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

Ford is among those downgraded to junk © Getty

(Image credit: Ford assembly plant, Chicago © Scott Olson/Getty Images)

published 22 May 2020

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.”

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.

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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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Cris Sholto Heaton is an investment analyst and writer who has been contributing to MoneyWeek since 2006 and was managing editor of the magazine between 2016 and 2018. He is especially interested in international investing, believing many investors still focus too much on their home markets and that it pays to take advantage of all the opportunities the world offers. He often writes about Asian equities, international income and global asset allocation.

Cris began his career in financial services consultancy at PwC and Lane Clark & Peacock, before an abrupt change of direction into oil, gas and energy at Petroleum Economist and Platts and subsequently into investment research and writing. In addition to his articles for MoneyWeek, he also works with a number of asset managers, consultancies and financial information providers.

He holds the Chartered Financial Analyst designation and the Investment Management Certificate, as well as degrees in finance and mathematics. He has also studied acting, film-making and photography, and strongly suspects that an awareness of what makes a compelling story is just as important for understanding markets as any amount of qualifications.