"It's Complicated"

Facebook made the expression famous by including it as an option in their dropdown menu for relationship status. It not only spawned a hideously awful self-titled movie starring Alec Baldwin and Meryl Streep (recall we are also expert movie critics) but also gave young and hip millennials a go-to answer when asked why they haven’t yet married their roommate of 3 years. Since GreenPort is also young and hip, we have decided to change our relationship status with the Fed to it’s complicated. We have frequently written about our distrust of Keynesian Economics and the current policies of the Federal Reserve. We keep telling ourselves we should break up with the Fed. We know what they’re doing will end badly. Spending all sorts of money that doesn’t even exist. With the help of the U.S. Treasury they’ve even gone so far as to simply send people money, no questions asked. They made up a brand-new financial term called “forgivable loans”. Even the most non-financial among us understand that if you don’t have to pay back a loan then it’s not actually a loan. It's simply more free money! The problem is that the party the Fed is throwing is so much fun we don’t want to leave. The Fed is a party animal. We know we are being overserved and the afterward will be painful, but this party doesn’t appear to be ending anytime soon. The mantra, “don’t fight the Fed”, has proven time and time again to be good advice. The original application of this mantra was to buy stocks when the Federal Reserve was lowering interest rates and sell stocks when the Federal reserve was increasing interest rates.

This was the traditional and primary role of the U.S. Federal Reserve. If the business cycle (economy) was growing too fast the Fed would raise rates, which tightened the money supply and slowed the economy. This in turn kept inflation in check. If the business cycle was becoming recessionary (shaded blue areas), they would lower rates which would increase the money supply and jump-start the business cycle. This all changed during the financial crisis of 2008. The Fed adopted a one-time unconventional policy of supporting stock and bond markets by directly purchasing financial assets, in addition to lowering rates. They argued this would keep the credit markets from seizing up and causing financial Armageddon. Predictably, this one-time unconventional policy has become an all the time conventional policy. As the pandemic took hold on our economy, the Fed resurrected the 2008 playbook and committed to directly buying US Treasuries and mortgage-backed securities (MBS) again. Please note that prior to 2008 the Fed had zero assets on their balance sheet since asset purchases were not part of the Fed's toolkit. As of May, they reported accumulating $7.1 trillion in financial assets through their asset purchase programs. That number continues to grow rapidly.

The Fed set no limit on how much they were willing to buy, only assuring us that they would buy however much was necessary. Additionally, the Fed declared they would also be purchasing private corporate bonds, which is unambiguously not allowed in the Fed’s charter. The Fed found a loophole. They set up two Special Purpose Vehicles (SPV’s) “facilities to support credit to large employers—the Primary Market Corporate Credit Facility (PMCCF) for new bond and loan issuance and the Secondary Market Corporate Credit Facility (SMCCF) to provide liquidity for outstanding corporate bonds.” They authorized these SPV’s to initially purchase up to $750 billion in corporate bonds but promised to raise that limit if necessary. It's no wonder that corporate bond yields have dropped to all-time lows. Purchases of corporate bonds by the Fed have allowed corporations to borrow money at the lowest interest rates on record.

This is the reason we remain constructive on corporate bonds and believe the credit market will continue to be okay. Reality is that despite many individual investors being unwilling to buy corporate bonds at such low yields, our rich Uncle Fed will. Uncle Fed has much more money than the rest of us combined. Modern Monetary Theory argues Uncle Fed has an infinite amount of money. Whether infinite or not, Uncle Fed will ultimately dictate whether corporate bonds will default. He has clearly stated he doesn't plan on letting that happen. Unlike the doom and gloom headlines regarding second waves, social unrest, and political disasters, our outlier concern continues to be that the Fed, along with the U.S. Treasury, has provided too much stimulus and liquidity to the economy. We think it's a realistic scenario that the economy becomes overstimulated when our lives, and therefore the economy, start returning to normal. Admittedly, opinions (we refuse to call them forecasts) on when normalcy returns range from imminent to never. Our opinion, based on our experiences and observations, is that some form of normalcy has already started to return and that trend will likely continue, albeit with meaningful setbacks along the way. In this scenario the Fed would be forced to dramatically tighten monetary policy, bringing an end to this party. We are confident the Fed will err on the side of letting this party go on too long as opposed to shutting the party down and risking economic collapse. Until then, we expect both stock and bond markets to keep dancing wildly higher and lower, with the longer-term trend continuing higher until Uncle Fed decides the party is over. Have a Wonderful July 4th Weekend, The GreenPort Team