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Will the Fed start buying equities?

digitally generated image of money twister.

Will the Fed start buying equities?

Just when you thought the world of money could not get any more unusual, there is now talk – albeit only talk at this stage – of the Federal Reserve possibly buying equities.

As reported by Reuters here, former Fed Chair, Janet Yellen, told a banking conference in Kansas City that the Fed might be able to help the US economy during a future downturn by buying stocks and corporate bonds.

This might sound strange to many. Why would the Fed, as the central bank of the United States tasked to manage inflation and employment, feel like buying stocks is a good idea?

In short, the logic would be to increase asset values. (Sound familiar?) Depressed asset values are not good for an economy. Indeed, depressed asset values depress collateral values and can restrict the flow of credit into the economy. Furthermore, depressed asset values make consumers “feel” poorer, resulting in a reduction of spending to boost savings. Both of these dynamics suppress economic growth.

Now, Ms Yellen did point out that the Fed is currently barred by law from buying corporate assets. Will this change? For what it’s worth, your author thinks it will take only one more significant downturn for these rules to be relaxed.

The precedent here is Japan. Today, the Bank of Japan (i.e. Japan’s Fed-equivalent) owns around 80 per cent of Japan’s outstanding equity ETFs and 50 per cent of all outstanding government bonds. These are mind-blowing numbers. But remember, in the same way that Japan showed the world how to do QE many years in advance, it is not unreasonable to imagine they are doing the same thing again here.

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Andrew Macken is the Chief Investment Officer of the Montaka funds and the Montgomery Global funds. He established MGIM in 2015 in partnership with Montgomery.

This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.

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3 Comments

  1. Absolutely the Fed will start buying equities. It will also be an admission that free market capitalism as it has been practiced up until now does not in practice work as the model suggests.

    My question is about what this means for (measured) inflation especially given that with the pandemic that is unfolding the supply of basic goods is going to rapidly shrink. There is a complex relationship here between black swan events and radical interventions both of which can cause unforeseen economic consequences, perhaps stagflation which is the horror scenario.

  2. In all seriousness and with a touch of sarcasm, I say “Go for it”, because then, everyone and everything will be “too big to fail” and there are no sacred cows left anymore.

    The system is already broken, let’s break it some more because it doesn’t matter anyway. If the Fed will buy “zombie companies” and underwrite everything, then taken to the extreme, technically no one can lose when there is a guaranteed floor under stock prices, but where does it stop ? Technically, valuations go to the moon and become irrelevant because only the downside is limited…it’s then the greater fool theory. Just like hyperinflation in 1930s Germany, price becomes meaningless.

    It’s the answer to the question “What would you do if you knew you couldn’t fail ?”, my answer would be “bet the house and then some on the sharemarket, because I’d never lose”.

  3. Michael Shapiro
    :

    To me, it feels that the Fed is over interfering in the markets. They are disrupting a natural ebb and flow of the market. Corrections used to be a naturally occurring thing in the markets happening at least twice a year. These days mere 10% corrections are meat with such a zeal from the Fed that they almost never happen. They risk lulling generations of traders and investors into thinking that the normal market behaviour is to always go up un-interrupted.

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