Several lines below you can read an excerpt from my Weekly Market Letter available exclusively for subscribers. In this week issue:
- stocks, gold. bonds, volatility
- the Federal Reserve recent activities
- Corporate Credit market in the United States
- Money Supply and flows within the economy
- US Budget Deficit
- upcoming economic harm around the globe
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Here is the text:

“If the Federal Reserve bails out everyone, no one actually gets bailed out.” Jeffrey Gundlach

This is a very thought-provoking statement. Of course, in practice, it’s impossible to rescue everyone just like the Fed is trying to do. What I mean by that is that only less than 50% of the money injected by the biggest central bank in the world is going into the real economy. Some people claim that it is as little as 10%. Even if the former is true it will not solve the biggest problem of most businesses during this crisis – cash flows. Having said that it is very likely that the repricing process hasn’t come to an end yet and central banks with governments will flood the market and the economy with even more money. I'll repeat myself, it is not about how much money you throw in, it is about where that money eventually goes. We’ll come back to this issue. Let’s first recap the recent market developments.

THE FEDERAL RESERVE KILLED FREE MARKETS

Traditionally as every week, it is important to analyze recent moves of one of the most powerful institutions on the globe, the Federal Reserve. The US central bank has announced on Thursday to take additional actions and will provide up to $2.3 trillion support to “rescue the economy”. They are expanding their operations into the municipal bond market by creating another Special Purpose Vehicle and will buy up to $500 billion of municipal securities. The Fed will also buy corporate bonds from the primary market (directly from the issuer) INCLUDING JUNK BONDS if downgraded to as low as BB-/Ba3 after March 22, 2020, and junk-bond ETFs such as iShares iBoxx $ High Yield Corporate Bonds (Ticker: HYG) or Blackrock’s Corporate High Yield Fund (Ticker: HYT). It would be helpful to recall the table from the last week with the credit rating scales broken by the agency.


Furthermore, they will buy loans issued under the new $2.2. trillion government package, the CARES Act. In other words, the Fed is now buying everything, in unlimited size with exception to equities. I think that by stepping into the non-investment grade (junk) bond market the Fed crossed a rubicon which may lead to many unintended consequences. Below I listed some possible implications

1. The Federal Reserve is buying mentioned assets using Special Purpose Vehicles (SPVs) funded by the US Treasury (taxpayers). Therefore, in reality, American people are the buyers. Recall that the Federal Reserve is allowed to buy only government-backed securities.

2. By buying speculative assets such as BB- companies there are simply bailing out insolvent companies. Those activities violate the Federal Reserve Act (they are skirting it using SPVs).

3. If they are buying junk and investment-grade bonds plus related ETFs – will they start buying leveraged loans, stocks, and equity ETFs too if the market will continue its turmoil?

4. If companies default and will not be able to payout their debt, then the losses are covered by the Exchange Stabilization Fund (ESF) – emergency reserve fund of the US Treasury Department - using taxpayers' money.

5. The Fed hired BlackRock on March 24 to manage those trades (back then they were willing to buy only investment-grade bonds). Ironically, the biggest high-yield bond ETF was created and is managed by BlackRock.

6. The Federal Reserve and the Treasury are now merged. Special vehicles (SPVs) are technically owned by the US Treasury and financed by the Fed. Jerome Powell, the Fed Chair said that their abilities are limited by the law. All those activities then need permission from the Treasury Secretary. This has to be approved by President Donald Trump. Therefore it can be said that the Fed is now run by Trump. I call it the Federal Reserve of Donald Trump. If the US Treasury owns assets via SPVs it means that the market has been to some degree nationalized.

7. Considering the previous point, it creates a very dangerous situation. US central bank has unlimited bazooka and only Trump himself knows whether he will exploit it or not, for example, to get reelected. In other words, it will be LEGAL BY LAW for US president to push the S&P 500 to new all-time highs.

8. The Fed has literally lost its independence and it is very likely that after the crisis ends it will be questioned constitutionally.

It appears that we are witnessing the largest policy experiment in the history of economics. Think about unintended consequences. The US central bank is buying completely insolvent companies' debt while killing free markets. Moral hazard at its best. The message is clear: prudent and responsible investing is not anymore tolerated. In good times investors and companies can substantially gain when the economy is strong. Therefore, when it weakens they are supposed to incur losses. The Fed by buying everything is preventing this healthy market mechanism. Leftovers of capitalism have been killed. The United States of America is now closer to a banana republic than it has ever been before.

How thus did the market respond to those announcements? Corporate bonds and stocks have massively rallied.

Junk bonds ETF HYG jumped on Thursday by 6.55%, while investment-grade ETF LQD 4.70%. High yield corporate bonds ETF HYT owned by BlackRock cheered the day with a 7% upside. When you look at the chart of the year to date performance of the first two mentioned ETFs it turns out that LQD is actually 3.4% (grey line) up since the beginning of 2020! This is happening in the middle of the worst economic downturn in modern US history.


When we look at HYG it is down almost 5% this year. The most insolvent part of corporate America is down only 5%. This is truly unprecedented. The market is celebrating the Fed’s backstop of everything. The issue is, however, that many of those companies can’t pay interest. Having said that, the following question arises. Will the Fed has enough money to prop up this market through the crisis?


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Stay Safe.

Seb