The Fed said on Monday that it’ll buy corporate bonds directly from the market and intends to build a wide and diversified portfolio of US companies’ bonds. It was a huge bullish factor for stocks as well as the corporate bond markets which helped to deter sellers and initiate bullish momentum.
What are the consequences of this dovish move? In my view, they can be divided into two types – technical and psychological. Firstly, traders in the fixed-income market will try to predict the Fed’s choice of bonds and front-run the central bank. Secondly, the signal that there can be potentially unlimited demand on the market means that the chances of “getting on the wrong side of the market” are rising for short positions. This then skews the playing field towards bulls. Stable and low borrowing costs means that firms get safe opportunities to raise cheap debt financing and survive the period of low earnings.
Here is how credit market cheered the Fed’s signal of support:
The Fed’s bullish statement helped the S&P500 to defend support at the 3,000 level on Monday, providing an opportunity for buyers to gain control. Expectations of the Fed’s bond market support helped Asian stocks to rebound after the sell-off on Monday, which gained more than 4% on Tuesday. European and EM markets also cheered the Fed decision.
JP Morgan market guru Marko Kolanovich, who called to reduce exposure to US stocks two weeks ago citing rising geopolitical tensions, made a U-turn again calling to buy the dip, similar to the one that we observed last Thursday.
Kolanovich’s bullish stance is supported by two key arguments:
From a technical viewpoint, the sharp correction that we observed last Thursday reduced the feeling of the market being overbought, while at the same time, one of the main risk factors for the rally faded away, namely the tension between China and the United States.
A major source of untapped demand is naysayers of the current rally – hedge funds. For the most part, they refrained from participating in the stock rebound from March. The heads of several investment companies warned that the March rally had nothing to do with investing and was generated by speculative flows. However, given the policies of central banks, which guarantee unlimited support and near-zero rates for a long time (at least 2 years), the range of investment opportunities is narrowing, essentially making stocks the undisputed leader among other asset classes in terms of risk-reward ratio.
Two other major risk factors, according to Kolanovich, are the COVID-19 pandemic and unrest in the United States. As I wrote yesterday, the curve of new cases has gone up since the end of May, but this dynamic does not threaten lockdowns on a national scale. Especially since the government has already gained enough information about the new virus and does not face uncertainty, and the safety margin of national health services is already much higher.
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