ETF Edge

How the Fed's bond-buying stimulus could affect ETFs

Here's how the Fed's bond-buying stimulus could affect ETFs
Here's how the Fed's bond-buying stimulus could affect ETFs

"A short-term phenomenon."

That's what two leaders in the exchange-traded fund industry are calling the Federal Reserve's plan to buy a host of assets in an effort to stabilize U.S. markets during a historic period of volatility fueled by the global coronavirus outbreak.

The move includes the central bank's first-ever purchase of corporate bonds, which will be done via primary and secondary markets as well as through ETFs. Corporate bond ETFs have been a point of focus in the market as violent swings put a strain on liquidity in recent weeks.

"It is unprecedented for the government of the United States to own the corporate debt obligations of the private enterprises in this country. That is new territory," Dave Nadig, chief investment officer and director of research at ETF Trends, told CNBC's "ETF Edge" on Monday. "Short term, of course, we know what this means: buying pressure that'll bring up the price of the ETFs."

While the move was unprecented for the Fed, it wasn't "necessarily unexpected," Nadig said, pointing to countries like Japan, where the central bank has been buying ETFs for several years and now owns 80% of Japan's issued ETF assets.

Although most of Japan's asset purchases have been on the equity side, Nadig didn't discount the possibility of something similar happening in the U.S. market.

"I think we'll see something like that here in the U.S.," he said — but not without limits.

"It's not like they can all of a sudden own the whole bond market. They're limiting themselves to a fairly small percent — I think it's something under 20% — of the existing issuance of any one of these securities," Nadig said. "So, they're not going to become a dominant player, and I think that's an important point here. We're collecting a bunch of assets, presumably for a short term, much like we did with TARP back in 2008-2009. That was, again, the government stepping in to own assets they don't traditionally own."

TARP, or the Troubled Asset Relief Program, was an emergency asset-purchasing plan from the U.S. Treasury to stabilize U.S. financial markets in the aftermath of the 2008 financial crisis.

Todd Rosenbluth, senior director of ETF and mutual fund research at CFRA, said in the same "ETF Edge" interview that those limits would likely mean the Fed only deals with a few top ETF issuers, namely BlackRock's iShares, Vanguard and, "to a lesser extent," State Street.

The iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD) and Vanguard's Intermediate-Term Corporate Bond Index Fund ETF (VCIT) are two popular corporate bond products the Fed could target in this round of stimulus, he said.

"This is likely to be a short-term phenomenon, but it will help all the other corporate bond ETFs if they're buying the underlying bonds of AT&T and JPMorgan and Coca-Cola," Rosenbluth said. LQD holds all three companies' bonds.

"That helps these securities inside the portfolio, which will help to bring the net asset value back to more of a stabilized level for the foreseeable future," he said.

For Nadig, "all bets are off" as the stock market continues to churn.

"Major policy changes are happening day by day here. Things we never thought we'd see in our lifetime are getting dropped every 24 hours. So, at the moment, this seems like where the line in the sand has been drawn" for the Fed, Nadig said.

"I think it's really important to understand: this is not the federal government buoying the entire market, necessarily. They're explicitly not going to be buying ETFs that come up at a premium. So, if they manage to sort of reestablish equilibrium in the market, theoretically, that stops the purchasing and then the market can go back to resetting prices," he said. "This really, ideally, would be mostly an open market activity in the corporate bonds themselves. I think they're talking about ETFs here really just to help give some comfort to folks who are in that highly liquid ETF market."

U.S. stocks bounced back Tuesday as investors held onto hope that Senate lawmakers could agree on a coronavirus stimulus package.