Displaying items by tag: fed
The fixed income market used to be where you went for safety and steady income. Those days seem long ago, and fixed income is not just as likely as any other asset class to eb the riskiest and most volatile in your portfolio. Between COVID and the Fed, interest rates are extremely low, with yields low and bond price very high, and vulnerable. Some have been comparing the situation to Japan in the 1990s and beyond, but there is a huge difference that makes the US bond market much worse than Japan ever was—inflation. When Japan started its massive zero rate, ultra-low yield period, it was experiencing deflation, which meant there was still a positive real rate. But that is not true in the US today, as yields are actually well below real-world inflation, meaning genuinely negative real interest rates.
FINSUM: There is ultimately going to have to be a reckoning in the bond market, because real returns are not sustainable. That said, it does not seem like the Fed is going to let that happen any time soon.
The Fed made some highly anticipated policy adjustments at the end of last week. This was not about short-term rate moves either, but rather about its long-term role in the recovery and how it plans to manage the economy. The biggest change seems rather small in wording. The Fed basically corrected its mandate to say that it would not automatically tighten policy just because employment had reached or exceeded what it consider to be “full employment”. In effect, this means that the Fed is ready, willing, able to let the economy run very hot for many years. Analysts think the Fed will likely not hike again until at least 2024.
FINSUM: So the Fed is going to be very accommodative for the next several years. It is starting to feel like equity valuations are going to have no choice but to rise as the Fed has taken “there is no alternative” to a never-before seen level for equities.
Anyone who has been looking at the bond markets is likely to be shocked at the recent moves in the space. Many “high yield” bonds (it is now necessary to use quotes) are yielding what very high quality investment grade bonds were just months ago. A recent sale saw $1 bn of new issuance for a BB+ company at a 3% yield. The huge move downward in bond yields is the result of the Fed’s unprecedented stimulus action, and in particular, their mandate to backstop corporate bonds.
FINSUM: The Fed’s actions have been so warping that they have called into question the very definition of a high yield bond. If every bond is backed by the Fed, then it makes perfect sense that their yields would equalize. In this way the market’s reaction is entirely predictable.
JP Morgan’s head of research, famed analyst Joyce Chang, published some very interesting views this week. She argues that the pandemic has forever changed financial markets, and highlights what she says are four “paradigm shifts” that COVID has caused. The biggest of those from a market direction perspective is about the Fed. She contends that the huge and extraordinary measures central banks have undertaken in the last few months have fundamentally changed the role of central banks towards financial stability (something they were arguably already focusing on).
FINSUM: In our mind it has become very obvious over the last few years, and especially during the pandemic, that the Fed’s most important mandate is financial stability.
Muni bonds are seeing yields way above average right now even as Treasury bonds linger near all-time lows. The reason why is that it is increasingly apparent that there has been a huge erosion in municipal credit quality alongside the lockdown. Costs have surged at the same time as revenues have plummeted, leading to a significantly deteriorated financial picture for municipal issuers. The has been exacerbated by the fact that municipalities have largely been unsupported by the Fed as opposed to corporate issuers. But the sell-off has created opportunity, as even AAA issuers are seeing big discounts and much higher than usual spreads to Treasuries.
FINSUM: This is all about careful credit selection, as there are big opportunities, but there may also be major pitfalls.