The Federal Reserve will now buy "junk" bonds and stock market bears are deeply worried it could spark a much more serious economic collapse.
The Federal Reserve will now do what was unthinkable to many at the start of the year and start buying high-yield or “junk” debt. While this might be good news for the stock market in the short term, the long-term structural implications have bearish traders freaking out.
Bear twitter can be a dark place during a bull-run, meaning many of the investors, economists, and analysts calling for a stock market crash have had a rough decade.
Over the last month, however, the coronavirus pandemic has smashed the Dow Jones and S&P 500, with many of these bearish commentators finally seeing justification for their negative outlook.
After the global economy came to a sudden halt, equities priced for zero risk were forced to correct dramatically, causing severe stress to the financial system, and precisely what the bears have feared for some time.
Enter the Federal Reserve, who has gone full MMT (Modern Monetary Theory) to keep the greenbacks flowing. In the process, Chairman Jerome Powell and the FOMC have expanded a balance sheet that could hit $10 trillion this year.
The latest news is that not only will the Fed be making a foray into the high-grade bond world through ETFs, but it will also now reach into riskier junk bonds after making the following addition to its purchase of eligible assets, stating,
The preponderance of ETF holdings will be of ETFs whose primary investment objective is exposure to U.S. investment grade corporate bonds, and the remainder will be in ETFs whose primary investment objective is exposure to U.S. high-yield corporate bonds.
While the mainstream ignored this possibility, some commentators have been predicting it for a while.
The impact of this is potentially huge for debt-laden fallen angels like Ford Motor Company (NYSE: F), which saw its stock surging 6% after the announcement on Thursday.
While this is excellent news for stock market bulls looking for a Fed prop during this period of economic hardship, the longer-term ramifications are unclear, and the bears are not happy.
Part of the concern is that the FOMC is spending close to 10% of U.S. GDP on this program alone. Fear of inflation and the financial stability of the United States is prevalent among many stock market bears.
It is clear that Jerome Powell’s actions will do little to dissuade further risk-taking in the stock market.
While the foundations are in place for a big jump in the CPI, so far, this has not been seen, possibly due to the fact that demand for U.S. dollars is very high given its systemic importance to the global economy.
Still, the fact that the Federal Reserve is pursuing policies like the European Central Bank and the Bank of Japan means that many bearish stock market analysts are going to dive into safe-havens.
This could be beneficial for assets like gold and bitcoin, whose limited supply is believed to give them dis-inflationary qualities.
For now, it seems quite likely that the Fed eventually makes a move into equities. Though this is not explicitly allowed in the Federal Reserve Act, like all legal documents, they can be interpreted.
Powell is making it clear he will buy everything it takes to keep the economy moving forward, but with every downturn, he is absorbing more and more risk.
After having endured a stock market crash, the FOMC has continued to throw more and more at the economy as unemployment continues to spiral out of control.
However, with the Dow Jones back above 23,000 and the S&P 500 nearing 2,800, the question is how bad is the data that Powell sees if the FOMC continues to throw the kitchen sink at the U.S. economy?
This article was edited by Samburaj Das.
Last modified: April 10, 2020 12:05 PM UTC