Opinion: The Federal Reserve is going to Buy Stocks
This is an opinion I already had, but came across an article that really dug into the reasons why this is highly likely to happen.
I wanted to share some key ideas from the article and will quote sections of it for sure. To read the entire document you can do so here
The Fed is going to buy stocks.
One of many goals for the Fed is to keep employment in the U.S high. This unfortunately means they will do whatever they can do keep the economy out of recession. Which, by the way I think is dumb because free markets have expansions and contractions, but that is for another convo.
Given the Fed wants to avoid recession at all costs, keeping the markets propped up is vital. Not only does a down market destroy the "wealth effect" - that effect has ripples that go throughout the economy as people feel less rich and thus spend less leading to a slowdown in the economy.
In the aformentioned article he talks about how the rise of the carry-trade has essential forced the Fed hand....
"In 2008, and again in 2020, the Fed was able to support the S&P 500 indirectly by lowering rates, purchasing government debt and making loans to buy risky bonds. With each intervention they’ve crept closer to buying stocks. This is no accident. When the Fed intervenes to support markets, it suppresses volatility and truncates losses for carry trades. This in turn encourages them to grow in size and scope, thus almost automatically guaranteeing that the next round of support will need to be larger. The most recent round stopped just short of buying equities, the next round will take Fed over the threshold."
traders earn a yield spread, or an up-front premium payment, as compensation for the risk that the asset they’ve purchased will depreciate or the event they’ve insured against will occur. These transactions, and a wide variety others like them, are “short volatility”. They do well when the world stays the same but can crash suddenly when things change.
If you are not familiar with the carry trade it is basically a strategy that involves borrowing at a low-interest rate and investing in an asset that provides a higher rate of return.
This sound familiar? Can anyone say stock buyback programs over the last decade? Yep, that is one big example of a carry trade.
Which is an example of companies taking on more debt to reduce their outstanding shares rather than building up savings and cash flow for, ya know that thing we call a recession. They must know the fed will bail the markets out in the end so what does it matter then.
I believe this next passage confirms the enabling evidence in my paragraph above...
"If that seems a bit extreme, think about how dramatically Fed behavior has changed in a relatively short time. When Long-Term Capital Management failed in 1998, the Fed feared its bankruptcy could threaten the financial system. Yet despite this fear, its concern about excessive interference in private markets was still great enough that it went out of its way to avoid any appearance of direct intervention. Twenty-two years later the Fed is now using a loophole in its charter to run an SPV that finances the purchase of corporate debt, including junk bonds. That is a long road to have traveled and there is no evidence to suggest the road ends here"
In my opinion it is not a matter of if the Fed starts outright buying stocks, it is just when.
Posted Using LeoFinance
