The Fed Takes on Corporate Credit Risk: An Analysis of the Efficacy of the SMCCF 
The Federal Reserve’s efforts to stabilize the financial markets at the onset of the COVID-19 pandemic included the launch of the Secondary Market Corporate Credit Facility (SMCCF) in March 2020. The program’s objective was to support the $10 trillion U.S. corporate bond market—where prices were falling and credit spreads were surging—by buying individual securities in the secondary market. The SMCCF marked the first time that the Fed directly supported corporate credit markets by signaling a willingness to purchase outstanding corporate debt and potentially assume a substantial amount of credit risk. This paper evaluates the efficacy of the SMCCF and analyzes the mechanisms through which it affected the pricing of corporate bonds in the secondary market.
Key Findings
- The Fed’s March 23, 2020, announcement of the launch of the SMCCF for investment-grade bonds with a remaining maturity of no longer than five years and its April 9, 2020, announcement that it was expanding SMCCF eligibility to include companies that had recently been downgraded from investment grade to “junk” significantly reduced investment-grade credit spreads across the maturity spectrum.
- The SMCCF’s maturity-eligibility criterion played no role in reducing credit spreads, as the announcements ultimately restored the normal, upward-sloping credit curve in the investment-grade segment of the market.
- The investment-grade credit curve, which reflects the relationship between credit spreads and bonds’ remaining maturity, had inverted abruptly at the onset of the pandemic when investors rushed to sell their shorter-maturity investment-grade bonds—the “dash for cash”—and broker-dealers were unwilling or unable to absorb the ensuing selling pressure. The Fed’s SMCCF announcements reduced the heightened risk aversion and alleviated market segmentation, re-establishing the pre-pandemic upward-sloping term structure of investment-grade credit spreads.
- The Fed’s actual bond purchases, which were modest in volume by quantitative easing standards, reduced credits spreads of eligible bonds 3 basis points more than those of ineligible bonds, on average, for six to eight hours after the purchase. The effect was concentrated almost entirely in lower-rated investment-grade bonds.
Implications
The paper’s findings suggest that the primary effect of the SMCCF, or more precisely, the effect of the Fed’s announcements concerning the SMCCF, was to restore investor confidence and improve market sentiment. More broadly, the findings suggest that when markets trust rather than question a central bank’s ability to deliver on a promise—in this case, the Fed’s stated commitment to restore bond market stability by purchasing corporate debt in the secondary market through the SMCCF—the bank may not have to do as much to uphold that promise.
Abstract
This paper evaluates the efficacy of the Secondary Market Corporate Credit Facility, a program designed to stabilize the U.S. corporate bond market during the COVID-19 pandemic. The program announcements on March 23 and April 9, 2020, significantly reduced investment-grade credit spreads across the maturity spectrum—irrespective of the program’s maturity-eligibility criterion—and ultimately restored the normal upward-sloping term structure of credit spreads. The Federal Reserve’s actual purchases reduced credit spreads of eligible bonds 3 basis points more than those of ineligible bonds, a sizable effect given the modest volume of purchases. A calibrated variant of the preferred habit model shows that a “dash for cash”—a selloff of shorter-term lowest-risk investment-grade bonds—combined with a spike in the arbitrageurs’ risk aversion, can account for the inversion of the investment-grade credit curve during the height of turmoil in the market. Consistent with the empirical findings, the Fed’s announcements, by reducing risk aversion and alleviating market segmentation, helped restore the upward-sloping credit curve in the investment-grade segment of the market. .