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Annual Report 2020 | Federal Reserve Bank of St. Louis

The COVID-19 Economy: How the Pandemic Defined 2020

The first economic impact of the COVID-19 pandemic revealed itself in forward-looking financial markets, as stock prices plunged, uncertainty skyrocketed, trading sometimes froze up, and investors sought refuge in safer assets. Miguel Faria-e-Castro and Julian Kozlowski describe how such short but sharp financial turmoil played out in corporate bond markets, comparing conditions to those of the 2007-09 financial crisis.

Crises in Corporate Debt Markets: COVID-19 vs. the Global Financial Crisis

By Miguel Faria-e-Castro and Julian Kozlowski

In response to the pandemic in early 2020, the Federal Reserve returned to the toolkit it used during the global financial crisis of 2007-09 (GFC) and created facilities to purchase asset-backed and other types of securities, such as corporate debt, to ensure credit markets would continue to function.

Corporate debt, especially in the form of bonds, constitutes a major source of financing for nonfinancial companies. Bonds comprised almost 60% of total nonfinancial corporate debt at the end of 2019.This percentage is from the tables of Financial Accounts of the United States produced by the Federal Reserve Board of Governors. It can alternatively be accessed using FRED.

Corporate bond prices provide us with a window into the connection between financial market conditions and the larger economy: They measure the perceived risk that firms might default on their obligations; and in the secondary market, changes in these prices reflect changes in perceptions of that default risk (among other factors).

The Two Crises Were Similar in the Early Stages

The financial volatility caused by the COVID-19 pandemic in 2020 was similar in many ways to the volatility during the GFC. One indicator of that volatility is corporate credit spreads, which measure the difference between yields in corporate bonds and yields on similar (but safer) U.S. government securities.

The figure below compares the evolution in the median of credit spreads around the peak of financial market turmoil during the COVID-19 pandemic in early 2020 and during the GFC. The figure plots the credit spreads minus their value at time “0,” the beginning of increases in financial market volatility, which allows the comparison of the evolution of credit spreads in the crises. The vertical lines in the figure show the timing of Fed announcements about interventions.

Financial Market Volatility Early in both Crises Was Similar

SOURCES: FINRA’s TRACE, Mergent FISD and authors’ calculations.

NOTES: Time “0” marks the beginning of the increase in volatility in financial markets for the COVID-19 crisis (Feb. 28, 2020) and the GFC (Sept. 15, 2008). Vertical lines mark the timing of the Fed’s intervention in corporate credit markets. The first vertical line identifies the announcement of Primary and Secondary Market Corporate Credit Facilities (March 23, 2020) during the pandemic. The second and third vertical lines identify the announcement of QE1, the initial round of quantitative easing, (Nov. 25, 2008) and of the Term Asset-Backed Securities Loan Facility (March 3, 2009), respectively, during the GFC. The y-axis shows credit spreads in basis-point differences from time 0. (A basis point is one-hundredth of 1 percentage point.)

How the Two Crises Differed

The increase in corporate credit spreads was qualitatively and quantitatively similar in the two crises. But swifter Fed action in 2020 may have helped curb financial market volatility even more than in 2008, as shown by the steeper downturn of the orange line in the figure above.

However, there may be more to the story than the timing and size of the policy responses, such as the difference in the underlying shocks driving the two crises. For example, the most affected sectors in each of the crises were different: The fall in employment and rise in borrowing costs was very large in the construction sector during the GFC, while the leisure and hospitality sector was the most affected sector during the pandemic in 2020. The two crises have also differed in the types of perceived risk, as reflected in the movements of credit spreads. The figure below shows the distribution of corporate credit spreads, from the least-risky bonds (with lower spreads, the 10th percentile) to the most-risky bonds (with higher spreads, the 95th percentile).

The movements in the median spreads were relatively similar during the two crises, as we can see from the dashed-teal line (50th percentile), but the GFC featured much larger increases of the top percentiles: The relative sizes of the movements, shown by the dashed and dotted green lines, were almost three times larger.

Credit Spreads for High-Risk Bonds Moved More during the Global Financial Crisis

SOURCES: FINRA’s TRACE, Mergent FISD and authors’ calculations.

NOTES: The figure shows the distribution of corporate credit spreads for the 10th, 50th, 90th and 95th percentiles. Spreads in the higher percentiles reflect higher-risk bonds.

We split the variation in credit spreads before and during each crisis into three components: differences between sectors, between firms in the same sector, and within firms (i.e., in the spreads of bonds issued by the same firm).

We find that differences between firms were more relevant in the GFC, but that differences between bonds issued by the same firm were more relevant in 2020. This suggests that markets were more concerned about a firm’s solvency during the GFC (as a firm’s solvency risk should equally affect all its bonds), while funding and liquidity factors were more relevant in 2020.

Indeed, firms with solvency concerns had larger increases in credit spreads during the GFC. But the relevant dynamic in 2020 was that better liquidity meant smaller increases in credit spreads.

While the two crises have many similarities, the divergent paths of financial market indicators such as average corporate credit spreads may reflect the different policy responses and the different underlying aggregate shocks.

Mahdi Ebsim, a research associate at the St. Louis Fed, contributed to this article.

Notes and References

  1. This percentage is from the tables of Financial Accounts of the United States produced by the Federal Reserve Board of Governors. It can alternatively be accessed using FRED.

Related Resources


Miguel Faria-e-Castro Miguel Faria-e-Castro is an economist with research interests in fiscal and monetary policy and banking and financial institutions. He joined the St. Louis Fed in 2017.

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Julian Kozlowski Julian Kozlowski is an economist whose research focuses on macroeconomics and finance. He joined the St. Louis Fed in 2018.

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