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The US Federal Reserve's backstop keeps the bond market afloat

An announcement back in March from America's central bank, that it would buy corporate bonds, has given the corporate bond market a fillip even as companies are downgraded.

Corporate bonds have begun to recover their poise, says Marcus Ashworth on Bloomberg. High-yield credit spreads – the gap between yields on government bonds and those of riskier debt – are still double what they were before the crisis. “But almost half of the widening from the early days of the coronavirus lockdown has been reversed.”

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That’s partly because investors remain desperate for yield. However, sentiment was also buoyed by the US Federal Reserve’s announcement back in March that it would buy corporate bonds. This backstop, which finally started last week, may not cost the central bank very much, says Kate Duguid on Reuters: in the first two days it bought just $305m (through bond exchange traded funds) – trivial given that firms issued $58bn in investment-grade bonds and $11bn in high-yield bonds last week. But the Fed has $750bn to spend if needed; knowing this will “have the desired effect of keeping the credit market afloat”.

Of course, central bank buying only solves liquidity issues – ie, making sure firms have access to financing – as Fed chair Jerome Powell noted last week. Many firms will have seen their solvency (ie, their ability eventually to repay their debt) affected by the crisis. Hence credit ratings are coming under pressure. For example, there have been 24 fallen angels (borrowers downgraded from investment grade to high yield) so far this year, says S&P Global Ratings, with a record 111 potential fallen angels on watch for potential downgrade.

That said, this particular trend may not be all bad for investors, say analysts at Bank of America – since forced selling by investors who can only hold investment-grade bonds means this debt often ends up temporarily cheap. “History shows that fallen angels tend to outperform after downgrades,” it notes.

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