Morgan Stanley: Fed buying programme has benefits beyond direct purchases

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Analysis of the Federal Reserve’s Secondary Market Corporate Credit Facility (SMCCF) by Morgan Stanley analysts has found that its purchases of exchange traded funds (ETFs) are more impactful than its purchases of a similar notional value of bonds, as a result of the higher sensitivity to interest rate changes in the market (duration) and relative volatility (beta). Although ETF buying has tailed off, the bank observed that further benefits have been seen past direct investment in the markets.

ETF purchasing began on 12 May, while direct bond-buying began on 16 June. As of 8 July report noted the SMCCF held about US$10.8 billion of securities across corporate bonds and ETFs which as of 30 June, when a more detailed Fed disclosure had been made, included US$7 billion in ETFs and US$1.7bn in bonds. Morgan Stanley estimates ETF buying has settled at around US$8 billion, with the other US$2.8 billion being in bonds as of 8 July.

In its report ‘Summarizing the Fed’s Purchases’, the bank’s analysts note ETF buying by the SMCCF has been spread across nine investment grade (IG) and seven high-yield (HY) focused ETFs.

While average daily ETF purchases were US$265 million from 12 May to 15 June, after bond buying began ETF buying fell to US$114mm on 16 June and US$193mm on 17 June. The report found that it has since dropped to approximately US$67mm as of 29 June.

HY ETFs purchases had fallen as a component of total ETFs bought, making up around 17% of all ETF purchases through the first week and falling to approximately 12%. Within the IG ETF complex, the largest component was BlackRock’s iShares iBoxx USD Investment Grade Corporate Bond ETF (LQD), which accounted for 28% of all purchases, followed by the Vanguard Short-Term Corporate Bond Index (VSCH) at 18.6% and Vanguard Intermediate-Term Corporate Bond ETF (VSCIT) at 15.4%.

The SMCCF’s bond-buying benchmark includes IG-rated and certain fallen angel bonds. Corporate buying commenced at an average daily rate of about US$210 million, and has fallen since to level off at around US$150 million, with approximately 522 unique CUSIPs acquired spread across 345 issuers.

The analysts conclude that, despite early controversy, “The Fed’s passive index-based approach was a positive, and increases its ability to buy corporate bonds, but willingness depends on market conditions, and this is not conventional quantitative easing (QE). The SMCCF should act as an automatic stabiliser of credit on drawdowns, which makes the carry profile look attractive. At the current pace, the Fed will still have significant capacity left beyond the September expiry of the facilities.”

They also noted that “The tailwind from Fed support goes beyond direct purchases,” with the benefits including ETF inflows broadly accelerating as arbitrage activity picked up with the SMCCF buying at a premium.

“In addition, overseas demand has been very strong as currency-hedging costs have fallen and the value proposition for IG looks very compelling versus alternatives. Finally, the portfolio balance channel also continues to support credit, with the Fed having purchased in excess of US$2 trillion in US Treasuries and Agency mortgage backed securities (MBS),” they wrote.

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