As part of the Fed's ongoing
nationalization bailout of the entire market, yesterday we pointed out that in a dramatic reversal away from years in which the Fed would not intervene in the corporate market, the US central bank would now buy Investment Grade corporate bonds, and would even intervene in equities, by purchasing the LQD investment grade debt ETF.
Commenting on this stunning departure, this morning Nomura's Charlie McElligott said that "we actually see the Fed in the game of not simply suppressing the risk-free rate, and thus term-premium, as they did last time—but now buying spread-product (beyond MBS alone) with risk-assets outright / through the new SPV—it is reasonable to believe that investors will “reverse engineer” the Jay Powell playbook noted above, and go with their muscle-memory from this Fed “short volatility positioning” prior conditioning."
Judging by the market's surge today, the answer is yes. But even before that, savvy investors realized that the most bang for the risk-free buck comes by purchasing the one ETF that the Fed is now explicitly backstopping, and as Bloomberg notes, "the rush into investment-grade bonds picked up after the Federal Reserve said it will step into the market, with the world’s largest credit ETF seeing the second-biggest inflows in its 18-year history."
To wit: the $30.3 billion Investment Grade Corporate Bond ETF, the LQD, posted its second-biggest ever inflow of $1.06 billion on Monday, as traders piled into LQD ahead of the Fed. Monday’s one-day inflow was just shy of its record one-day intake of $1.09 billion in 2016.
All those who did as the Fed told them to do, were rewarded generously, as the LQD recorded its biggest rally since 2008 as investment-grade bonds rebounded. "The Fed will provide a steady bid supporting the large, highly liquid ETF as there are only so many funds that meet their buying criteria," said Todd Rosenbluth, director of ETF research at CFRA Research.
Separately, as we discussed yesterday, "one of the biggest laments about the breakdown in the market has been the blow out in the basis between ETF prices and NAV values, which in the case of the investment grade ETF, the LQD, has soared to a record high 5% as a result of crippling illiquidity in the underlying bond market. It is this gap that the Fed is hoping to close."
And that's precisely what happened: and not just close, but the move went in the opposite direction, as the rally in LQD boosted its share price nearly 3% higher than the value of its underlying assets - the fund’s biggest premium since 2009! The fact that LQD is now trading at a premium illustrates that the traders responsible for channeling bonds in and out of the fund were likely short credit, according to Academy Securities' strategist Peter Tchir.
"Market makers are now on the wrong side of the move,” head of macro strategy Peter Tchir wrote in a note Tuesday. “This should create a virtuous cycle for inflows and bids for bonds."
In short, as short "burner" Elon Musk would approve, the Fed just precipitated the biggest ever short squeeze in corporate bonds, showing once again that fighting the Fed can be quite hazardous to your health.