Anatomy of a Liquidity Crisis: Corporate Bonds in the COVID-19 Crisis

Abstract

We examine the microstructure of liquidity provision in the COVID-19 corporate bond liquidity crisis. During the two weeks leading to Fed interventions, transaction costs soared, trade-size pricing inverted, and dealers, in particular non-primary dealers, shifted from buying to selling, causing dealers’ inventories to plummet. Liquidity provisions in electronic customer-to-customer trading increased, though at prohibitively high costs. By improving dealer funding conditions and providing a liquidity backstop, the Primary Dealer Credit Facility (PDCF) and the Secondary Market Corporate Credit Facility (SMCCF) calmed dealers and stabilized trading conditions. Most of the impact of SMCCF on bond liquidity seems to have materialized following its announcement. We argue that the Federal Reserve’s actions reflect a new role as market maker of last resort.

Keywords: Corporate bonds, liquidity crisis, COVID-19, PDCF, SMCCF, electronic trading, customer-to-customer, market maker of last resort.

JEL Classification: G14, G21, G23, G24