Just after I hit go on the last post, we got a bombshell announcement from the Federal Reserve. And I’ve responded in real-time on Twitter. So, let me respond more quickly here very briefly too.
The Fed is essentially putting a floor on multiple asset classes in the money and credit markets. Equities and high yield bonds are not in the mix. The point is that the Fed is saying it will backstop as many investment grade credit markets as it can — and in unlimited quantities.
Why? The Fed is simply trying to prevent a financial crisis.
For me this is the key part of the Fed’s announcement:
The SMCCF will purchase in the secondary market corporate bonds issued by investment grade U.S. companies and U.S.-listed exchange-traded funds whose investment objective is to provide broad exposure to the market for U.S. investment grade corporate bonds.
The Fed recognizes that liquidity has dried up everywhere. So it is provide blanket credit support. Think of the Fed as essentially the buyer of last resort for all investment grade credit assets. But, equities and high yield are residual asset classes. And, they are still exposed to the downturn in the real economy and earnings decline.
In terms of credit markets, given how many asset classes the Fed is backstopping, think of this as both a backstop and credit easing. But, the reason the Fed is exempting junk bonds from its credit backstop blanket because that is a step too far in terms of credit easing. Equity and high yield bonds are still subject to the risk that residual asset classes have. And their fortunes will depend on the fiscal response.
As Tim Duy wrote this morning, fiscal policy is still missing in action. Nothing the Fed announced this morning will prevent the real economy from cratering under global lockdown. They are addressing a liquidity crisis. Only fiscal can address the real economy.
Maybe fiscal authorities will give the Fed quasi-fiscal responsibilities via legislative fiat. But, that’s just a liquidity fix ultimately. Private sector solvency is more about a lack of consumption and output. I still think that’s a fiscal problem.
Note this from the Fed’s announcement though:
Treasury, using the ESF, will make an equity investment in the SPV established by the Federal Reserve for this facility.
This is a ‘consolidated balance sheet approach’. The Fed and Treasury are working hand-in-glove as buyer of last resort of all US dollar assets. It tells you that, in a fiat money world, central banks will completely align their response with governments in monetarily sovereign currency areas. Whatever the government wants to do to marshal real resources toward a crisis, the central bank will facilitate.
This is just the beginning of the policy response though. The real economy is still cratering and nothing I wrote here changes the overall downbeat logic of my last post regarding outcomes for the real economy and shares. In fact, the Fed’s response only reinforces the fact that equities (and high yield) are a residual and, thus, exposed. Nevertheless, at a minimum, it does give me hope that politicians get that we are on the edge of a Great Depression.