They Fought The Fed And Lost: How Powell Triggered A "Spectacular" Short Squeeze In LQD

Over two years ago, in Jan 2018, we first showed that when it comes to betting on trouble in the investment grade bond market, investors had a preferred instrument for pessimism: shorting the LQD, the largest US investment grace corporate ETF.

In retrospect, and loosely paraphrasing Crocodile Dundee, what happened to the LQD in Jan 2018 wasn't trouble. This - as shown in the chart below - was "trouble"between its all time high on March 6, and the ten year low hit just two weeks later on March 19, the LQD went bidless as the corporate bond bubble burst, and both investment grade and high yield debt ETFs and single names cratered.

As LQD plunged, the shorts soared, rising to never before seen levels, send the index even lower and sparking even more shorting. By this point, only one thing could save capital markets - both bonds and stocks (why stocks? Because as a reminder the only buyer of stocks in the past decade have been buybackskill the bond market and suddenly companies can't issue debt to fund buybacks and it's bye bye, not buy buystocks): the Fed had to step in and buy bonds, something we explained on Thursday, March 19 in ""The Bond Market Is Broken" And Only Fed Buying Bonds Can Fix It".

However, on quad-witching Friday, March 20, the Fed did not do what so many traders were now expecting, and the liquidation continued with stocks in freefall, sending the Dow below 19,000, and to levels not seen since the Trump election.

By the following Monday, the Fed was trapped - either it unleashes not a bazooka but a "nuclear bomb" (as Paul Tudor Jones called it) and stabilizes the unprecedented panic gripping traders, or the market was about to close. It picked the former, and before the open on Monday, March 23, the Fed announced not only unlimited QE, but in an unprecedented move, Powell said he would also start buying loans and bonds in the secondary market, as well as the LQD.

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