Morning Note: This Is, Alas, A Historic Day

An old (in terms of how long we've known each other 😎) friend and client said to me yesterday, “this is like nothing we’ve ever seen.”

Well, yes, in two respects; 1. Global pandemic. 2. The Fed stepping into (dominating) a market that was never intended to be its domain. In fact it was explicitly forbidden from stepping there.

Here it is, right out of the Federal Reserve Act:

“Nothing in this chapter contained shall be construed to prohibit such notes, drafts, and bills of exchange, secured by staple agricultural products, or other goods, wares, or merchandise from being eligible for such discount, and the notes, drafts, and bills of exchange of factors issued as such making advances exclusively to producers of staple agricultural products in their raw state shall be eligible for such discount; but such definition shall not include notes, drafts, or bills covering merely investments or issued or drawn for the purpose of carrying or trading in stocks, bonds, or other investment securities, except bonds and notes of the Government of the United States. Notes, drafts, and bills admitted to discount under the terms of this paragraph must have a maturity at the time of discount of not more than ninety days, exclusive of grace.”

There were fundamental reasons behind that rule; markets, even securities markets, serve to allocate resources to their most productive use. The Act’s writers absolutely understood the risk that future Fed members could be coerced to act on behalf of politically-powerful market actors, and politicians themselves, and should they succumb, they risk destroying the resource-allocation and price-discovery mechanisms that are so critical to markets in a capitalist economy. 

Well, they figured their way around their own law as if it were never there, and the stock market loves it, like an addict loves his fix…

Thing is, and this is where the huge risk lies, buying junk bonds and, thus, saving the bacons of big investors doesn’t make the debt payments for the companies who issued those bonds. I.e., the economic -- and, thus, the ultimate stock market -- risk remains. In fact, per Sunday’s blog post, the Fed’s actions are increasing that risk exponentially… It’s just that it’ll be the Federal Reserve’s balance sheet that takes the default hit, as opposed to those who actually took on the extreme risk to begin with. They walk away winners, the taxpayers, well, they’re the losers…

So, today the Fed makes its first purchases of junk bonds. And the stock market -- after selling off markedly overnight -- is now in celebration mode. Funny thing is, as I type, gold and bonds are trading higher as well, and copper’s trading off a tiny bit. The latter three reflect the weak (to put it mildly) economy, the former reflects the FOMO (fear of missing out)...

Stay tuned...