The Fed has been juicing the market. Let’s get into it.
One of the ways the Federal Reserve has attempted to use monetary policy to stimulate the economy is by buying corporate bonds. Before we get into its latest move, here’s why it’s doing that and how buying corporate bonds stimulates the economy.
The Fed began buying corporate bonds earlier this year in order to directly support the price of bonds by adding demand in the corporate bond market. When bond prices rise, remember, we’re keeping the dollar amount in interest payments the same, so the yield of those payments, against the higher price, comes down. Then, companies can borrow at lower yields, which allows them to borrow more, which stimulates the economy. That’s put against the risk lenders and bond investors see in companies, so it can only bring yields down so much.
The Fed had been buying bonds in the secondary market, meaning it has been buying bonds already trading and changing hands between investors. This is after the company had issued the bonds to the lenders, which then sold, or syndicated, a chunk of the bonds to investors, thereby engaging the secondary market. The Fed’s actions in this market is called its Secondary Market Corporate Credit Facility, or its SMCCF.
The Fed also has executed a PMCCF, or Primary Market Corporate Credit Facility. In this facility, the Fed buys bonds directly from the issuer, or the company. The Fed is literally a lender to U.S. corporations. This enables the Fed to even more directly inject liquidity into the economy.
At first, the Fed was buying bond exchange traded funds, so shares in funds that then bought corporate bonds.
Now here’s the big update:
As part of the Fed’s SMCCF, it will not only buy bond funds, but also individual corporate bonds, the Fed announced in mid-June. It’s buying a broad index of bonds across sectors.
The total size of all bond-buying programs is $750 billion, roughly 4% of U.S. GDP.
Now to see how this could impact the market, watch the quick video above.
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