High-Yield Junk Bonds Rally On Fed Buying

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So, this is new.

The Federal Reserve announced that it would buy junk bonds, or high-yield bonds, depending upon your point of view.

Despite the name, junk bonds are not worthless and aren’t “junk” at all. Also called, “high-yield bonds,” junk bonds are regular corporate bonds issued by companies just like regular, or “investment grade bonds.” Many corporate bond issues are rated by various companies including Moody’s, and Standard & Poor’s. The ratings go from AAA (Excellent), all the way down to D. Typically, bonds rated BB or lower are considered junk bonds.

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Fed Buying Fallen Angels

The Fed isn’t headed out to buy the most fragile of corporate bonds. Rather, the Fed is looking at buying the so-called fallen angles. Bonds that were rated investment-grade — B or higher — on March 22, but have since fallen into junk territory are eligible for Fed intervention.

junk bonds
Junks bonds aren’t actually trash, but clip art is fun!

The idea is that there are several otherwise decently capitalized and secure companies out there that have been downgraded into junk territory not through any fault of their own, but rather due to the bottom of the economy falling out from under them due to the coronavirus. Many investors are restricted from owning junk bonds based on their charter or other governing principals. Those firms piling out of a wide array of formerly investment-grade bonds could cause havoc in the bond markets.

The Fed still will focus the vast majority of its economic support on investment-grade, and government bonds. However, this new tactic send shares of high-yield ETFs like iShares iBoxx $ High Yield Corporate Bond ETF soaring on the announcement Thursday. Things have settled down a bit since then with such funds giving back some of the highest gains. However, they still sit well above Wednesday’s close.

As always, long-term investors are best served by a well-diversified portfolio tailored to the investor’s goals and risk tolerance. However, the Fed’s action is further evidence that these times are in many ways highly unusual, if not unprecedented.

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