Investors are fleeing corporate bonds at a record pace, sending down shares of funds that buy investment-grade debt at a magnitude not seen since the financial crisis of 2008, according to Bank of America research.
The Federal Reserve could help calm “the basically broken” market by buying corporate bonds, a seemingly “small step” after announcing earlier this week that it would buy commercial paper to support the flow of credit, Bank of America said in a report dated March 18 that was circulated Thursday. While it would take time for the Fed to set up a corporate bond facility, the report said an announcement alone would be “very powerful” amid escalating fears over the coronavirus.
“Some of the decisions the Fed would have to make include what they buy,” the bank’s credit strategists said in the report. “Do they buy like an ETF, i.e. in a market neutrality way?”
Central banks can “sharply improve pricing given illiquidity,” according to the strategists, who estimated that $4.5 trillion of U.S. corporate bonds are eligible for Fed purchases plus $49 billion of average monthly new issuance.
While credit spreads had widened much more in the throes of financial crisis, declining Treasury yields helped offset corporate debt problems at the time, the strategists said. “The problem currently is that investors seemingly sell all they have, which includes Treasuries, thus corporate bond prices face a double whammy of wider spreads and higher interest rates.”
BlackRock’s exchange-traded fund focused on investment-grade corporate bonds has seen big price declines. The net asset value of iShares iBoxx $ Investment Grade Corporate Bond ETF, which trades under the ticker LQD, dropped 5 percent on March 18. Its shares continued to fall Thursday.
The steep price declines of the ETF over the past few days resemble the massive drop seen in a similarly short period during the financial crisis, the Bank of America report shows. A downward spiraling effect is at play, with investors fearing corporate cash flows will dwindle as the escalating coronavirus crisis halts economic activity.
“Large price declines trigger large outflows,” the credit strategists said. “We look for large outflows to continue.”
The billions of dollars in outflows from U.S. investment-grade corporate debt funds and ETFs in each of the past few days reached record levels, according to the Bank of America report. During the financial crisis, investment-grade bond funds and ETFs lost 3.7 percent of assets over two months, which the strategists estimated would be $133 billion based on today’s assets under management.
[II Deep Dive: The High-Octane, In-Demand, and Worrying World of Risky Loans]
The bank’s credit strategists last week sounded the alarm on high-yield debt, saying it was quickly nearing “the point of no return” as coronavirus concerns ripple through the markets.
Meanwhile, cases of Covid -19, the disease caused by the novel virus, are soaring in the U.S.
Small and mid-sized businesses will be hurt the most by economic inactivity as people stay home to stop the spread of the virus, a senior portfolio manager in Morgan Stanley’s asset management business told Institutional Investor in a March 17 phone interview. “What we haven’t been seeing is enough private sector support,” Jim Caron, head of global macro strategies for Morgan Stanley Investment Management’s fixed-income group, said in the interview.
In debt markets, “everything is under stress right now,” he said, arguing that the Fed can’t stem panic all on its own.
Congress and the White House are now working on a $1 trillion economic stimulus plan to support businesses and workers amid fears the pandemic will lead to recession and high unemployment.
