A la Japan, the U.S. Fed stands ready to buy ETFs.

In a move aimed at ensuring liquidity in the bond market and related ETFs, for the first time, the U.S. Fed will purchase corporate bond ETFs. (MarketWatch)

The Fed’s new facilities are the Primary Market Corporate Credit Facility (PMCCF) for new bond and loan issues, and the Secondary Market Corporate Credit Facility (SMCCF), to provide liquidity for outstanding corporate bonds.

The facilities support only investment-grade bonds and are aimed at issues of big corporate employers. The ETFs on the Fed’s shopping list must invest in U.S. investment-grade corporate bonds.

The Bank Of Japan extends similar support to only equity ETFs, however. Earlier this month, the Japanese central bank, in an emergency move, doubled its annual ETF buying plan to ¥12 trillion from ¥6 trillion. The BOJ may soon surpass the Japanese state pension fund, the GPIF, as the largest holder of domestic stocks.

Why the Fed is supporting corporate bond ETFs

The mayhem caused by the coronavirus has upended business prospects for businesses stretching from airlines to energy. Scared, investors have sold off corporate bonds, on concerns that cash flows could dry up and impact their servicing.

Corporate bonds and related ETFs have slumped sharply, sometimes creating pricing anomalies. In one oft-quoted example, the big investment-grade corporate-bond fund iShares iBoxx $ Investment Grade Corporate Bond ETF (NYSEARCA: LQD), closed on one occasion about 5% lower than its net asset value.

Moreover, a Goldman Sachs (NYSE: GS) report said high yield bond defaults could surge to 13% by the end of the year. This further unnerved the market.

In these circumstances, the Fed’s credit line could be a valuable steadying hand for the bond market.

The fine print

However, the facility will come with limits as follows:

“Limits per Issuer/ETF: The maximum amount of bonds that the Facility will purchase from any eligible issuer will be capped at 10 percent of the issuer’s maximum bonds outstanding on any day between March 22, 2019, and March 22, 2020. The facility will not purchase more than 20 percent of the assets of any particular ETF as of March 22, 2020.

Pricing: The Facility will purchase eligible corporate bonds at fair market value in the secondary market. The Facility will avoid purchasing shares of eligible ETFs when they trade at prices that materially exceed the estimated net asset value of the underlying portfolio.”

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