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Fed Props Up Zombie Businesses with Corporate Bond Bailout

4 mins
16 June 2020, 14:47 GMT+0000
Updated by Kyle Baird
29 June 2020, 06:09 GMT+0000
In Brief
  • The Federal Reserve will start buying corporate bonds from today.
  • The move is intended to prop up businesses struggling in the wake of the COVID-19 pandemic.
  • Critics of the policy warn that such monetary creation to prop up failing businesses may have disastrous consequences.
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The U.S. Federal Reserve (Fed) has just announced it will start buying the individual bonds of corporates struggling in the wake of the coronavirus pandemic.
Markets responded positively to the news, but observers warn that supporting “zombie businesses” with freshly printed money will only lead down a dangerous path. The announcement extends previous corporate bond purchase programs announced during the unprecedented economic shutdown. Previously, bond purchases were made from primary markets only. However, the latest stimulus efforts will see purchases made from secondary markets too.

U.S. Stock Prices Rebound on Bailout News

The bond purchase extension came in response to falling U.S. markets based on renewed fears in the spread of COVID-19. Dow futures plunged by almost 1,000 points overnight on Sunday but showed signs of early recovery in the week. U.S. stock prices are already rising following the news. Since the measures were announced on Monday, the Dow Jones Industrial Average (DJI) closed up almost 0.6%, while the S&P 500 (SPX) firmed by 0.8%.

Fed to Support Corporations via Secondary Markets

The central bank will begin buying corporate bonds from secondary markets starting today. Updates to the Secondary Market Corporate Credit Facility (SMCCF) will see the Fed buy high-grade bonds (those rated AAA, AA, A, and BBB) only. The program is expected to end on September 30. The SMCCF was first announced in March. Last month it began buying corporate-credit ETFs. The SMCCF is intended to complement the Primary Market Corporate Credit Facility (PMCCF). And the aim of the PMCCF, according to a release from the central bank, is to “provide companies access to credit so that they are better able to maintain business operations and capacity.”

Fears of a COVID-19 Second Wave in the U.S. Rising

The coronavirus pandemic absolutely battered markets over the last few months. Forced business closures and individual movement restrictions have left vast sections of the economy barely able to function. In addition, positive cases continue to rise in several U.S. states that have reopened their economies. Coronavirus Finance Hub Risk Speculation persists that the rise in cases may prompt the authorities to initiate a second period of lockdown. The prospect would surely be devastating as the U.S. economy struggles to recover from the first. Reports indicate that a further 1,600 cases per day are being reported in Florida. North Carolina is witnessing an average of 1,200 new COVID-19 infections each day. Meanwhile, in Asia, Beijing reported an additional 80 new COVID-19 cases in the Chinese capital since Thursday.

Yet More Questionable Fed Policy Prompts Concern

The unprecedented lockdown has already seen the Fed and other central banks around the world print a colossal amount of money. The world’s largest central bank has manufactured trillions of dollars, taking its balance sheet to an all-time high of more than $7 trillion. Even before the latest stimulus, industry observers were concerned about inflationary pressures. The additional money creation only adds to their worries. Cryptocurrency industry observer MMCrypto highlighted this via Twitter earlier today. The YouTube influencer called the measures “horrifying” and “pure insanity.” He notes:
“This is the nail in the coffin for free markets. We will see the biggest bubble burst in the history of mankind.”
For MMCrypto, the issue is that many of the eligible companies of the program are no longer viable. The free market is not bailing these companies out, so why should the government do so? Calling the recipients “zombie businesses,” the YouTuber made the case that many of these companies are no longer accountable to the market and do not even need to operate at a profit to remain viable. He concluded:
“… this will translate into a very high inflation, and eventually, maybe even into a hyperinflation.”
Other cryptocurrency industry observers and hard money proponents also expressed concern over the latest bailout. Gold bug Peter Schiff warned of “destruction not salvation, for everything we cherish.”

Traditional Valuations Out the Window

Meanwhile, digital asset manager Charles Edwards highlighted the completely warped nature of the market:
“… you may as well throw all traditional valuation and technical techniques out the window at this point.”
Cryptocurrency YouTuber Omar Bham added that the Fed would essentially be able to pick and choose which companies survive:
“So, it pays to have been friends with the Fed (if you run a big corporation). By extension, you can basically also print money!”

Bitcoin Bounces

Contrary to the belief that Bitcoin is entirely uncorrelated to traditional markets, the price of the leading digital currency experienced a rebound of its own. In the last 24-hours alone, it briefly traded below $9,000, before gaining more than 6% to reach a high of $9,596. Bitcoin’s rebound is likely due to an increase in risk appetite from U.S. investors, rather than as a hedge against inflation from the COVID-19 fallout. Despite the crypto industry’s favorite narrative that Bitcoin is a safe-haven asset, the recent correlation between U.S. markets and the Bitcoin price suggests that investor interest in BTC has been rising and falling in tandem with this risk-on attitude. Global investment bank JP Morgan, led by ardent Bitcoin critic Jamie Dymon, recently claimed that Bitcoin passed its “first real stress test.” The bank made this claim based on the fact that the flagship coin did not “crash harder” during the mid-March panic. In a report published last week, strategists from the bank claim that the digital asset has a future as a vehicle for speculation, not as a safe-haven. The recent correlation between Bitcoin and the S&P 500 appears to support this conclusion, at least for now. If Federal Reserve policy does usher in the rampant inflation many are expecting, it will be interesting to see if Bitcoin investment picks up. Thanks to its hard monetary policy versus a rapidly devaluing U.S. dollar, it appears to only be a matter of time.


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