The Federal Reserve has dramatically increased its efforts to save the economy, even adding junk bonds to the list of assets it can buy, as a wave of businesses may be struggling to survive the expected recession.
Stocks surged, Treasury yields rose, and the dollar sagged after the Fed announced it would provide $ 2.3 trillion in programs that expand operations to reach small and medium-sized businesses and cities and American states. Gold futures jumped $ 51, a 3% gain to $ 1,735 an ounce, as the Fed’s initiatives could be inflationary.
Corporate debt ETFs also rebounded. The iShares iBoxx $ Investment Grade Corporate Bond ETF rose 3.2%, while HYG, iShares iBoxx $ High Yield Corporate Bond ETF jumped 6.8% in its biggest evolution since 2008.
The Fed provided details of some of the programs it had previously announced, but added new ones and a few surprises. Fed Chairman Jerome Powell said after the announcement that the Fed was targeting the part of the real economy that needed the most help and that more programs could be added.
As part of its announcement, the Fed expanded its corporate lending programs to take them into a whole new field, including the ETFs of companies rated below investment grade. He previously announced a high-quality debt and ETF purchase program. It will also now accept triple-A rated commercial mortgage-backed securities and secured loan obligations as part of its term debt-backed securities facility, created for the first time during the financial crisis.
“It would seem that the Fed is aware that the economy is in a critical situation, especially with small businesses and that they are about to take very unusual steps, some unprecedented, to see if they can ease this sector, “noted Art Cashin, Director of Floor Operations for UBS on the New York Stock Exchange.
The Fed provided details of its business lending program on Main Street, setting a $ 600 billion lending target of $ 1 to $ 25 million for medium-sized businesses. He also said he would provide term financing to banks involved in the payroll protection program, authorized by Congress to help small businesses.
The Fed also said it would create a new municipal liquidity facility that would offer states and municipalities up to $ 500 billion in loans, and that it would receive $ 35 billion in treasury support for the protect from potential losses.
“Now, apart from buying stocks, every asset class is open for purchase by the Fed,” said Peter Boockvar, chief investment officer at Bleakley Advisory Group. “They are concerned about credit. They see themselves as a lender of last resort. They are now the lender of all stations. Going below the investment grade in the high yield junk area is now a dangerous area they’re heading to, but it will be a discussion or some other day. “
Boockvar does not believe the Fed will buy stocks, although there has been a lot of speculation in the market recently.
The Fed has stated that most of the ETFs it buys “will be ETFs whose primary investment objective is exposure to quality US corporate bonds, and the rest will be ETFs whose objective is to main investment is exposure to high yield US corporate bonds. “
“I thought they would if things went down again. They keep doing it day after day, it makes you wonder how bad the data is, “said John Briggs, chief strategy officer at NatWest.
The economy should already be in recession, after several weeks of state closings, now affecting around 90% of the US economy. Economists expect the current quarter to be the worst with estimates of a record 30% drop in GDP. The economy is expected to start to recover in the third quarter after the economy reopens.
“The Main Street stuff looks good. I just didn’t think they would get into unwanted bond ETFs. It will be fair to be the next to complain, “said Briggs. “They will not buy high quality bank paper. I think it is interesting that they buy junk bonds. I save fallen angels. How do we get out? How do you assess the risk in the future, will they take something? “
Targeting high yield debt in particular can help energy companies, many of which are rated as unwanted and struggling with collapsing oil prices.
The Fed has been aggressive, adding massive amounts of liquidity to the market, cutting interest rates to zero and committing to unlimited purchases of treasury bills. Congress has authorized a $ 2.2 trillion aid program and plans to expand it.
By taking action, the Fed has helped lower spreads in some stressed parts of the credit markets. It also added cash to various asset classes, including commercial paper that was virtually frozen.
“We have acted forcefully to make our markets work again,” said Powell, adding that the efforts have improved market conditions. The Treasury backed the Fed, including $ 85 billion in protection for three Fed credit facilities that target $ 850 billion.
“This is a monetary policy partnership, a monetary policy partnership that has accomplished a great deal,” said Ward McCarthy, chief financial economist at Jefferies. “The tax problem is the political angle and the politicians just can’t help themselves … they overcame it with the first stimulus bill. Eventually they will overcome it with this stimulus bill. In the meantime, the economy needs help and the Fed is in a vacuum. “
The Fed clearly made progress in the corporate debt market, which was illiquid until the central bank announced its corporate debt purchase program last month. This not only opened the market and narrowed spreads, but triggered a record wave of new debt issuance as companies sought money to weather the crisis. The high-yield market has also improved and there have been a number of new problems in this market in the past week.
The Fed has long expressed concern about the large number of companies rated Triple B, just above the high yield category. A drop in the credit rating of companies at this lowest rating level would mean higher interest rates for these companies, but also potentially less liquidity in the bond market for their debt.