The Fed takes on corporate credit risk: an analysis of the efficacy of the SMCCF

Summary

Focus

We evaluate the efficacy of the Secondary Market Corporate Credit Facility (SMCCF), a programme implemented by the Fed to stabilise the US corporate bond market in the wake of the Covid-19 shock. The Fed announced the SMCCF on 23 March 2020 and expanded the programme on 9 April. We estimate the direct effects of the Fed's announcements on corporate bond prices and market liquidity measures using a matched sample of programme-eligible and ineligible securities. We also identify the Fed's actual purchases in the secondary market, which allows us to quantify the impact of the facility's purchases on credit and bid-ask spreads.

Contribution

We study the impact of the Fed's announcements and the impact of its actual purchases, highlighting the power of promises made by modern central banks when markets have trust that the central bank is able to deliver on its promises. We show that in circumstances where there is trust, the central bank needs to do less to deliver on its promises.

Findings

We find that the two announcements significantly reduced credit and bid-ask spreads and that this appears to have had little to do with whether or not a particular bond was eligible for purchase by the SMCCF. The narrowing of credit spreads was due almost entirely to a reduction in credit risk premia, as opposed to a reduction in default risk. The Fed's forceful response to pandemic-induced turmoil in financial markets shored up investor confidence and improved market sentiment, effectively forestalling fire sales and stabilising conditions in the market well before the Fed bought anything. In fact, our results indicate that the Fed's actual purchases of individual corporate bonds had negligible effects on credit and bid-ask spreads.

Abstract

We evaluate the efficacy of the Secondary Market Corporate Credit Facility (SMCCF), a program designed to stabilize the U.S. corporate bond market during the Covid-19 pandemic. The Fed announced the SMCCF on March 23, 2020, and expanded the program on April 9. Our results show that the two announcements significantly lowered credit and bid-ask spreads, the former almost entirely through a reduction in credit risk premia. The announcements had a differential effect on the program-eligible bonds relative to their ineligible counterparts, but this difference is not due to program eligibility per se, according to our results. Rather, the announcements restored the "normal" upward-sloping profile of the term structure of credit spreads by substantially reducing spreads at the short end of the maturity spectrum relative to spreads at the long end. Using an IV approach, we also document important announcement-induced spillovers across all bonds outstanding for issuers whose bonds were likely to be purchased by the facility. Finally, we show that the Fed's actual purchases had negligible effects on credit and bid ask spreads. Our results highlight the extraordinary power of modern central banks: when markets have trust in the central bank's ability to deliver on its promise, as exemplified by the iconic "whatever it takes" remark by Mario Draghi, the central bank needs to do less (if anything) to deliver on its promise.

JEL classification: E44, E58, G12, G14

Keywords: Covid-19, credit market support facilities, diff-in-diff, event study, purchase effects