Eric C. Jussaume Senior Vice President, Senior Portfolio Manager & Director of Fixed Income
Over the past few weeks, the Federal Reserve Bank has announced several major programs to help stabilize the fixed income markets in the wake of COVID-19 virus and the impacts to the overall economy. These measures were necessary to alleviate the stress and add liquidity into the market. By the 2nd week in March, the corporate bond market had ceased to function normally; corporations were unable to access the market, and secondary market liquidity had dried up. Fast forward to today; liquidity has returned, companies are able to access the market to raise needed capital, and investors have been buying in record amounts.
A lot has happened, but we want to emphasize a few measures that the Fed has initiated. On March 15th the Fed began cutting the policy rate to a range of 0-25 bps (basis points) (0% - 0.25%) and, since then, has announced 28 additional measures. The Fed learned from the financial crisis in 2008/2009 and were able to quickly roll out these programs. Some of these may seem inconsequential, but the intended action has greater meaning. Easing bank liquidity ratios will allow banks to continue to lend. Purchasing up to $500 billion of US Treasuries and up to $200 billion in mortgage-backed securities have helped to keep interest rates low. Lower interest rates help borrowers by lowering their interest payments and can be a disadvantage for savers as their interest payments are declining. The yield on the 10-year US Treasury has declined by 118 bps since January and front-end rates (1-week up to 1-year maturity US Treasuries) are near zero. As yields decline, the price of the security increases, meaning investors in bonds earn a positive return.
On March 23rd the Fed established the Primary Market Corporate Credit Facility (PMCCF) for new corporate issuance offering bridge loans for investment grade companies up to 4 years and the Secondary Market Corporate Credit Facility (SMCCF) to provide liquidity for outstanding corporate bonds. These programs have helped to reduce the spread on the ICE BofA US Corporate Index from 401 bps to 261 bps through April 10th. Spread on a bond is a measure of credit risk; lower spreads (tightening) is a positive indicator, as it indicates less stress in the market and lower funding costs for corporations.
Spreads on mortgage-backed securities (MBS) have also declined with the additional Fed purchases. The option adjusted spread on the Barclays MBS Index reached a high of 132 bps on March 19th and has declined to 41 bps as of April 10th. Refinancing activity has slowed, as banks seek to fund the backlog of prior activity.
As yields on US Treasuries declined, municipal bond yields increased over concerns with how the state shutdowns over COVID-19 would impact their finances. Tax receipts, which make up a larger percentage of state revenues, are expected to decline. The CARES Act will provide for funding of up to $150 billion in aid to states and municipalities based upon population, with no state to receive less than $1.25 billion. Additionally, on April 9th the Fed established the Municipal Lending Facility that will offer up $500 billion in lending to states and municipalities. The facility will purchase mostly short-term securities in exchange for the funding. These measures have helped to reduce the stress in the municipal bonds market. Yields on 10 year AAA-rated municipal bonds have declined from 2.78% on March 23rd to 1.30% as of April 10th. The municipal yield as a percentage of US Treasury yield still remains elevated, with ratios in the 100 to 300% range, depending on maturity.
This continues to be an unprecedented time in our history and the Fed and US Government have taken drastic measures to stabilize the financial markets and offer relief to millions of citizens. We are finding the areas of the market that the Fed is supporting as attractive, and we are looking for opportunities to increase our allocations.
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