The Fed’s ‘Zombification’ of Corporate America

• Fed to Buy Individual Company Debt
• Stay Long Gold…
• Zombifying Corporate America

Late Sunday evening Dow Futures were down 900 points… 

The sharp selling from last week looked set to continue… with the Dow opening Monday morning down around 600 points. 

But it didn’t last long…

By the close the Dow closed up 157 points… in an impressive 800+ plus point turnaround. And those gains look to set to continue.

The reason?

$750B more in Fed money is on the way…. and this time its targeted at buying individual company debt. 

“Watershed Moment” in Monetary Policy

Today’s surprise announcement from the Fed caught the market by surprise. 

Here’s CNBC: 

As part of a continuing effort to support market functioning and ease credit conditions, the Fed added functions to its Secondary Market Corporate Credit Facility.

The program has the ability to buy up to $750 billion worth of corporate credit. Its March 23 initial announcement is largely considered a watershed moment for the financial markets, reeling from the coronavirus threat spread.

 

“The decision to buy a broad portfolio of corporate bonds represents a shift to a more active strategy for the secondary market corporate credit facility, rather than the passive approach originally envisioned,” said Steven Friedman, senior macroeconomist at MacKay Shields.

The move comes less than a week after a downbeat Federal Open Market Committee view of the U.S. economy in the wake of the coronavirus pandemic.

Moving to a more aggressive bond-buying strategy “may also reflect the Committee’s view that the economic recovery from the ongoing COVID-19 crisis will be an extended and challenging one, with credit markets requiring extensive support,” Friedman added.

Yep… it will be a long one. 

In terms of specific company debt the Fed will be buying – they offered this: 

The intent of the individual debt purchases will be “to create a corporate bond portfolio that is based on a broad, diversified market index of U.S. corporate bonds,” the Fed said in a news release. 

“This index is made up of all the bonds in the secondary market that have been issued by U.S. companies that satisfy the facility’s minimum rating, maximum maturity, and other criteria. This indexing approach will complement the facility’s current purchases of exchange-traded funds,” the statement said.

Issuers must have been rated BBB- or /Baa3, depending on the agency, as of March 22, just before the Fed announced its credit facilities. 

But Why Worry?

When the Fed declared their intent to purchase corporate debt ETFs at the height of the crisis (both high and low quality) – some considered this an overreach / moral hazard. 

The Fed are now taking this a massive step further… and I would argue just a very short hop, skip and a jump away from buying stock itself.

The takeaway is expect stocks to accelerate again

This is a big f&%king deal.

But what it also tells me is the Fed are deeply concerned by taking such extreme measures. 

And I suspect I know why… 

First up – last month saw the largest number of corporate bankruptcies in the US since 2009: 

Second – and perhaps more concerning – was the record high corporate bond defaults in the second quarter…

But hey? 

Why should investors worry?

We have a silver bullet right… a Fed willing to buy “everything and anything”!

Mmm… 

Stay Long Gold

The Fed are extremely worried about the current (and near-term) state of the economy… 

It’s starting to make what we saw in 2008 look like a cake walk… 

But if there’s one clear asset to benefit from what is essentially central bank panic- gold. 

Gold – June 15 2020

In short, the more central banks increase the money supply (M2), the greater the probability gold will continue to rally. 

M2 Money Supply vs Gold

To me, the correlation between increased money supply and higher gold prices over the long-run is clear. 

When the Fed announced its intent to buy high quality corporate debt – I felt this was too much. 

From there, they said they were going to also include high-risk (low quality) debt.

At that point, I felt we were now in the game of creating zombie companies. 

These companies would otherwise not survive.

But what’s more troubling is they have grossly distorted both debt and equity markets.

For example, investors have no way of knowing or evaluating what’s quality (especially with respect to debt). 

So what’s next? 

The Fed to start buying stocks?

I felt the Fed had already done more than enough…

For example, their primary objective through this government-led mess was to lower credit spreads… and they did that.

I shared this chart for 5-Year Credit Default Swap Spreads (from Scott Grannis) last week: 

Job done?

Apparently not…

So what more are they trying to do? Just ramp the market?

Or perhaps the question is what do they know that we don’t?

Anyway… let’s hope the longer-term unseen consequences of zombifying corporate America won’t be extreme. They might be… 

Who can say for sure… we have never been here before. 

Throughout history debt has always come at a price. No exceptions. 

Regards
Adrian Tout