The Perceived Problem
While the Fed’s purchase programs succeeded in providing corporations with credit and stabilized markets during the pandemic-related economic crisis, it raised expectations that the Fed could intervene again, ring-fencing corporations from future economic shocks. That might artificially cut the cost of credit and encourage companies to overleverage, sowing the seeds of a future crisis.
Investor expectations of an enduring “Fed put” for US corporate bonds could also affect the success of various investment strategies by reducing credit spread widening during periods of economic and financial market volatility.
As of June 30, 2022.
Source: UBS, used with permission.
Euro-Area Market Provides Some Far-from-Conclusive Evidence
The market may have expected the ECB to scale up corporate bond purchases if necessary to ensure business access to credit. The ECB had started an ongoing corporate debt program in 2016 and resumed purchased in late 2019, after a pause. There were no legal or political barriers to it doing more.
But there are other potential reasons for the decline in euro-area credit spreads and spread volatility after the ECB program began in 2016. Most simply, nothing bad happened to rattle the market until the pandemic, while the prior decade included both the Global Financial Crisis and the European Sovereign Debt Crisis. ECB rate cuts and its launch of sovereign quantitative easing in 2015 could also explain the decline in spreads and spread volatility, as investors took more risk by moving down in quality in response to lower interest rates.
What to Watch
It is possible that market expectations of a Fed put might only become apparent when a recession or financial crisis looms. It is worth monitoring how spreads, model valuations and option prices evolve, particularly as investors focus on whether the Fed’s rapid rate hikes this year will lead to a recession.
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