Boston - Multiple factors are at play in the corporate bond market creating fear and uncertainty among an increasing number of sellers struggling to raise cash. There's the expected economic effects of the coronavirus. There's also the free fall of oil prices. It's even gotten to the point where some trading counterparts are now unable or unwilling to add investment-grade corporate risk to their balance sheets.
For those investors looking to raise cash in their corporate ladder portfolios, liquidity has improved slightly over the past week. Transaction costs, however, remain elevated, with the possibility of exceeding 3.0%. These costs are exponentially higher than the typical 0.1% we're used to seeing.
Investors across all fixed income asset classes — from US Treasurys to emerging markets — are being forced to adjust to this new liquidity environment. Our trading team has adapted to this fast-moving market by employing new and innovative approaches to generating liquidity to meet all requests from our ladder investors. We note that the price volatility and the lack of dealer participation are — in many ways — more dramatic than what we experienced during the 2008-2009 financial crisis when the corporate bond market was one-third of its current size.
Corporate market action: Yields, spreads, and returns
The data below illustrates the significant and especially abrupt market downturn, followed by a partial recovery. After setting a record-low yield of 1.90% on March 5, the intermediate investment-grade corporate bond market registered 11 straight days of negative returns, nearly pushing the month-to-date loss into double-digit territory by March 23. The rapid deterioration of investor confidence caused credit spreads — which rarely exceed 250 bps — to jump from 110 bps to 395 bps, a level previously seen only during the credit crisis.
To put the magnitude of this price action into perspective, the credit crisis resulted in a record-setting max drawdown of 14.6%, which took place over the course of 282 days. The recent sell-off sparked by the coronavirus produced a max drawdown of 10.7% over 17 days. In a distant third comes the tight monetary policy that led to a max drawdown of 5.9% over 98 days in 1994.
New Fed programs established
With the coronavirus pandemic spreading throughout the US and recession fears disrupting financial markets, the Fed reacted with a series of policy actions and proposals to stem the tide of liquidity flowing out of the corporate bond market. In addition to reestablishing some of the programs that proved effective at restoring confidence during the 2008 credit crisis — such as the Troubled Asset Relief Program and the Money Market Mutual Fund Liquidity Facility — the Fed is using its full range of authority to support the flow of credit to American families and businesses.
Two of these new quantitative easing programs are aimed directly at the corporate bond market — the Primary Market Corporate Credit Facility (PMCCF) and the Secondary Market Corporate Credit Facility (SMCCF). Established to support large employers, the PMCCF ensures that credit will be available to investment-grade bond issuers, and the SMCCF will be used to purchase outstanding bonds in the secondary market to provide additional liquidity for investment-grade corporate bond investors.
Corporate bond prices have reacted favorably to these financial programs aimed at keeping investment-grade issuers operating through the crisis. The quick passage of a substantial stimulus bill helped fuel a partial recovery through the end of March. While trading flows have improved, liquidity is still a long way from normal.
Broader market perspective
We believe it's encouraging that the intermediate investment-grade corporate bond market finished March on a strong note. During the last six trading days of the month, the market returned 4.8% and credit spreads tightened over 100 bps. Despite this movement, the current spread of 306 bps is historically cheap, and may still provide an attractive entry point.
Bottom line: While it's been our experience that market trends never occur in a straight line, we believe investors will be rewarded for staying the course during these volatile times.