The Federal Reserve is not leaving any corner of the U.S. bond market behind in this crisis.
There's no other way to interpret the central bank's sweeping measures announced Thursday, which together provide as much as $2.3 trillion in loans to support the economy. It will wade into the $3.9 trillion U.S. municipal-bond market to an unprecedented degree, can now purchase "fallen angel" bonds from companies that have recently lost their investment-grade ratings, and has expanded its Term Asset-Backed Securities Loan Facility to include top-rated commercial mortgage-backed securities and collateralized loan obligations.
The details matter. Here's what's new and significant for bond markets:
Municipal Liquidity Facility
This is new and close to what I've argued for over the past year. The Fed's facility will buy muni debt directly from issuers that's sold for cash-flow purposes and matures no later than 24 months from the date of issuance. I had figured that for simplicity the central bank would make this available only to states, but the Fed decided that in addition to states and Washington, D.C., it would also buy notes from cities with more than 1 million residents and counties with more than 2 million.
The Treasury Department is making an initial $35 billion equity investment, and the vehicle can snap up as much as $500 billion of eligible debt.
At first glance, this looks well done. The parameters are probably enough that it won't break the muni market, while it should force down short-term borrowing costs and allow states and large localities to raise a lot of cash in a hurry. That's what's needed as much as anything during the coronavirus pandemic.
Primary/Secondary Market Corporate Credit Facilities
I said the Fed should never buy junk bonds. My Bloomberg Opinion colleague Noah Smith said speculative-grade borrowers need a lifeline, too.
The central bank split the difference. It changed the parameters of both of its corporate credit facilities to include fallen angels that were investment grade just a few weeks ago but lost those ratings because of the intentional economic shutdown. The specific wording is this: "Issuers that were rated at least BBB-/Baa3 as of March 22, 2020, but are subsequently downgraded, must be rated at least BB-/Ba3 at the time the Facility makes a purchase."