Federal Reserve Starts Buying Junk

$750 billion . . . That’s how much the Federal Reserve plans to spend buying up ETFs to support asset prices.

It’s the latest aggressive action from the U.S. Federal Reserve.

In April, America’s central bank announced plans to buy corporate bonds. And today, the Fed is implementing that plan.

During the Great Recession of 2007 – 2009 the Fed also bought bonds. Yet these were investment-grade securities from stable American companies.

There are two huge differences with the Fed’s new programs . . .

#1: Buying Junk Bonds

The Federal Reserve will buy bonds of companies deemed “fallen angels.” These are companies that previously had investment-grade bonds.

Then the coronavirus outbreak caused the economic crisis. And as a result, these companies had their bonds downgraded to high yield. High yield is a more polite way to describe junk bonds.

$101 billion of bond debt was downgraded to junk status in the first quarter of 2020, according to ratings agency Fitch.

These bonds were downgraded for three key reasons. It’s because these companies:

  1. Took on too much debt during the 10-year economic boom
  2. Are now reporting financial losses as a result of the economic downturn
  3. Don’t have the cash flow to service their existing debt obligations

Some well-known fallen angels include Ford (NYSE: F), Kraft Heinz (NYSE: KHC) and Occidental Petroleum (NYSE: OXY).

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#2: Purchasing ETFs to Support Prices

Buying bonds directly from companies is one thing.

Yet even more unusual is the Federal Reserve moving into Exchange-Traded Funds (ETFs).

Starting today, the Fed will buy ETFs in the open market. These ETFs will focus on investment-grade bond funds.

The Fed will also purchase ETFs that are invested in high yield or junk bonds.

This means the Fed is essentially in the market simply to support bond prices. The message is clear: The Fed’s new role is to support asset prices at any cost.

Of course, high-yield bonds shot higher after the Fed’s April announcement. Here you can see the rebound in the SPDR Barclays High Yield Bond ETF (NYSE: JNK).

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Investors have embraced the Fed’s aggressive actions. They’ve jumped back into the market even before the Fed started buying ETFs.

That, in turn, allowed corporations to issued $234.7 billion of debt in March and another $203.4 billion in April.

Companies issued $33 billion of junk bonds in April. That’s 10 times more than were issued in March. And that is twice the volume of April 2019.

What’s Next @ The Fed?

This aggressive new program gets underway today.

Investment manager Blackrock will receive $75 billion from the Treasury. The firm will take that capital and leverage it 10-to-1.

That means Blackrock will potentially invest $750 billion in ETFs in the coming months.

This move shows just how far the Fed will go to support asset prices. It shows that the Fed is willing to bail out both good companies – and those with shaky businesses that have taken on too much debt.

This also has some folks wondering: Would the Fed would buy stocks if  prices fell too much?

The Fed’s aggressive actions are driving prices higher in the bond and stock market.

Frankly, that’s the No. 1 reason that stock prices are rebounding so sharply since late March.

Of course, stimulus from President Trump and Congress is also helping.

The next $2 trillion stimulus bill could be coming in May. And Trump says it will be focused on re-building America’s infrastructure.

Fifth-generation wireless – known as 5G – could be a major new infrastructure project.

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Yours in Health & Wealth,

Ian Wyatt

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