The Federal Reserve has made clear its intent: It’s willing to do essentially anything to support markets and the economy. And it really, really means it.
Interest rates have been taken to zero, and unlimited quantitative easing, or QE, is in effect. The central bank then raised the ante with daily trillion-dollar engagements in repo markets, and its QE program is growing its balance sheet by about $625 billion per week. For context: one bout of QE post-2008 financial crisis was $600 billion over the course of eight months.
This is profound involvement. However, it’s all activity the Fed is allowed to partake in - it can transact in any asset that carries a government guarantee.
The Fed also has now begun purchasing “risk assets” or securities that carry no such federal guarantees. The Secondary Market Corporate Credit Facility has it buying corporate bond ETFs in the open market; its Commercial Paper Funding Facility and Primary Market Corporate Credit Facility has it transacting in commercial paper and corporate debt directly from businesses. The Fed also is about to begin acting like an actual bank for small business via the Main Street Lending Program.
“By any means necessary” probably deserves to be added right after “In God We Trust” on dollars at this point.
The Fed isn't legally able to do this by itself, and it’s making it happen through some creative financial engineering. The Treasury is officially the one making the purchases with the help of BlackRock (BLK) - Get Report via special purpose vehicles (SPV) that are financed by the Fed. So the Fed is essentially acting as banker to the Treasury, which is employing BlackRock as its broker to carry out the effective nationalization of parts of markets.
There are now rumblings the Fed may start buying the ultimate risk asset: stocks.
But how would it do so, can it actually do it, and when would there Fed start?
Can the Fed do this? No, the Fed would need congressional approval to begin directly intervening in equity markets. But as demonstrated by the inventiveness it's already displayed to buy assets it shouldn't be buying, there isn’t any reason to doubt it can’t move forward with the Treasury and an SPV to make it happen without formal approval.
How would the Fed do it? The Fed isn't going to pick specific stocks. Just as it’s leveraging ETFs to provide ballast to the bond market, that’s the path it woild take to support equities. This is not an approach without precedence, as the Bank of Japan has been supporting its own stock market this way for quite some time (to rather uninspiring effect). Due to how ETFs are created and redeemed, if the Fed starts buying an index-tracking ETF it forces the managers of the ETF to go out and buy the stocks the index tracks, effectively supporting a vast array of stocks with one symbol.
When would the Fed start? The answer to this is less clear. A steep decline that breaks through the March lows of what has been the fastest bear market in U.S. history would be necessary. Whether that means Dow 18,000, 17,000 or 16,000 is not something we can pinpoint directly. An environment that would cause the Fed to begin what was unthinkable not even two months ago would have to include an escalation of negative news and sentiment around Covid-19, coupled with a plummet to new lows that possibly includes some degree of market dislocation.
The volatility we experienced in March was on par with what was seen during the Great Depression. If daily 5% moves like that are seen again, coupled with deteriorating virus conditions and a sense of market panic that takes us to new lows, expect the Fed to intervene like it never has before.