What’s that sound? That would be the collective sigh of relief emanating from C-suites across the U.S. and around the world yesterday, as executives (and their employees) register the good news that the Fed has delivered.

We’ve written a lot in these pages about the powerful measures that world leaders and central bankers have taken to support the global economy against the threat of the COVID-19 pandemic. Holders of the fiscal and monetary purse strings have committed trillions of dollars to the fight for economic survival — money earmarked for small and mid-size businesses and for employees who would otherwise have been laid off.

Well, yesterday, the U.S. Federal Reserve has taken its support to a whole other level by expanding; announcing $2.3 trillion (yes trillion) of new programs to provide credit to small and medium size businesses and state and local governments in the United States. Critically for financial markets it expanded its corporate bond-buying program and casting a virtual safety net around the investment-grade and high-yield credit markets. There’s no overstating this — the Fed’s actions mark a major turning point for the economic recovery (see “Bazooka Blast II”).

If you recall, the Fed on March 23 announced a historic shift in the way it would respond to economic shocks like the COVID-19 pandemic. For the first time ever, in order to stave off widespread bankruptcies, the Fed would add new weapons to its arsenal by purchasing not just government bonds, but also corporate bonds directly from issuers and even bond ETFs from secondary markets — much in the way the Bank of Japan has already done.

The Fed’s initial response was a bazooka blast to be sure. Just one month ago, I wrote in our Monthly Perspectives (see the March edition, “Courage”) that an expansion of

monetary policy — not just in terms of size, but also scope — was likely on its way. I also expressed my personal belief that any movement by the Fed into the corporate credit market would be pivotal, and possibly signal the beginning of a rebound.

We can’t get ahead of ourselves, of course. Economic shocks like this one typically result in a “double-bottoming” process and a W-shaped correction, as opposed to the V shape that we’re all hoping for. Still it’s fair to say that the Fed’s initiatives have been enthusiastically received by the bond market.

Just take a look at the following two charts. Figure 1 shows how the massive daily swings that were happening in the U.S. investment-grade and high-yield markets in the middle of March have stabilized since Fed's corporate bond-buying program was initiated on March 23. Figure 2, meanwhile, shows how the bond-buying program has boosted credit markets and pared back losses incurred at the end of February and in early March.

Market InsightsApril 10, 2020

The Soul of the FedBrad Simpson, Chief Wealth Strategist and Head of PAIR

Source: FactSet as of April 09, 2020.

Figure 1: Strengthening Correlation

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Market Insights: The Fed Reloads

PAIR | Portfolio Advice & Investment Research

If there could be any criticism of the package unveiled on March 23, however, it was that the programs were too small and too anticipatory. They were designed to prevent economic damage without regard to the damage that had already been done.

Yesterday's announcement can be seen as a reloading of the Fed “bazooka”, which has been a favourite metaphor of the business media. But the Fed’s move is really more about protecting the most important elements of global financial markets. By including a retroactive grading element, the Fed will now be able to purchase bonds from companies that were considered investment-grade just a few weeks ago.

Look at it this way. The economic shock resulting from COVID-19 has led to a scenario where there would be winners and losers. The problem with this is there are some good companies that will not survive this self-induced coma, or they might survive only to succumb to their wounds later on. Prior to its announcement yesterday, the Fed was looking to protect only the winners — the most financially secure companies that, despite the shock, were still able to hang on to their investment-grade status.

The Fed’s protection will not be extended to underserving corporations, the so-called zombie companies. Instead, the support is meant for viable companies that may have been going through a bit of a rough patch until the bottom fell out from underneath. Ford and Macy's are two companies that come to mind. This was an oversight that the Fed has now redressed by extending bond purchases retroactively to all issuers with investment-grade status as of March 22.

The Fed also announced yesterday that it would be throwing a lifeline to the high-yield market, not by purchasing junk bonds directly, but by purchasing up to 20% of the outstanding shares of bond ETFs.

We’ve talked in the past about how exchange-traded funds can magnify market volatility by giving algorithmic traders a convenient mechanism for syphoning billions of dollars

in and out of major indices, creating a “wave pool” effect. Well, the Fed’s move into ETFs turns that vulnerability into a strength, and a means for supporting the fragile high-yield market. The same pipeline that was being used to rapidly draw capital away from the markets, in other words, is now being used to replenish them.

At the end of the day the U.S. Federal Reserve Board cast its safety net around vulnerable and strong companies alike, and in doing so it took an important step towards protecting the bedrock of the global economy.

It’s given us all a reason to join the chorus of C-suite execs sighing in concerted relief, and it should give us some reassurance that we are not mere victims. We, as in the collective We — governments, central banks, doctors, employees, advisors, neighbours and friends — we are active participants in this struggle, and we all have a role to play in beating back the pandemic and its economic implications.

Yesterday, the Fed has delivered on its promise to do “whatever it takes” to support the economy, and we should all sleep a little better.

Enjoy your weekend and happy holidays, everyone!

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Source: FactSet as of April 09, 2020.

Figure 2: Lifeline for High Yields

Brad Simpson,Chief Wealth Strategist

Bazooka Blast II: Bigger, Better

More credit purchases. The Fed plans to purchase an additional $550 billion in corporate credit, expanding the total program to $750 billion ($500 billion in primary markets, $250 billion in secondary markets).

Retroactive grading. The Fed is still buying bonds with maturities of five years or less, but the definition of "investment-grade" has been expanded. The Fed will now include bonds that were IG as of March 22 but have been subsequently downgraded to no lower than BB. This great-ly expands the scope of the credit-purchase program.

High-yield ETFs included. While the majority of purchases will be in the investment-grade bond space, the Fed will also purchase ETFs "whose primary investment objective is exposure to U.S. high-yield corporate bonds."

Maximum stakes remain in place. The Fed will be limited to a purchase of 10% of any issuer's outstanding bonds, and 20% of any outstanding ETF shares.

Still no double-dipping. The Fed's program continues to exclude issuers who are already receiving support from the Coronavirus Aid, Relief and Economic Security (CARES) program.

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Market Insights: The Fed Reloads

PAIR | Portfolio Advice & Investment Research

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Portfolio Advice & Investment Research | PAIR TeamBrad Simpson | Chief Wealth Strategist and Head of PAIR

North American Equities:Chris Blake | Senior Portfolio ManagerMaria Bogusz | Manager, North American EquitiesChadi Richa | Manager, North American Equities

Managed Investments:Christopher Lo | Head of Managed Investments Aurav Ghai | Senior Fixed Income Analyst Kenneth Sue | Senior Alternative Investments AnalystMansi Desai | Senior Equity Analyst Van Hoang | Global Macro Strategist