The Federal Reserve decided to expand its bond-buying program to include individual corporate bonds. The total size of the corporate bond-buying is $750 billion with $250 billion allotted to individual bonds. Previously in March, the central bank had announced its intention to purchase corporate bond ETFs, and it began doing so in May. At last week's FOMC meeting, Chairman Jerome Powell was very dovish with his strong statements about not raising rates, projecting zero percent rates for the next 18 months, and his pessimism about the economy.
Asset Prices Jump
The Fed's focus will be on individual bonds with less than five years till maturity. It's looking to create a portfolio based on a broad, diversified mix of corporate bonds. All the bonds will be rated BBB or higher. The Fed's earlier efforts have been remarkably successful in terms of loosening financial conditions and lowering spreads.
This move resulted in the S&P 500 (NYSE: SPY) finishing 1% higher. In Tuesday's premarket trading, the S&P 500 looked ready to open 3% higher. Corporate bonds also moved higher, and the largest corporate bond ETF (NYSE: LQD) moved to a new, all-time high.
Assets moved higher. For one, this will lower borrowing costs for corporations. Second, it creates more demand for existing assets with the Fed taking some out of play. Last, it also sends a psychological message to markets that the Fed is continuing to be involved and support the recovery.
Is Japan the Future
In many ways, the Fed seems to be following the path of Japan's central bank. Since the Great Recession, Japan has waged war against deflation with intensifying measures. It's done various quantitative easing measures, experimented with negative interest rates, and expanded asset purchases from government bonds to ETFs, corporate bonds, and stocks. It's even coupled these programs with fiscal policy.
Despite these aggressive measures, the economy has not been able to stave off deflation in a meaningful way. Of course, it could possibly be worse without these interventions. One explanation for this discrepancy is that these measures stimulate the "financial economy" but there's no assurance that it will flow into the "real economy".