Federal Reserve Announces It Will Buy Individual Corporate Bonds: What This Means for Markets

The Federal Reserve made a surprise announcement during market hours stating that it will start buying individual corporate bonds as part of a previously-announced stimulus plan. This is big news because it marks the first time the Fed has created its own corporate bond portfolio. After one of the most tumultuous months for financial markets in recent history during March, the Fed initially announced massive stimulus including a move into corporate bond purchases to help the valuations for risk assets to rebound from their pandemic-lows. It’s safe to say that the stock market would currently be trading at very different valuations had the Fed not stepped in back in March, but what does this new announcement really mean for investors?

The main goal here for the Federal Reserve is to keep markets functioning well and improve the overall conditions of the credit market. The program is known as the Secondary Market Corporate Credit Facility and allows for the central bank to add up to $250 billion in corporate bonds from certain issuers. We’ve never really seen The Federal Reserve’s balance sheet expanding at such an accelerated pace, and these types of moves could have long-lasting impacts on the monetary system as we know it. Let’s take a look at what this news really means for markets below.

Stability for Now

Last week, Federal Reserve Chairman Jerome Powell offered a sobering take on the current state of the economy that sent markets plunging the following trading day. This selloff gave investors a strong reminder of just how quickly things can change in financial markets. However, this well-timed announcement has instantly improved market sentiment and eased many of the worries that sent markets down in March. The Federal Reserve will essentially be able to provide extra stability for financial markets in the coming months with its corporate bond buying.

Before the Fed stepped into credit markets in March, banks and institutional investors were selling stocks and bonds to get into cash as quickly as possible. Major businesses that needed cash to overcome the rapidly changing economy weren’t able to issue bonds because there wasn’t anyone that wanted to buy them. However, when the Fed announced this new program, things in the bond market started to stabilize and stocks have rallied ever since. It remains to be seen what the long term impacts of this program will be, but we know that the credit and financial markets have stabilized for the moment.

Bond Buying On the Secondary Markets

With this announcement, the Fed will start buying individual bonds that have remaining maturities of five years or less from companies that are considered investment-grade. The goal is to “create a corporate bond portfolio on a broad, diversified market index of U.S. corporate bonds,” This essentially means that the Federal Reserve will be providing liquidity to businesses that need it during this period of economic contraction.

We know that the economy is currently in a bad place, which will lead many major companies to seek additional funds in the bond market. With the Fed’s activity, they will be helping to keep corporate bond yields down which in turn makes it less expensive for companies to borrow. As taxpayers, it’s interesting for us to note that The Treasury Department provided the Federal Reserve with $75 billion in taxpayer funds to offset any losses that occur from these corporate bond investments.

Stocks Will Get a Boost

When you think about how this announcement relates to the stock market, it’s important to understand the relationship between the bond market and the stock market. Bonds are thought of as safer investments than stocks, which is why they offer a lower rate of return. Generally speaking, when bonds are decreasing in value, which is definitely happening thanks to the Federal Reserve, stock prices go up.

Since investors will be getting much lower returns on bonds as a result of the Fed’s action, there’s a good chance that they will move their money into the stock market for a higher return. This could lead to even higher valuations for stocks and a continuation of the rally we have seen since March. It’s debatable whether or not the Fed actually needed to step in and start purchasing these corporate bonds, but it is an activity that should be considered bullish for stocks until proven otherwise.