The Fed Takes on Corporate Credit Risk: An Analysis of the Efficacy of the SMCCF

Abstract

We evaluate the efficacy of the Secondary Market Corporate Credit Facility (SMCCF), a program designed to stabilize the U.S. corporate bond market during the Covid-19 pandemic. We show that the program announcements on March 23 and April 9, 2020, significantly lowered credit and bid-ask spreads across the maturity spectrum and ultimately restored the upward-sloping term structure of credit spreads. Using intraday event study methodology, we also document that actual program purchases reduced credit spreads of eligible bonds by about two basis points more than those of ineligible bonds. To shed light on the underlying mechanism, we calibrate a variant of the preferred-habit model and show that a "dash for cash," a sell-off of shorter-term lowest-risk investment-grade bonds, combined with a spike in the arbitrageurs' risk aversion, can account for the inversion of the credit curve during the height of the pandemic-induced turmoil in the market. Consistent with the empirical findings, the Fed's announcements, by reducing risk aversion and alleviating market segmentation, helped restore the upward-sloping credit curve in the investment-grade segment of the market.

Keywords: COVID-19, credit market support facilities, regression discontinuity, diff-in-diff, event study, purchase effects, preferred-habitat

JEL Classification: E44, E58, G12, G14