For the first time in history, the Fed is buying corporate bonds.
Credit markets participated in the overall market recovery in the second quarter, thanks in large part to the actions of the Federal Reserve. All categories of bonds showed positive returns in the second quarter.
The Fed was successful in averting a credit crisis in March and April by simply promising to start buying corporate bonds. In May, the Fed began by buying exchange-traded corporate bond funds and began buying individual corporate bonds in June. This is a first for the Fed, who didn’t even buy corporate bonds during the worst of the Financial Crisis in 2008-2009. As a result, corporate bonds snapped back, showing a total return of 5% for the first six months of the year after having fallen 3.6% in the first quarter. As of this writing, the Fed has purchased an estimated $8.7 billion in bonds and bond funds since the program started in mid-May.
The high-yield option-adjusted spread (OAS) fell from nearly 11% in late March to about 6.5% by the end of the second quarter. This despite a record junk bond issuance of $51.5 billion in the month of June alone, as struggling companies rushed to the capital markets to build up their cash buffers amid the ongoing COVID-19 pandemic.
With Chairman Jerome Powell indicating the Fed is unlikely to raise interest rates until late 2022 at the earliest, and with continued corporate bond purchases by the Fed, overall interest rates are likely to remain low for the foreseeable future. For income-oriented investors, the next couple of years will likely present a significant challenge. We will look to generate more income from other asset classes such as our real estate asset class.