Bond markets in Spring 2020 and the response of the Federal Reserve

Abstract: This paper studies bond market dislocations during the initial phase of the COVID crisis in March and April of 2020. Distortions were large in Treasury and investment-grade bond markets with yields increasing sharply (and much more than CDS) from March 9 through mid-March. Outflows from bond mutual funds, especially investment-grade funds, peaked during the weeks of the largest price distortions and were likely contributors to both Treasury and corporate market price pressure (as funds first sold Treasuries, then less liquid securities to meet outflows). Other large Treasury sellers included the household sector and the rest of the world, both of which are affected by hedge funds. I link the poor performance of investment-grade securities in mid-March to a disappearing safety-effect. Analysis of Federal Reserve interventions reveal that Treasury yields started falling with large daily Fed purchases of Treasuries in the days after March 18. Investment-grade yields fell sharply after the Fed’s March 23 announcement, which included corporate bond purchases. In sharp contrast to the importance of large purchases in the Treasury market, corporate markets stabilized without immediate purchases and purchases made have been delayed and modest. I argue that providing liquidity requires large purchases (the Treasury market) but one can stop a run on corporate bond funds buying very little with a sufficiently strong announced willingness to buy. I compare these lessons with how QE worked during the financial crisis. Single authored paper.