Fed bond buying shows preference for liquid household names

5 min read
Americas, EMEA
William Hoffman

The Federal Reserve bought US$429m of US corporate bonds in the secondary market during two days in June revealing some the purchase trends markets can expect from the programme.

A breakdown of the Fed's purchases on June 16 and 17 was released Sunday alongside a breakdown of ETF purchases showing a preference for safer, highly liquid paper in healthcare, consumer goods, tech and energy sectors.

The Fed began buying ETFs in May and only just began buying individual corporate bonds on Tuesday June 16 through its Broad Market Index, which allows the central bank to purchase bonds from companies that did not seek certification. Instead, the Fed invests in an index of bonds.

The Fed created its own index, which focuses on specific buying criteria such as the exclusion of bank paper, only buying companies that had investment-grade ratings as of March 22 and bonds five years to maturity or shorter.

With those criteria in mind, the Fed bought the most debt from AT&T, UnitedHealth, Anthem, Comcast and IBM over those two days, according to a CreditSights report.

The majority of debt was bought from the Triple B bucket, which accounted for some 53% of the total purchases.

Another 2% was allocated to high-yield Double B paper, 42% went to bonds rated Single A or higher and 3% were issuers that do not have bond sizes that qualify for either the ICE BAML Index or Bloomberg Index, according to CreditSights.

Those allocations are roughly in line with stated goals of the index, but do show a preference for more liquid, household names in the market, such as Microsoft, Coca-Cola and McDonald's.

"We’ve been saying for a while that we thought the Fed would be favoring more liquid product and it looks like if this trend continues they will be favoring the safer stuff and more liquid stuff within the index of eligible debt," said Daniel Belton, vice president of fixed income strategy at BMO.

The Fed is digging into illiquid areas of the bond market to purchase riskier credits or ones that trade infrequently.

By doing so the Fed avoids negative optics that it only supports the largest companies and shows that if the liquidity situation in the bond market were to materially deteriorate it is willing to buy such bonds, Belton said.

"Liquidity in the front of the curve isn't deep and many of these issues are now quite small," CreditSights noted.

"We had to search to figure out who some of the issuers are, and we do not expect the Fed to be able to source paper in some of these small, off the run names, all while limited to the front of the curve."

NON-US PAPER:

The Broad Market Index requires that issuers be created or organized in the US, but drops a requirement from the certification process that says a company must have "significant operations" and a majority of employees based in the US.

The removal of that distinction will lead to more non-US paper to be bought by the Fed than previously thought.

For example, the Fed bought two Toyota Motor Credit bonds for a total purchase amount of US$5.07m.

"While our initial cut named many of the large issuers on the list, we excluded many of the big auto players given our more stringent reading of the country of risk wording," CreditSights noted.

"However, the Fed puts those names as the largest weights in its index."

The Fed put out an additional document that highlights a list of eligible issuers under the program of which more than 82% have a country of risk listed as the US and 14% are listed as non-US based, according to CreditSights.

Germany accounts for the greatest non-US exposure with names such as Bayer, BMW, Daimler, and Volkswagen eligible for purchase.

UK paper is the second biggest non-US category and includes companies such as BP, Diageo, BAT, and GlaxoSmithKline followed by Swiss companies Nestle, Novartis, Roche, and Swiss Re.

The report released Sunday includes all Secondary Market Corporate Credit Facility purchases through June 17 and the Fed is expected to release its next report in another 30-days, per Congressional disclosures for a special purpose funding facility, according to BMO's Belton.