The second quarter of 2020 was all about optimism. After initial fears about the consequences of COVID-19, we began to find our footing in the new world. We learned to do most activities (with air travel and mass public events the obvious exceptions) differently, which gave us the optimism to get through it. We’re still not out of the woods, and we know more adjustments will be needed going forward.
But let’s be clear: the economic optimism in the U.S. economy is courtesy of the Federal Reserve. Jay Powell, the Chairman of the Fed, decided early in the crisis that the central bank would do everything in its power to stem the consequences of economic shutdown. No Fed Chair wants to go down in history as the one responsible for a depression. Powell acted quickly and decisively, giving the markets confidence that he knew what he was doing.
Beyond doing the minimum of dropping the Fed Funds rate to zero, the Fed immediately backstopped sectors of the economy that could’ve caused systemic failure without protection. For example, they injected billions of dollars into the corporate bond market in the form of the $600 billion Main Street Lending program. This program was designed to buy corporate bonds both directly from issuers and in the secondary market (mostly from dealers holding inventory). The Fed acted because, at the height of the COVID panic in mid-March, the bond market was frozen to the point of zero liquidity. Bonds rated as high as “A” were priced as if the issuer was going to default. These initiatives (and others) were key to driving down yields. Even the hint of the Fed buying in this magnitude immediately repriced yields on even the lowest rated corporate bonds to levels just above risk-free Treasuries. Ultimately, Powell and company drove the entire yield curve down to historic lows. The scope and power of an electronic printing press with infinite capacity is an amazing thing!
With the Fed aggressively pushing down interest rates, prices of bonds rose – driving strong performance of credit products in the second quarter. For the year to date, the BarCap US Aggregate Index is up 6.14%. The BarCap 5-10 Year Municipal Index is up 2.34%, and the BarCap 1-5 Year Credit Index is up 3.35%. Just as with every past crisis, the lesson this time around is clear – don’t fight the Fed.