Market sentiment certainly improved following the announcement from the Fed that it will start purchasing “corporate bonds to create a corporate bond portfolio that is based on a broad, diversified market index of US corporate bonds. This index is made up of all the bonds in the secondary market that have been issued by US companies that satisfy the facility's minimum rating, maximum maturity, and other criteria. This indexing approach will complement the facility's current purchases of exchange-traded funds.”
So, in another unprecedented Coronavirus induced move, the Fed has shifted from passively buying investment grade ETFs via its SMCC to actively purchasing individual corporate bonds; of which it can buy around USD 750bn. The announcement came after a wobbly couple of days across global stock markets which saw the S&P index, for example, temporarily fall through the psychological 3000 level. So to many, it may look as though the Fed is intervening to keep equity and credit markets stable. There are questions over whether this was totally necessary considering the spreads on lower-grade debt are back to trading near the pre-Covid levels, and AAA-rated credit yields were around 2.5% at the end of May, close to the lowest levels seen since the end of World War II. The move clearly falls in-line with Powell's statement last week, that the Fed will "act forcefully, proactively and aggressively." However, the Fed’s balance sheet clearly has no ceiling, and for us the issue comes when the central bank is required to unwind such positions, once economic recovery is back in full force and inflation crawls out of its cosy shell.
Staying with the Fed, following chatter of so-called “yield-curve control” Dallas Fed President Kaplan yesterday said he remains skeptical of the tool; which the Fed could potentially deploy to cushion the US economy from a deep recession. "I wouldn't rule it out, but right now Treasury yields are relatively muted," he added. Kaplan also commented on the Fed’s recent use of Modern Monetary Theory saying: “Unfortunately because of the crisis, we have actually taken a number of steps which are heading into new territory — and so we’ve done some version of MMT to some extent to deal with this crisis”. And echoing our concerns he added,, “The challenge is, I don’t think the implications of MMT were well understood before and I was concerned about them, and now that we’ve done some of these things, I continue to be concerned and we’re going to have to reckon with the implications”.