This guest commentary was written on 6/9/20 by Mike O'Rourke of JonesTrading.
Over the past couple of weeks, we have highlighted the Federal Reserve’s role in degrading the market's pricing mechanism.
In addition to our own views, we have highlighted the perspective of respected market participants and former Government policymakers.
These distortions appeared to climax this week as a handful of companies that have filed for bankruptcy, or are anticipated to file for bankruptcy with little expected recovery value, skyrocketed several hundred percent.
While reality appears to have started to settle in today, one must keep the animal spirits of this market in mind, especially since the S&P 500 has returned to flat on the year.
It is important to remind everyone that Chairman Powell has described the pandemic as an “exogenous shock” that has caught the nation off guard and there is no fault or blame. On his March 15th conference call, Powell cited illiquidity in the Treasury market as the reason for the initial emergency Quantitative Easing, which turned into unlimited QE the following week.
Every FOMC meeting generally appears to focus on what more the Fed can do, even at recent meetings after the several Trillion dollars of monetary accommodation were injected into the financial system.
Going into tomorrow’s meeting, one should reflect on Mohammed El-Erian’s comments that we highlighted last week, “It is striking to me that we are talking about YCC, yield curve control. That we are talking about negative rates when there is no evidence of market malfunction, when there is no evidence of credit freeze and when there is no evidence monetary policy is a constraint to economic recovery.”
El-Erian’s comments are an understatement. Since Powell’s March 15th call, the financial markets have essentially made a full recovery and animal spirits are on steroids. Not only has the S&P 500 recovered its losses for the year, but the Nasdaq 100 registered new all time highs today.
In 2020, High Yield issuance is occurring at its fastest pace in 5 years, and May was the third busiest month on record. Investment Grade issuance is even stronger and less than halfway through the year, it reached $1 Trillion for 2020, which is almost double the pace of 2019.
The equity market euphoria has been embodied by bankrupt bellwethers. We have said that the success of the Federal Reserve’s intervention can be measured best by whether its emergency facilities are needed. The Fed has expanded its balance sheet by $3 Trillion since the pandemic started, but the special facilities that have the capacity to go into the Trillions only amount to approximately $155 Billion.
The key financial market program, the Corporate Credit Facility, has only purchased $35.6 Billion of Corporate Bond ETFs.
Last week’s purchases were only a modest $6 Billion, but the reality is that none were necessary. A key requirement of all of the Fed facilities is that an eligible issuer must “provide a written certification that it is unable to secure adequate credit accommodations from other banking institutions and the capital markets and that it is not insolvent.”
Considering the equity market today even has a penchant for insolvent companies, it is plausible that any company that needs to raise equity or debt and is solvent should be able to do so in this environment. The pandemic is no longer an exogenous shock disrupting markets.
The Federal Reserve’s balance sheet expansion has provided all public companies with the opportunity to tap recovered capital markets. These facilities are theoretically supposed to expire on September 30th. Since every corporation has been offered the opportunity to take its capital raising mulligan, anyone who has not done so yet does not deserve it later.
The Fed has an opportunity to exit this situation with a balance sheet the will likely be doubled in size, but it won’t be loaded with the toxic securities it may be forced to take on later. The appropriate step would be for the Fed Chairman to remind corporations of this reality, and that would be mildly hawkish. The Chairman’s acknowledgement of the financial market recovery would also be mildly hawkish.
That said, this is a highly politicized Federal Reserve and the President’s last hope for re-election, therefore, we expect Chairman Powell to continue to coddle financial markets and likely snatch policy defeat from the jaws of victory.
This is a Hedgeye Guest Contributor piece written by Mike O'Rourke, Chief Market Strategist of JonesTrading, where he advises institutional investors on market developments. He publishes "The Closing Print" on a daily basis in which his primary focus is identifying short term catalysts that drive daily trading activity while addressing how they fit into the “big picture.” This piece does not necessarily reflect the opinion of Hedgeye.