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Market Commentary

Weekly commentary providing analysis with an outlook for the equity market.

August 5, 2020

Scott Wren, Senior Global Equity Strategist

Jawboning

Key takeaways

  • The Federal Reserve (Fed) uses a number of techniques and strategies to influence and support financial markets.
  • Sometimes the Fed just making statements and “jawboning” the market helps to get the job done.

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The U.S. Federal Reserve (Fed), historically, has been able to get a lot of mileage out of expressing its desires and watching the financial markets react, many times without lifting a monetary policy finger, at least in the short term. In other words, the Fed has shown time and again that it can help get the market to do the work. The foreign exchange (FX) market has been on the receiving end of both Fed and Treasury Secretary influence many times in the past, particularly from the late 1980s into the mid-to-late 1990s when virtually all the major global central banks teamed up to intervene, verbally or through actual transactions when they thought the dollar was too strong or too weak (all pre-euro, of course). This strategist has fond memories of getting Fed calls on the special “hot phone” on our trading desk relaying what the U.S. central bank was going to do (buy or sell dollars) based on the current market conditions at the time or reacting to sudden statements from Fed officials as they hit the newswires.

While aggressive Fed intervention in the FX market has not occurred in many years, the Fed has continued to use its ability to influence market conditions, sometimes by making statements, in the current COVID-influenced economic environment. Look no further than the fixed income market for the latest example.

When the Fed created its Secondary Market Corporate Credit Facility (SMCCF) back on March 23, the idea was to facilitate the purchase of up to $250 billion of mostly investment-grade (IG) corporate bonds and exchange-traded funds (ETFs). Investors were concerned that the economy was slipping into a deep recession and issuers of corporate debt might be unable to meet their interest and principal obligations. As a result, spreads between Treasury bonds and IG corporate debt shot higher, reflecting these concerns. But the top in spreads came on the day the Fed made the announcement in March. Since then spreads for both IG and high-yield fixed income obligations have narrowed meaningfully. The interesting thing about this narrowing is that the Fed has actually purchased only a small amount of bonds (under $25 billion in total) relative to the amount allowed under the SMCCF.

The credibility of the Fed and its strongly stated stance to provide market liquidity and keep interest rates low has influenced market behavior. Investors have stepped in to participate in the market and provide the necessary liquidity while the Fed has been able to keep the vast majority of its powder dry. This is part of the reason for our favorable ratings on U.S. taxable IG and intermediate-term fixed income bonds. Jawboning by the Fed has, at least for now, provided the corporate bond market with the stability it needs to function smoothly.

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