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US Fed starts buying corporate junk bonds. How it will affect India?

junk bond

In a more aggressive move, US’s Federal Reserve has decided to buy corporate junk bonds. The Federal Reserve is extending its credit facility to companies with junk rating and is now purchasing corporate credits on top of the exchange-traded funds already it purchased. The Central bank announced on Monday.

Under sustained efforts to promote market operations and ease the credit squeeze, and create additional jobs the Fed will intervene in the secondary market corporate credit facility.

The programme has the plan to procure corporate loans of value US$ 750 billion. Its early announcement on March 23 is broadly considered a watershed moment for financial markets, which is encircled by the coronavirus threat.

Steven Fridman, a senior macroeconomist in Mackley Sheild, said the decision to buy a wider portfolio of corporate bonds represents a change in a more active strategy for the secondary market corporate credit facility.

The move comes a week after the US-led Federal Open Market Committee’s action to a market meltdown in the wake of the coronavirus epidemic. The move towards a more aggressive bond-buying strategy could “reflect the view of the committee that the ongoing COVID-19 crisis would need economic reforms as a comprehensive and challenging situation needing wider support.”

As per the latest guidelines, Fed agreement stated that they would purchase individual bonds in the secondary market which were five years of age or less. This purchase would be with ETFs which are already being purchased. It is balanced in the case of investment class indexes, but it also includes some junk – bond funds that track debt, which had been investment grade before the crisis but had subsequently declined.

The purpose of these loan purchases has been stated in a news release that it will be to create a corporate bond portfolio which is set up based on a broad, varied market index of corporate bonds.

The index is made up of all the bonds in the secondary market that is issued by companies that satisfy the minimum rating, maximum maturity, and other forms of the facility. This indexing approach will supplement the current purchase of exchange-traded funds.

What is a junk bond?

A bond which is at the most risk of a basic default company is called a junk bond. Such companies issuing junk bonds usually start, or companies which are economically struggling. Junk bonds have a risk because investors are uncertain about whether they will be paid their principal and paid regular interest. As a result, Junk bonds pay a higher yield than their secured counterparts in order to compensate investors for additional risks.

Disturbed companies from the junk bond market can raise fresh capital to pay off their old debts to continue their business. Lenders such as investment banks and asset reconstruction companies may also benefit from an active junk bond market. They can reduce their own risk. by selling at a market set price, to participants who are willing to take more risks.

Many low – end companies, unable to tap the formal bond market, turn to retail investors to raise money through high-productivity companies. In such cases, retail investors get inaccurate information on the valuation of the risk prize and have very little protection against delays and omissions.

How that will affect the Indian markets?

The move is expected to support the credit markets which collapsed in mid-March. This fresh infusion of capital is also expected to benefit India as the new currency is expected to reach emerging markets too through Foreign Portfolio Investors who become more willing to take more risk in less developed markets.

The Indian markets along with all other major world markets have been in an uptrend despite the economic losses from COVID-19. Till now the Fed’s intervention in ETFs helped in reversing the trend after the March collapse. Fed’s decision to jump in the bond market will be an added boost.

The recent Fed moves have allowed the insolvent companies to stay afloat which in turn have helped in maintaining stable wages throughout the pandemic.

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