High Yield Update – Fed to buy some fallen angels

Published 10th April 2020

David Crall, CEO and CIO, Nomura Corporate Research and Asset Management Inc.

On Thursday, April 9, the US Federal Reserve announced that they will begin purchasing some US high yield fallen angels and US high yield ETFs, an unprecedented extension of their willingness to support the US corporate debt markets. The Fed has said they will buy fallen angles (if they were rated at least BBB-/Baa3 as of March 22 and at least BB-/Ba3 at the time the facility makes a purchase) and high yield ETFs (which include all high yield ratings categories). We believe the entire US high yield market will benefit from these purchases, because when the Fed removes some bonds from the open market, capital “flows down the waterfall” to other bonds. This effect was clearly seen when the European Central Bank bought European investment grade bonds during 2016-2017 and European high yield spreads tightened significantly. In response, the US high yield market was up +3.16% on Thursday, extending the gains on the week to +5.28%, as measured by the ICE BofA US High Yield Constrained Index (HUC0).


Note that the Fed never bought corporate bonds before the recent fiscal stimulus package, the CARES Act, authorized the US Treasury to provide credit support to SPVs that the Fed would leverage. In its implementation of the CARES Act, we were not expecting the Fed to include high yield fallen angels or high yield ETFs, so this development was significant for the market. These high yield purchases will occur via the “Primary Market Corporate Credit Facility” and “Secondary Market Corporate Credit Facility” with a combined maximum size of $750 billion. The Fed’s announcement was part of a broader package of $2.3 trillion in loans to support the economy. Various SPVs will makes loans to entities including small and mid-size businesses, states, and municipalities, while also purchasing AAA CLOs, investment grade bonds, municipal bonds, and other assets. Federal Reserve Board Chair Jerome H. Powell said, “the Fed’s role is to provide as much relief and stability as we can during this period of constrained economic activity, and our actions today will help ensure that the eventual recovery is as vigorous as possible.”


This major Fed action comes at the same time that there is evidence that the rate of new Covid-19 infections may peak this week in the New York City metro area, and peak within the next two weeks in the US nationwide. Furthermore, Saudi Arabia and Russia have made progress toward reinstating the OPEC+ production cuts which provides a modest benefit to the oil sector. We are optimistic that a slow reopening of the economy may begin in June, and the economy will grow again in Q3. At the same time, we do acknowledge the risk of Covid-19 flare-ups will exist until a vaccine is developed. We are hopeful that better testing and better medicine will help us reopen. In the meantime, the economic data will be very bad, but monetary and fiscal stimulus will provide meaningful support for the economy and markets until the Covid-19 crisis has passed.


MTD through April 9, the US high yield market is up +2.72%, and the YTD returns are down -10.77%. As a reminder, the Bloomberg Barclays index family rebalanced to include fallen angels this month, while HUC0 and other ICE BofA indices did not rebalance, and accordingly, the Bloomberg Barclays US High Yield Index is outperforming HUC0 a bit, up +3.17% MTD. As mentioned in previous updates, we have endeavored to be a significant net buyer during the market sell-off over the last few weeks wherever possible in our funds and accounts. We have purchased large quantities of fallen angels across our portfolios during this period, though in general they have been tough to buy. We have also made many purchases in stronger credits and sectors, while making some value purchases among stressed sectors. Coupons and inflows in certain accounts provided some cash to invest, and meanwhile we have sold issuers where we expect liquidity problems, some energy positions, and some higher dollar securities in order to recirculate capital back into lower dollar price bonds.


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The ICE BofA US High Yield Constrained Index (HUC0) tracks the performance of US dollar denominated below investment grade corporate debt publicly issued in the US domestic market. Qualifying securities must have a below investment grade rating (based on an average of Moody’s, S&P and Fitch), at least 18 months to final maturity at the time of issuance, at least one year remaining term to final maturity as of the rebalancing date, a fixed coupon schedule and a minimum amount outstanding of $250 million. In addition, qualifying securities must have risk exposure to countries that are members of the FX-G10, Western Europe or territories of the US and Western Europe. The FX-G10 includes all Euro members, the US, Japan, the UK, Canada, Australia, New Zealand, Switzerland, Norway and Sweden. Original issue zero coupon bonds, 144a securities (both with and without registration rights), and pay-in-kind securities (including toggle notes) are included in the index. Callable perpetual securities are included provided they are at least one year from the first call date. Fixed-to-floating rate securities are included provided they are callable within the fixed rate period and are at least one year from the last call prior to the date the bond transitions from a fixed to a floating rate security. Contingent capital securities (“cocos”) are excluded, but capital securities where conversion can be mandated by a regulatory authority, but which have no specified trigger, are included. Other hybrid capital securities, such as those issues that potentially convert into preference shares, those with both cumulative and non-cumulative coupon deferral provisions, and those with alternative coupon satisfaction mechanisms, are also included in the index. Securities issued or marketed primarily to retail investors, equity-linked securities, securities in legal default, hybrid securitized corporates, eurodollar bonds (USD securities not issued in the US domestic market), taxable and tax-exempt US municipal securities and DRD-eligible securities are excluded from the index. Index constituents are market capitalization weighted, provided the total allocation to an individual issuer does not exceed 2%. Issuers that exceed the limit are reduced to 2% and the face value of each of their bonds is adjusted on a pro-rata basis. Similarly, the face values of bonds of all other issuers that fall below the 2% cap are increased on a pro-rata basis. In the event there are fewer than 50 issuers in the Index, each is equally weighted and the face values of their respective bonds are increased or decreased on a pro-rata basis. Accrued interest is calculated assuming next-day settlement. Cash flows from bond payments that are received during the month are retained in the index until the end of the month and then are removed as part of the rebalancing. Cash does not earn any reinvestment income while it is held in the index. Information concerning constituent bond prices, timing and conventions is provided in the ICE BofA Bond Index Guide, which can be accessed on our public website (https://indices.theice.com), or by sending a request to iceindices@theice.com. The index is rebalanced on the last calendar day of the month, based on information available up to and including the third business day before the last business day of the month. New issues must settle on or before the calendar month end rebalancing date in order to qualify for the coming month. No changes are made to constituent holdings other than on month end rebalancing dates. Inception Date: December 31, 1996.
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