Powell Explains Fed’s Business in Corporate Bonds

Summary

  • On 15 June 2020, Fed declared that it would buy individual corporate bonds on regular basis and its stimulus; monetary easing will continue depending on market conditions.
  • US equities surged up and wiped out losses after Fed’s announcement, with S&P 500 index rallying ~40% on 16 June since March 23 when it began its experiment with junk bonds.
  • Fed’s Chairman Jerome Powell stated that the US economic recovery would require virus to be under control.
  • Economists at Morgan Stanley have doubled down on their bet for V-shaped recovery even after cases are still rising in the US.

US Federal Reserve has been taking up some unconventional measures since last three months amid credit-starved economy. Coronavirus induced lockdown and slowdown in economic activities worldwide have made economies come to a standstill. The US central bank has taken up a series of emergency lending programs since COVID-19 pandemic started.

Lately, the US central bank stated that it planned to increase corporate bond-buying beyond its ETFs (exchange-traded funds) and into individual issues. The bank started with purchase of corporate bonds on 16 June after making an unexpected announcement a day before. Fed can buy nearly USD 250 billion incorporate debt from eligible issuers under the new provisions. The bank has also been allowed to drain off $25 billion from Treasury funds released in recent CARES Act. The move will enable the Fed to make substantial purchases through Secondary Market Corporate Credit Facility.

Fed also launched Main Street Lending Program on 15 June so that financial executives can extend loans to small and medium-sized enterprises that meets the lender registration standards. Fed's branch in Boston will be the principal buyer of such loans and will permit buying of up to 95% of Main Street Lending Program's debts.

Powell commented that Fed’s move was out of excess caution

On 16 June, Fed Chairman, Jerome Powell warned that the economic recovery of the US is burdened with significant ambiguity while addressing Congress in semi-annual testimony. However, he acknowledged that there have been signs of improvement in the economy.

Powell cited the recent jobs report by the Labor Department reflecting that there was an unexpected rise in employment when 2.5 million jobs were added in May. The surge in job growth was attributed to reopening of businesses due to relaxing of restrictions and extension of federal loans, stimulus measures and unemployment benefits supporting household incomes and spending. However, output and employment remained far less than pre-pandemic levels.

He told the Senate Committee that move to buy corporate bonds fulfils the vow it made previously but is not an attempt to take over the market.

Powell stated that the Fed did not want to run through the bond market like an elephant and appealed the markets to be sensible enough.

He stated that the return to risk from investors came because of belief that the Fed would do what it says it would be doing. Nevertheless, he did not promise a program with open ends as the Fed is performing with a minimum $120 billion monthly buying of Treasury and mortgage-backed securities.

ALSO READ: Federal Reserve Turns Cautious Signals ‘Long Road’ to Recovery, Markets Jittery

Bond yields have been close to record lows for company debt and spreads when compared with the Treasury debt shrunken to levels prior to COVID-19 outbreak. He noted that the pace of purchase would be contingent on response of the market concerning Fed's move on purchasing of corporate bonds. If the market function improves persistently, bond purchases could be slowed and stopped eventually.

Stock market jumps in response to the Fed's move

Day traders recently stacked into the stock market when share prices started falling due to pandemic worries and few probing authentications of the stock market rally.

Fed announced the expansion of corporate bonds beyond ETFs and into an individual issue on 23 March, the move matched with a market that went from longest growth period in history to fastest drop of more than 20%. However, the US stocks erased all losses and instantly rallied after the central bank declared that it would buy corporate debt, with S&P 500 soaring around 40% since March 23, when Fed notified its experiment with junk bonds.

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Fed has been in a rush to boost liquidity in the form of fiscal and economic stimulus, with reopening of economy that has surged the stock market from March lows. However, there have been new cases of COVID-19 in China that has forced the government to reinstate containment procedures and a massive rise in hospitalisations in many US states has diminished the risk appetite of investors.

Recovery ahead

The Fed has also cautioned that V-shaped recovery is unlikely for the economy.

ALSO READ: COVID-19 Aftermath: US Real GDP expected to shrink by 5.6% in 2020

As per a survey conducted by Bank of America, 53% of global fund managers stated that it is bear market rally, and not commencement of a new bull market, while 78% say the stock market is overvalued.

Economists at Morgan Stanley have doubled down on their bet for V-shaped recovery even after cases are still rising in the US. The bank expects global GDP to bounce back to pre-coronavirus levels by the end of 2020. It further anticipates that selective lockdown will keep the world economy from shrinking into recession even though threat of second-wave of coronavirus looms ahead.

Powell stressed that longer the economic slump, greater is the possibility of long-term destruction from long-lasting job losses and business shutdowns. Also, public confidence in containing the virus will determine the full recovery of the economy.

(Note: Currency denoted in USD unless otherwise specified)



 


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