Within weeks of the March 11th declaration of COVID-19 as a global pandemic by the World Health Organization, rating agencies were downgrading businesses across virtually every sector of the economy. Not surprisingly, these downgrades were felt most acutely by businesses that one would reasonably expect to be directly harmed by the ensuing shutdowns, including travel and hospitality firms and retail stores. But the downgrades also hit food companies and other areas of the economy that tend to be more recession resistant.
An accompanying spike in credit spreads was even quicker to materialize. Royal Caribbean’s and Marriott’s credit spreads tripled essentially overnight, while those of other large companies increased by twofold or more.
But then something interesting happened. Almost as quickly as they had risen, most of these spreads began retreating to more normal levels. By mid-June, most spreads were at or lower than where they were prior to the pandemic declaration.
What business reason could plausibly explain this? The pandemic is ongoing and aggregate demand for these companies’ products does not appear to have rebounded in any material way. People are not suddenly flocking back to Marriott’s hotels or Wynn’s resorts.
The story is indeed one of increased demand. But rather than demand for the companies’ products, we’re seeing an upswing in demand for these companies’ debt. What could be driving this demand?
Enter the Federal Reserve. On March 23rd, The Fed announced that its Secondary Market Corporate Credit Facility (SMCCF) would begin purchasing investment-grade corporate bonds in the secondary market, first through ETFs and directly in a later phase.
And poof! Instant demand. And instant price stabilization. All the Fed had to do was announce that it would begin buying bonds (it hasn’t actually started buying yet) for demand to rush back in, push prices up and drive credit spreads down.
To illustrate how quickly spreads reacted to the Fed’s announcement, we tracked seven of the top 20 companies listed by S&P across different industries from early March through mid-June. The chart below plots swap spreads for a single bond (with approximately five years to maturity) from each of the following companies:
- Royal Caribbean Cruises (RCL)
- The TJX Companies (which includes discount retailers TJ Maxx, Marshalls, and HomeGoods, among others)
- Wynn Resorts
- Kraft Foods
- Ford Motor Company
We sourced the underlying data for these charts from two RiskSpan partners: S&P, which provided the timing of the downgrades, and Refinitiv, which provided time-series spread data.
The companies we selected don’t cover every industry, of course, but they cover a decent breadth. Incredibly, with the lone exception of Royal Caribbean, swap spreads for every one of these companies are either better than or at the same level as where they were pre-pandemic.
As alluded to above, this recovery cannot be attributed to some miraculous improvement in the underlying economic environment. Literally the only thing that changed was the Fed’s announcement that it would start buying bonds. The fact that Royal Caribbean’s spreads have not fully recovered seems to suggest that the perceived weakness in demand for cruises in the foreseeable future remains strong enough to overwhelm any buoying effect of the impending SMCCF investment. For all the remaining companies, the Fed’s announcement appears to be doing the trick.
We view this as clear and compelling evidence that the Federal Reserve in achieving its intended result of stabilizing asset prices, which in turn should help ease corporate credit.