Just when you thought the Federal Reserve couldn’t possibly stimulate any more, it launches a new stimulus program.
On Monday, the central bank announced it would begin buying individual corporate bonds through its so-called Secondary Market Corporate Credit Facility (SMCCF).
This is yet another unprecedented move even as the central bank makes “unprecedented” mundane.
The Fed put its feet in the corporate bond market back in May when it started purchasing exchange-traded funds (ETFs) holding a mix of corporate bonds. According to Business Insider, the Fed has bought about $5.5 billion in ETFs so far. Now it will begin to prop up individual companies.
Historically, the Fed has limited its purchases to government bonds, primarily US Treasuries and mortgage-backed securities. But the central bank has taken a “buy everything but the kitchen sink” approach to stimulus in the wake of the coronavirus-included government shutdowns.
At this rate, I’d keep an eye on the kitchen sink.
The US Treasury gave the Fed $25 billion for SMCCF as part of the CARES Act. The central bank can leverage that 10-to-1 to buy up to $250 billion in corporate paper. The Fed will create the additional $225 billion out of thin air.
According to a press release, the Federal Reserve will build “a broad and diversified portfolio of corporate bonds to support market liquidity and the availability of credit for large employers.”
The Fed will purchase bonds that meet its criteria on the secondary market. The bonds must have remaining maturities of five years or less. The central bank cannot hold more than 10% of the bonds issued by a given corporation. The program ends Sept. 30, but there is an option to extend it.
An economist for MacKay Shields told CNBC the move to buy individual bonds was “a shift to a more active strategy for the secondary market corporate credit facility, rather than the passive approach originally envisioned.”
In effect, the Fed’s foray into the corporate bond market will create artificial demand for corporate debt. It will boost bond prices higher than they otherwise would be and hold interest rates down. Ostensibly, the Fed’s tinkering will make it easier for corporations to borrow money.
In simplest terms, the central bank is manipulating the corporate bond market.
Corporations were leveraged to the hilt before the pandemic. So much so that the Federal Reserve issued warnings about the increasing levels of corporate indebtedness late last year.
“Borrowing by businesses is historically high relative to gross domestic product (GDP), with the most rapid increases in debt concentrated among the riskiest firms amid weak credit standards.”
The government shutdowns in response to COVID-19 have only exacerbated the problem. This new bond-buying program will exacerbate it more. This raises the specter of a wave of defaults and bankruptcies as reality catches up to these zombie companies.
Stocks rallied on the move, which was the point according to Patrick Leary, chief market strategist at Incapital.
“What it does primarily is continues to push fixed income lower and tighter and helps prop up the stock market, which is the real issue here. It’s a reminder to the marketplace that the Fed is here with its balance sheet and is going to deploy that balance sheet to try to support markets and market functioning.”
S&P 500 erased a 2.5% drop on word of the bond-buying program and finished up 0.83%.
The Fed’s move comes on the heels of the June Federal Open Market Committee meeting where the central bank committed to continuing stimulus into the foreseeable future. Fed Chairman Jerome Powell said the central bank was committed to “do whatever we can, for as long as it takes.” The Fed indicated zero percent interest rates would likely continue into 2020. In fact, Powell said, “We’re not even thinking about thinking about raising rates.”
Peter Schiff called the Federal Reserve policy a “monetary Hail Mary.”
“The Fed is desperate. They know that everything is going to fall apart. So, they just got interest rates at zero and they don’t care what happens. It’s like they got their pedal to the metal, and they’re going full-speed ahead, and they just closed their eyes. They don’t even care what’s on the road because it doesn’t matter. Even if they go over a cliff and crash and burn, it doesn’t matter because they’re going to die anyway. I mean, that’s basically what they’re saying.”
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