Risk? There’s No Such Thing!
The Federal Reserve is doing another thing it’s never done before; buying corporate debt.
The lockdowns have companies cash-strapped, that’s no secret, we’re all broke. Naturally, there aren’t many lenders confident about lending at the moment, especially with news reports everyday about good debtors turning bad.
The Federal Reserve needs to take matters into its own hands. It needs to rescue companies that are facing demoted credit ratings and can’t raise clutch financing. However, this is contentious. The move indirectly puts investors at risk of reaching too far for gains in the bond market.
Take Gap, for example. The brick-and-mortar retailer has been slipping into the abyss for years. Many investors feared the coronavirus impact was insurmountable. You could buy a bond in Gap a few weeks ago, therein lending money to the company for payback later, but its ‘junk bond’ rating rightly implied a low-to-no chance of payback. The bonds were cheap because they were risky. Now, the Fed is in the market for those bonds, and the Fed is bidding very high as if they’re not risky.
It’s nice for Gap; dangerous for everyone else. Federal Reserve Chair Jerome Powell is saddling himself (and us) with the investment risk of a company in terminal decline. Even if the retailer makes an unlikely comeback, Powell paid such a generous price for the bonds in the first place that he squashed the yield, which is his (and our) reward.
If the Federal Reserve prints money to plug these losses, it’ll come back to bite in the form of inflation. In the shorter-term, we’ll have to live in a world of Fed-squashed yields.
For something juicy, bond investors will need to lend money to companies with much sketchier repayment prospects, companies even the Federal Reserve wouldn’t touch. What’s sketchier than Gap?