"The Bond Market Is Broken" And Only Fed Buying Bonds Can Fix It

Tyler Durden's Photo
by Tyler Durden
Thursday, Mar 19, 2020 - 11:16 PM

One week ago, Bank of America's credit strategists issues a dire assessment of the current state of the bond market: the Treasury market was no longer functioning properly.

Fast forward to today, when Citi issued a similar warning about the overall state of the corporate bond market, noting that "order book has collapsed to 10% of historical average and trade impact cost has risen to more than x2 normal market function" pointing out that in terms of overall market liquidity "current levels are close to historical extremes."

Bank of America also chimed in again, only this time instead of focusing on the Treasury market, it shifted its attention to the corporate market where its take was simple: the "market is basically broken at this point." Why would the normally non-hyperbolic BofA credit strategist Hans Mikkelsen come out with such a shocking assessment? Simple: just like Janet Yellen and Ben Bernanke the day before, BofA is now confident that the only thing that can fix the bond market - where BofA had been busy herding its clients into corporates for the past year only to see the rug pulled from under them this week - is the Fed which should not waste any time in starting to buy corporate bonds.

Here is the section in question:

A Financial Times article [on Wednesday] - by no less than Janet Yellen and Ben Bernanke - suggested the Fed should start buying corporate bonds. That seems a small step since they just set up a facility to buy commercial paper and, if little else, would be useful to calm a market that is basically broken at this point, with large outflows that look set to continue and pent-up issuance.

Moral hazard? More like no-real hazard.

Corporate credit has become a big concern for investors and, as we have seen in Europe, central banks can sharply improve pricing given illiquidity. Obviously it will take some time for the Fed to set it up but the announcement itself would be very powerful. The ECB announced corporate bond purchases in March 2016 and began buying in June that year. Their justification was for monetary policy purposes and - unlike for the Fed - the ECB has no 13.3 requirement so there was no need to seek approval. We estimate an eligible universe in the US of $4.5tn outstanding (Figure 4) plus $49bn average monthly new issuance.

Oh wonderful, at least there is a lot of bonds the Fed can buy.

So sure is BofA that the Fed will come to its - and its clients' rescue - that it is already preparing a list of bonds and monthly amounts that the central bank should buy:

Some of the decisions the Fed would have to make include what they buy. We assume no bank bonds for example, as that would cut a little close to home with the Fed being the regulator. In other words how do you define the eligible universe? Also, while the ECB buy anything that is eligible irrespective of what the company does, the Bank of England in their program checks that every company makes a "material contribution to the UK economy".

The next question? How much could they purchase weekly/monthly?

Maybe $50bn/monthly. Do they buy in primary, which would give them access to a lot more bonds and hurts secondary liquidity less. Do they buy like an ETF, i.e. in a market neutrality way? If so the Fed - like the ECB - needs no credit analysts. How do you treat Auto finance units? How much of any single security can they buy as a maximum? They need to define IG - maybe one IG rating and at least two if there are more, which is similar to Bloomberg-Barclays index and the Feds methodology for the new CPFF. What happens to downgraded bonds from IG to HY? Etc.

And since we doubt that BofA is so dumb not to realize that a vast number of the corporate bonds the Fed buys will default in the next few months as a result of the coming global depression - as a reminder, buying a company's securities does noting for its cash flow but merely drives an even bigger wedge between fundamentals and market prices - and will therefore be equitized post-reorg, BofA is now essentially working under the assumption that the Fed should be buying stocks, an assumption which we are confident all other banks will soon adopt, especially since Janet Yellen expressly said that the Fed should purchase stocks during the next crisis. i.e., right now.

Which, of course, is the final step before the nationalization endgame begins, because once monetizing corporate credit fails to lift the market and bail out both BofA's client as well as its sellside research division whose only out now is to beg the Fed for a rescue, all that's left is for the central bank to directly enter the stock market and end price discovery as we know it.

Come to think of it, life will be much easier when the trading day consists of just one daily press release from the Fed advising markets what the closing price is. The only possibly problem could be when just like Kuroda, the Fed chair is asked to explain how despite printing money out of thin air, the central bank is still facing trillions in paper losses.