’d refused to speculate, had it coming. To heck with them – that’s the official policy of the Fed.”