The Federal Reserve is set to start selling off the corporate bonds and fixed income ETFs it acquired last year during the coronavirus turmoil.
In an announcement made on Wednesday, the Fed said it will begin reducing holdings in the vehicle it used to make the emergency purchases – known as the Secondary Market Corporate Credit Facility (SMCCF) – which houses some $5.2bn bonds and $8.56bn ETFs.
The sale, which is expected to complete by the end of the year, will see the US central bank first reduce the number of bond ETFs it owns before winding down the corporate bond holdings.
The Fed said in a statement: “Portfolio sales will be gradual and orderly, and will aim to minimise the potential for any adverse impact of market functioning by taking into account daily liquidity and trading conditions for exchange-traded funds and corporate bonds.”
Although a minor move that is distinct from the $7.3trn debt on the Fed’s balance sheet, it is another sign the central bank is prepared to begin tightening monetary policy after a period of ultra-loose conditions that have supported the US economy since coronavirus sent shockwaves through the global markets early last year.
The US central bank will continue to purchase at least $120bn of US debt a month in order to continue to support the recovering economy.
As Andrew Limberis, investment manager at Omba Advisory & Investments, said: "With the Fed never having owned much more than 5% in any single bond ETF, the impact at an ETF level will likely be negligible.
"US corporate credit spreads are however extremely tight and so it will be interesting to see if the market reacts to this announcement."
On 24 March, the Fed announced plans to purchase ETFs for the first time in history as part of what was described as potentially unlimited quantitative easing measures.
The SMCCF was subsequently set up in order to facilitate the purchases and caused a surge in inflows as traders prepared for the Fed’s involvement in the market.
The central bank began purchasing ETFs such as the iShares iBoxx $ Investment Grade Corporate Bond ETF (LQD) and the Vanguard Intermediate-Term Corporate Bond ETF (VCIT) in early May last year.
This unprecedented step played a key role in improving the liquidity within bond markets as the Fed acted as the buyer of last resort.
All eyes will now turn to whether the Fed begins to tighten monetary conditions further following the spike in US inflation data last month.
Jordan Sriharan, head of MPS and passive and Canaccord Genuity Wealth Management, said this shows the Fed's credibility is "hugely important" in the functioning of capital markets.
"The next six months or so in terms of how they talk about tightening monetary policy will have a clear effect on markets," he added.