The Fed to the Rescue!

But how many arrows are left in its quiver?

Today was a perfect example of the Pavlovian effect that central banks are exerting on asset prices. The markets traded with a negative tone throughout the day until the US Federal Reserve announced that it would be buying individual corporate bonds (in addition to the corporate bond ETFs it is already purchasing under its new SMCCF facility). The central bank has created its own internal index of eligible US corporate bonds that it can buy, which removes the hurdles that had forced bond issuers to certify that they were eligible for the program.

*Cartoon Source: Hedgeye

The announcement completely changed the direction of corporate bonds, equities, fx and rates markets. The largest US credit ETFs, LQD and HYG, jumped 1.9% and 1.6% respectively, the S&P 500 swung from a loss of as much as -0.8% to a gain of as much 1.3% (it ended the trading day up 0.8%), the US dollar weakened 0.6% and the US 10 year treasury yield went from 0.65% to 0.72%.

This demonstrates how worried central bankers are even by small selloffs. All it took for them to act was one poor week for risk assets last week and a weak tone this morning on negative Covid developments. This is a negative development that further erodes confidence in the system. It makes one wonder how bad things may be under the hood for them to act in this manner. Central banks should allow volatility to manifest itself and instead focus on ensuring markets function smoothly. Otherwise they run the considerable risk that all this price distortion and volatility suppression will lead to a large, uncontrollable conflagration down the road…

Mack Row