To protect us economically from the coronavirus, Fed Chairman Jerome Powell has acted faster than a speeding bullet and with more force than a locomotive. Between activating “unlimited” quantitative easing and launching $4 trillion in “Main Street” lending programs, the US Fed has amassed enough ammunition so far to fortify nearly 25% of the entire US bond market. Their audacious activities on the week led to historic gains across both the debt and equity markets. While the ultimate economic impact of the coronavirus remains unknown, Americans should all take comfort knowing that our US Federal Reserve, in conjunction with our US Treasury, will do whatever it takes to see us through.
On Friday, the Federal Reserve announced that it will greatly expand the reach of its asset purchase programs. The Fed now has the authority to purchase Treasury bonds, agency bonds, municipal bonds, investment grade corporate bonds, high yield bonds, and derivatives. With Treasury legislatively backstopping the Fed, and the Fed now backstopping roughly the entire bond market, nearly all bonds have become Treasury bonds. In response, the largest investment grade corporate bond ETF (ticker: LQD) rose 9% on the week while the largest below-investment grade corporate bond ETF (ticker: HYG) rose 12% on the week. Magically, transferring all these credit risks to the US Treasury only increased 10-year Treasury Bond yields from .68% to .73%, leading to a .7% loss in the largest, broadest Treasury fund ETF (GOVT). Paying .7% to receive 9-12% within a $45 trillion market amounts to one of the greatest trades in history.
But wait, there’s more!
While large companies often issue debt for financial engineering, small companies often issue debt for survival. Therefore, the nationalization of the bond market should benefit smaller companies disproportionately more than larger companies. Mr. Market agrees! This week, the S&P 500 large company index rallied 12%, while the S&P 600 small company index rallied 20%. No, the Federal Reserve did not directly purchase small cap stocks, but by co-signing on their debt, they dramatically reduced risk levels and thereby boosted valuations. Excellent work, Chairman Powell!
Many vaunted pundits branded the Fed as feeble once interest rates dropped to zero. Not so. This Fed has audaciously counter-punched this crisis with seemingly unlimited monetary resolve to save the US economy. Yes, they rapidly cut rates to zero and pumped $2 trillion in liquidity into the financial system through quantitative easing. But now they have ventured out of “wall street” onto “main street”. Remember, of the $2.2 trillion stimulus package passed two weeks ago, Congress allocated $450 billion to the Fed as loan collateral. The Fed can lever this money up nearly 10x, providing $4 trillion+ for stabilization endeavors. How much money is that? The value of the entire corporate bond market is $9.5 trillion. The value of the entire municipal bond market is $3.8 trillion. Adding together the $4 trillion authorized and the $6 trillion already on their balance sheet, the US Federal Reserve has enough ammunition to purchase nearly 25% of the entire US bond market. With this power, the Fed has transitioned from being the lender of last resort to being the buyer of last resort. The implications of this will last for generations as the unintended consequences amass. But for now, we must applaud Chairman Powell and the US Fed for their bold and daring leadership during such an unprecedented period in world economic history.
Lastly, I know I am using some exaggerated language here. The US bond market hasn’t really been nationalized, but the scale of the Fed’s involvement certainly deserves the overemphasis. However, the overemphasis equally applies to the White House, Congress and the Treasury. The speed and size of their coordinated actions have been equally astounding. For example, there are about 60 million Americans working within small businesses. If each of them earns roughly $50,000 per year, the total payroll cost for US small businesses approximates to $250 billion a month. Congress has already allocated $350 billion to the Payroll Protection Program, with another $250 billion likely on the way. Taken together, this $600 billion can subsidize 96% of all small business payrolls for two-and-a-half-months! To save the day, Chairman Powell isn’t the only Beltway hero suiting up.
Have a great weekend!
David S. Waddell
CEO, Chief Investment Strategist