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The Fed Has Powered Stocks Again: Here's the Fed's Role Going Forward

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The Fed's role moving forward will be to keep the underlying pipes that move money through the system clean and unclogged as the economy has suffered on the back of the coronavirus. While that's basically good news for stocks, there's a lot to be sorted out as the virus rages on. 

Recently, stocks have soared out of bear market territory. Primarily, investors are looking for signs -- and they're getting a few -- that the spread of the coronavirus will abate and eventually be terminated. But for the short-run, the Federal Reserve has done literally everything within its powers to keep liquidity flowing to households, small businesses, municipalities and even large corporations, all of which have seen income and revenue streams seemingly vanish. 

The S&P 500, after having fallen 34% from its all-time-high hit in February, is up 25% from that 2020 low and down just 17% from the high. A bear market is defined by a price level 20% below the high. 

By several metrics, stocks are now looking less attractive versus safe treasury bonds compared to several weeks ago. 

The Fed has injected trillions of dollars -- and will inject trillions more -- into the banking system and the economy. It has initiated small business and household lending programs through its special purpose vehicles, which lend to banks, which the re-lend to borrowers.

 The Fed has entered the investment grade corporate bond market and even recently the high yield market to keep prices stable and yields lower. It has supported repo market operations. It is buying mortgage bonds. Importantly, the Fed has lowered the effective federal funds rate to near 0%. 

Investors, increasingly confident in a sharp recovery post-virus, have been recently willing to buy more risk assets like stocks and high yield bonds. 

But there are economic risks, especially with risk assets trading at slightly more expensive valuations now. The world is nowhere near out of the woods on the virus. The way people and businesses use new funds, and the speed at which they receive them before illiquidity takes old again, remains to be seen. 

So what more can the Fed do from here? 

"The Fed is really the plumber in the situation. The Fed can be either a plumber in terms of having the free flow of credit from the banks to consumers, and the Fed can be an architect, really positioning the economy through really low interest rates into a recovery," said Nela Richardson, investment strategist at Edward Jones. 

While Europe and Japan have resorted to negative interest rates, "I think the Fed is going to shy away from negative rates," Richardson said. "We've seen very limited success in going below zero on interest rates and remember the banks are really tool that the Fed is using -- it's their wrench to get that credit to main street and if you hamper the banks by lowering rates to negative, you lower their net interest margins. It's going to be very difficult for the banks to serve its function." 

Richardson sees the Fed continuing its unlimited bond-buying program, which is music to the ears if investors. 

As for those all-important banks, here's a look at what to expect for a crucial bank earnings season upcoming. 

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