Don't Let Sleepy Fed Meeting Fool You

The outcome of Wednesday's Federal Open Market Committee meeting was strangely dull. Strange, because of how incredibly active the Fed has been in the six weeks since its last meeting. Dull, because with all the Fed's already said and done, there was nothing left to say or do. But rather than thinking that the Fed is done, think of it more like a game where Jerome Powell & Co. have played their turn. Now they see what their opponent's move is. The Fed has plenty left to fight this recession, but what it will do depends very much on how things evolve. Here are some things to watch for and how I'm positioned. What Happened? The Fed's main goal coming out of this meeting was to stay on message. From now until this public health crisis abates, you will hear every Fed release and every speaker reiterate the same point: They are strongly committed to keeping rates low until they are quite confident that the economy is recovering strongly. In addition, they will do whatever it takes to ensure liquid and functioning markets. I saw some observe that there isn't any explicit forward guidance. But I think this kind of guidance is much more powerful. This probably means they don't hike rates until either inflation is above 2.5% or unemployment gets to 4% or lower. Remember that it is generally agreed that they began lift off too soon in 2015. They won't make that mistake again. There is a good chance unemployment recovers more quickly than it did after 2008 to 2009. But that's not saying much. Unemployment was 4.4% in May of 2007. It didn't get back to 4.4% until March of 2017. So, even if unemployment recovers at double the speed of the last recession, we're five years away. If it is triple the pace, we're three years away. When estimating how long the Fed's target will stay at zero, that's the kind of time frame you should be assuming. The other interesting items came from Chair Powell's press conference, where he responded to a few lingering questions about the Fed's liquidity programs and what other tools they might use. What About High-Yield ETFs? We also have to consider the corporate bond buying program and ask about when will it start and what about high-yield exchange-traded funds. Despite much discussion around this program, it hasn't actually started. Powell didn't give us any useful guidance here, saying it would start fairly soon. In terms of high-yield ETF buying, perhaps the most controversial of the Fed's liquidity programs, Powell was rightfully coy. I've argued that this program was intended as an emergency-only option in case the high-yield new issue market were to shut down. Right now that's definitely not the case, with highly impacted companies like AMC Entertainment or SeaWorld Entertainment bringing new high-yield bonds in recent weeks. Powell can't know the future, and therefore can't know if this emergency-only tool might be needed later, so he's not going to publicly close the door on it. But under the circumstances, I doubt very much that they buy anything but a pittance of junk ETFs. I'm honestly not totally sure they'll even complete the original amount of corporate bond buying period. More Could Come Powell suggested several times that it's possible more will be needed or that the economy might need more support to really boom. I don't think anything fresh is imminent, but he doesn't want markets to assume that means there is nothing more to be done. I think any thing new will wait for either fresh signs of a liquidity crunch, or else an opportunity to move beyond the bridge phase and to an actual stimulus phase. These are two possibilities, however, that keep getting bandied about that I think are non-starters. What About Negative Rates Last week, former Minneapolis Fed President Fed President Narayana Kocherlakota advocated for such a stance. This isn't something they are considering. Indeed in the March FOMC meeting, some FOMC members were concerned that by cutting rates to zero they'd encourage markets to assume negative rates were possible. In other words, not only are they not considering such a policy, they don't want to give even the remotest impression that they are considering such a thing. To this end, many expected the Fed might actually increase interest on excess reserves in an attempt to keep rates positive. They didn't, but they will do what they need to to keep short-term rates above zero. Might the Fed Buy Equities? In this case, maybe never say never? But this is miles away from happening. Broadly, I think everything the Fed is doing should be read as a bridge from here until the economy can fully reopen and heal. They know they can't actively stimulate demand right now. All they can do is try to prevent too much damage during the lockdown period, and foster an environment where the economy can boom once things start opening up again. There are two scenarios where buying stocks would be defensible. One is where market confidence is extremely low and the central bank wants to reverse it. That's definitely not the case now with the S&P 500 28% off the lows and less than 3% down year-over-year. The other is where the central bank wants to keep providing stimulus and it's run out of assets to buy. This is why the Bank of Japan started buying equities. In the U.S.' case, neither of these are true. As I said above, the Fed isn't looking to stimulate the economy right now, just build a bridge. Moreover, we've got tons of assets to buy. Like the negative rates idea, buying equities is more click-bait than policy consideration. What to Own in Bonds Right Now? Intermediate-term bonds aren't rich, but there's not much upside. If the Fed is stuck at zero for the next three-to-five years, then the five-year Treasury should trade closer to 15 basis points to 20bps vs. around 35bps. But that's not a ton of price upside. Long-term bonds are much more vulnerable to an upside surprise in either inflation or growth. If either of these happen, 20-30 year bonds could lurch into the 2% area pretty quickly. The best trade is five to 10 year investment-grade corporate bonds. Because of my first point, I'm not worried about base rates rising, so you can just ride relatively high yields and low downside risk if you pick companies with great liquidity. I don't love high-yield. There will probably be opportunities in distress, but straight high-yield has many more vulnerabilities than investment-grade. If you want to play an aggressive recovery trade, small cap stocks is probably better risk/reward. Municipals are also very cheap, although sentiment around munis is terrible right now. The structure of this market is such that a sudden snap-back is hard to imagine. Whereas I think investment-grade corporate bonds have potential to produce 7-10% price return over the next few months, munis will be more of a slog.

Don't Let Sleepy Fed Meeting Fool You

This is a game in which Jerome Powell & Co. have played their turn, and now await their opponent's move; also here are the bonds to own now.

Columnist Conversation

This Weekend on Real Money

AAP Podcast: A Tongue -- and a Market -- Twister: 'Get a Debt Deal Done'

Selling Some of This Surging AI-Related Stock

COLUMNIST TWEETS

Please Join or Log In to manage and receive alerts.