Fed to Keep ‘Invisible Presence’ in Bond Market, Citigroup Says

The Federal Reserve will keep its “invisible presence” in the corporate-bond market even after unwinding a program that sent borrowing costs for companies plummeting while spurring a rally in credit, according to Citigroup Inc.

The Fed couldn’t credibly exit the debt market because “it cannot tolerate the catastrophic consequences of bond origination and secondary trading snapping shut,” Citigroup strategists led by Daniel Sorid wrote. They also noted that the central bank’s sale of its portfolio by year end will be easily absorbed.

Market participants have mostly shrugged off the Fed’s plan to unwind its corporate-credit facility, seeing the intervention during the depths of the pandemic as a model to be used in future crises. Citigroup says high-grade investors value this presence at about 30 basis points at the index level.

Chairman Jerome Powell’s assertion that the central bank would only act as a backstop in once-in-a-generation emergencies like Covid-19 hasn’t dimmed investor sentiment either. Risk premiums barely moved, and companies are still selling bonds after a relentless rally over the past 14 months.

Fed to Keep ‘Invisible Presence’ in Bond Market, Citigroup Says

As long as corporate bonds remain important to the financial system, the Fed’s program will “continue to exert power over the market,” according to Citigroup. Still, there are growing regulatory pressures that could make the easy liquidity Wall Street has enjoyed tougher for the Fed to provide during the next crisis.

Treasury Secretary Janet Yellen has expressed a desire to review the risks posed by asset managers and other large investment institutions that amplified stress in the financial system during the pandemic.

“To truly exit from the bond market, the Fed has signaled it will need to address its concerns with a major market player: mutual funds,” the Citigroup strategists wrote.

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