Price Efficiency a Key Component as Fed Prepares to Buy Bonds

The Federal Reserve has the bond markets in their sights with $75 billion at the ready, which it will use to buy debt issues directly from the companies or through exposure via exchange-traded funds (ETFs). One caveat is that the Fed will ensure price efficiency by avoiding debt issues trading 1% or one standard deviation above their net asset values within a 1-year timeframe.

Early May was the proposed time the Fed would begin snatching up these bonds, which means that they may have already started.

“For all we know, they could’ve already started buying, so we’ve gotten confirmation that they haven’t,” said Dave Nadig, chief investment officer and director of research at ETF Trends, said Monday on CNBC’s “ETF Edge.”

“The real news here is this definition of what too big a premium is, and there was a lot of speculation around this because we really don’t have an instance where a government entity has come in and said what fair value looks like,” Nadig added. “We now know what the playbook looks like.”

Bond ETFs are inherently not as priced accurately compared to equities—as such, dislocations abound in the Fed’s bold move to backstop corporate debt, but Nadig feels the 1% and one standard deviation precedent is reasonable.

“I think that’s a very reasonable way of thinking about that. The bond market is not nearly as efficient as we see in equities. So, a plus or minus 1% on what is being called the net asset value is actually a very reasonable number,” he said. “I do think this might have the interesting consequence of everybody piling into these ETFs trying to get in before the Fed and then the Fed maybe not even showing up because [of]the persistent premiums.”

With the Federal Reserve stepping in to purchase corporate bonds to help keep the economy afloat, one ETF to consider is the Goldman Sachs Access Investment Grade Corporate Bond ETF (GIGB). GIGB seeks to provide investment results that closely correspond to the performance of the FTSE Goldman Sachs Investment Grade Corporate Bond Index.

The fund seeks to achieve its investment objective by investing at least 80% of its assets (exclusive of collateral held from securities lending) in securities included in its underlying index. The index is a rules-based index that is designed to measure the performance of investment grade, corporate bonds denominated in U.S. dollars that meet certain liquidity and fundamental screening criteria.

For more market trends, visit ETF Trends.