WASHINGTON -- The Federal Reserve said Monday that it will begin purchasing corporate bonds as part of a previously-announced plan to ensure companies can borrow through the bond market during the pandemic.
The program will purchase existing bonds on the open market, as opposed to newly-issued debt. The central bank said it will seek to build a "broad and diversified" portfolio that will mimic a bond-market index. The bonds will have to be from highly-rated, investment-grade companies, or firms that fit that description before the viral outbreak struck.
The announcement boosted the stock market, which was already rebounding from early losses. The Dow Jones Industrial Average rose 0.6% Monday in New York.
The Fed's purchases should hold down corporate bond yields, making it cheaper for companies to borrow. But by also lowering the return from investing in those bonds, the Fed's actions will likely encourage investors to shift money from corporate bonds to stocks in hopes of achieving a higher return.
When the Fed announced its bond-purchase program in March, few companies were able to issue bonds. Banks and other large investors were dumping assets in favor of cash. New research has found that simply by announcing the program, the Fed was able to encourage more bond trading and improve the market's efficiency.
The Fed has said it will buy up to $750 billion of corporate bonds and exchange-traded funds made up of corporate bonds. The Treasury Department has provided the Fed $75 billion of taxpayer funds to offset any losses that occur from the investments.
"This index is made up of all the bonds in the secondary market that have been issued by U.S. companies that satisfy the facility's minimum rating, maximum maturity and other criteria," the Fed said in a statement. "This indexing approach will complement the facility's current purchases of exchange-traded funds."
The creation of the index removed a potential hurdle for companies that would have had to certify that they were in compliance with restrictions outlined for the program.
The cost to protect investment-grade corporate debt against default dropped the most since April 9, when the Fed expanded the scope of its bond-buying program to include some high-yield debt.
"It's a significant positive," said Dominique Toublan, head of U.S. credit strategy at BNP Paribas SA. "The main reason is that they removed the requirement that issuers certify their eligibility. Many investors were worried that this would impair the ability of the Fed to buy bonds."
The move is one of nine emergency lending programs announced by the Fed since mid-March aimed at limiting the damage to the U.S. economy by the coronavirus pandemic. With a capacity of $250 billion it has so far invested about $5.5 billion in exchange-traded funds that purchase corporate bonds.
The New York Fed said in a separate statement that purchases of bonds from eligible sellers will begin today.
Market watchers said that while the announcement wasn't a complete surprise, confirmation by the Fed that it would start buying individual bonds in additional to exchange-traded funds provided additional support for the bond market.
The Fed said it could slow or even pause daily purchases if market functioning showed sustained improvement, though buying could pick back up if conditions worsened again.
Earlier Monday, the Fed separately announced that it has opened its Main Street lending program for small and mid-size businesses.
Lenders are now able to register through the Boston Fed, which will administer it. The Fed will begin purchasing 95% of loans made through the program's three facilities "soon," the Boston Fed said on its website Monday.
"Lenders can find the necessary registration documents on the program site and are encouraged to begin making Main Street program loans immediately," said the Boston Fed.
The program will lend up to $600 billion through the three facilities, each of which will make slightly different loans to businesses with up to 15,000 employees or $5 billion in revenue last year. Loans will range in size from $250,000 to $300 million for an expansion of existing debt.
The Main Street facilities were first announced at the end of March as part of the Fed's emergency response to the coronavirus pandemic. The program has been expanded twice since, in attempts to make sure it would be used by a broad swathe of American companies after facing criticism from lawmakers and business groups that said it wouldn't have wide enough reach.
The facilities mark the first time the Fed will directly support America's so-called Main Street firms. The loans are meant to reach those that may not be able to easily access capital markets for borrowing or to raise equity, but are too large to tap the Small Business Administration's Paycheck Protection Program loans, which are meant for businesses with fewer than 500 employees.
Information for this article was contributed by Christopher Rugaber of The Associated Press and by Christopher Condon, Craig Torres, Molly Smith and Catarina Saraiva of Bloomberg News.