Unpacking the Fed’s corporate bond-buying program
On the latest edition of Market Week in Review, Senior Quantitative Research Analyst Abraham Robison and Senior Client Investment Analyst Chris Kyle discussed the U.S. Federal Reserve (the Fed)’s recent announcement on corporate bond purchases, the latest macroeconomic data and the outlook for investors.
Fed provides updates to bond-purchasing program
On June 15, the Fed detailed enhancements to its Secondary Market Corporate Credit Facility—the program it created in March—to purchase up to US$250 billion in corporate bonds and bond ETFs (exchanged-traded funds). “In purchasing this debt, the Fed’s aim is to build a broad-based, diversified portfolio of U.S. corporate bonds,” Robison said. He added that the program had previously featured a clunky opt-in provision for companies. The Fed will now purchase all corporate bonds that are rated BBB or higher with five years or less to maturity, Robison explained.
“Essentially, these new details pave the way for the central bank to buy everything it wants to buy, in order to deliver on its whatever-it-takes promise to stabilize the U.S. economy," he said. Fixed-income markets were pleased by the Fed’s announcement, Robison noted, with credit spreads tightening on the news.
The Fed’s approach has led some to question the risks of the central bank buying just about everything, he noted. Robison said that while such an approach can lead to problems down the line—such as runaway inflation—the Fed’s response to the 2008 financial crisis didn’t lead to any significant inflation issues. While moral hazards could also become a problem later on, Robison emphasized that the Fed’s focus right now is on the short-term—in other words, in helping the economy pull through the COVID-19 crisis.
“The Fed’s actions today have been compared to the steps the Bank of Japan took in 2001, in the wake of a decade-long housing crisis. The Japanese central bank ended up expanding its balance sheet so much that now, nearly 20 years later, it holds assets amounting to roughly an entire year’s worth of the country’s GDP (gross domestic product),” he explained. While this has led to market-functioning problems in Japan, Robison said it’s important to note that the Fed’s current balance sheet only comprises about 30% of U.S. GDP.
Is the U.S. economy improving?
Shifting to recently released U.S. macroeconomic data, Robison noted that as more businesses reopen, consumer spending is on the rise. U.S. retail sales numbers from May came in surprisingly strong, he said—evidenced by a record 17.7% month-over-month increase. Regional Fed surveys from New York and Philadelphia also showed improvement, Robison noted. “While the latest U.S. weekly jobless claims number came in higher than expected, in the aggregate, things do appear to be improving—although the recovery is by no means finished,” he stated.
Robison also noted that the National Bureau of Economic Research recently determined that February 2020 marked the peak of the business cycle, followed by the onset of the recession. “At Russell Investments, our team of strategists suspects that the recession may technically have ended in May—which means it would have only lasted for a few months. If true, that’s some good news,” Robison remarked.
Robison assessed the current state of markets through three key components of the team’s investing framework: cycle, valuation and sentiment.
The business cycle outlook has improved, he said, due to extremely accommodative central banks and very low interest rates. Such an environment is a positive for equity markets, Robison noted.
In the aggregate, the strategist team views sentiment as neutral, as investors are generally conflicted on the path forward for markets. “Some are bullish and some are bearish—and that’s indicative of a much more normal state,” he remarked.
Valuation also checks the box as neutral, Robison noted, with stocks in most regions looking expensive again—similar to how they were before the COVID-19 crisis hit.
“Ultimately, our cycle, valuation and sentiment framework underscores the importance of maintaining a diversified, multi-asset portfolio in today’s uncertain times,” he concluded.