The Federal Reserve may ramp up its purchases of corporate bonds if stocks and corporate debt markets weaken further, following a sharpest stock sell-off, analysts at Citigroup said in a report.
Investors dumped high-flying technology stocks on Thursday and Friday, while investment-grade corporate bond spreads widened one basis point to 135 basis points, based on the ICE BofA U.S. Corporate Index.
The iShares iBoxx Investment Grade Corporate Bond ETF fell 0.7% to 135.34, following a 0.22% fall on Thursday.
“Investors will be watching the Fed’s response to Thursday’s sharp sell-off in risk assets; the Fed could decide to marginally ramp up purchases in the days ahead to reassure the market,” analysts Daniel Sorid and James Keefe said in a report on Thursday.
The Fed has been reducing its average daily corporate bond purchases from around $300 million, when the program was introduced in May, to $26 million this week, as credit spreads have tightened and lending markets have recovered from logjams stemming from panic over the coronavirus.
Any renewed deterioration in market conditions, however, could prompt the U.S. central bank to increase them again, as it did in June when stocks dropped 7% from June 8 to June 11 and investment-grade credit spreads widened 17 basis points to 161 basis points, Citi said.
In that instance, the Fed increased its daily purchases of corporate bonds and Exchange Traded Funds (ETFs) by $40 million a day to $235 million on June 9 and to $275 billion on June 11. The next week it ramped up purchases even further, buying $355 million a day on average, a 50% increase on the amount it took in on the first day of the sell-off, the analysts said.
“If the market’s risk-off move continues into and beyond Labor Day weekend, and the Fed reaction function is consistent with its June behavior, we could potentially see average daily purchases return to (around) $100 million a day,” they said.
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