Our observation that as of this moment the Fed owns, via the HYG and JNK ETFs, bonds of bankrupt rental company Hertz sparked inexplicable outrage in the bullish camp. We find this confusing: how is the Fed owning bonds either a bullish or bearish case? It merely confirms that capitalism is now dead, that we have centrally-planned, “fake markets” as Bank of America put it, and which as Deutsche Bank further clarified, “these are administered markets and market outcomes will be dictated by the policy goals of the Fed and Treasury, and the tools they select to implement policy.”
That bulls are taking this fact as an affront, simply shows just how vested they too are in perpetuating a myth that markets still exist (as if it is somehow the imploding economy and not the Fed’s $4 trillion in liquidity injections since March that has boosted the stock market) while pretending they have some idea of what happens next based on “fundamentals” or “data” when in reality the only thing that matters is how much liquidity the Fed injects on any given day, making strategists, analysts and “paywalled pundits” irrelevant (an outcome which is devastating to their financial health).
In any case, shortly after our article, the Fed apologists scrambled to write articles such as this one whose sole counterarguments are outright obtuse: the amount of bankrupt bonds held by the Fed is so small so please don’t worry, and in any event, the ETFs will likely sell them.
First of all, anyone who claims to “know” what the ETFs will do with the defaulted bonds likely has a barrel of snake oil they need offloaded with immediate delivery, and their motives should be closely scrutinized from now on. As we explicitly said in our article, it is most certainly the case that the Fed will seek to offload its exposure – similar to what the ECB did when it ended up holding bonds of bankrupt Steinhoff but not before sparking a major scandal in financial cricles – after all the last thing Powell needs is another Congressional hearing inquiring how the Fed buying junk bonds – and junk bonds from massively levered, defaulted zombie corporations at that – is helping US workers. If anything, this merely cements our core argument that the process of rushing to buy corporate bonds was a panicked scramble meant to preserve confidence in a bursting asset bubble, one that was rushed from the beginning without almost any thought as to the consequences.
And since said “paywalled pundits” appears to have missed what we said, we will repeat it: the way the Fed’s purchases of corporate bonds are structured, especially as the US nears a default tsunami, it is only a matter of time before Powell ends up holding dozens if not hundreds of defaulted CUSIPs both directly and via ETFs. Will Powell then quietly dump all of them to pretend the Fed never intended to lose the Treasury’s funds by propping up insolvent companies? He will of course try. But if he fails, and if the ETFs do not offload their exposure to defaults, the Fed will most certainly be part of the bankruptcy process, courtesy of the debt-to-equity conversion of the underlying securities.
We also eagerly look to find just which independent, third-party entity buys the defaulted Hertz bonds held by HYG and JNK on behalf of the Fed to absolve Powell of his dismal decisionmaking.
The truth is that nobody knows what happens next, now that the Fed is an active intermediary in capital markets and is purchasing highly risky paper that defaulted just days after the Fed started buying ETFs. Anyone who claims otherwise is a complete hack.
As for that other “counterargument”, that “neither the Fed nor the Treasury has significant exposure to HTZ“, well- yes of course – the program has been in operation for just over a week: it better not have significant exposure to Hertz. What about in 3 months, or 6 months or one year from now when dozens of the companies that make up the JNK and HYG ETFs also file Chapter 11? Or what about the “fallen angel” companies that sell bonds directly to the Fed and end up having to file themselves. Will it be significant then?
Here is the answer: now that the Fed has gone the path of the BOJ and is directly intervening in capital markets, if not yet buying stocks (we can’t wait for the same bulls to explain how the Fed buying the SPY is great news for everyone), we can look to the Bank of Japan for examples of just how “insigificant” its exposure to the corporate bond market is.
WEll, according to SMBC Nikko Securities analyst Riyon Matsuyama, the Bank of Japan was the biggest buyer of Japanese corporate bonds in April compared with other categories for the first time since June last year, as Bloomberg reported overnight.
That sounds pretty significant to us: when the central bank is not only the buyer of last resort, but buyer of biggest resort, that would suggest that something is very, very wrong. It also suggests that there are virtually no other buyers (although we are confident the abovementioned bulls can “explain” how this too is “not one of the things to worry about”). In any case, it would also suggest that the BOJ owns a lot of corporate bonds.
And the Fed is hot on the BOJ’s footsteps.
According to Matusyuama – who calculated using data released by the Japan Securities Dealers Association this week and BOJ – the BOJ’s purchases as a proportion of all notes transacted in April rose to 30%, the highest level since June 2018.
This surge in holdings should not come as s surprise: after all, at the end of April, the BOJ decided to double its purchases of corporate bonds and sure enough, that’s what it is doing even if it means not only crowding out all other market players, but in the process destroying what little was left of price discovery. Why? Because the BOJ buys corporate bonds with money it creates out of thin air, and with no regard for fundamentals, resulting in a complete disconnect between fundamentals and asset prices.
Maybe this is why the abovementioned “paywalled pundits” are so angry: the fact that they are now relegated to merely frontrunning central bank purchases (something which even Blackrock embraced, admitting that’s the only way to make money now adding that it “will follow the Fed and other DM central banks by purchasing what they’re purchasing, and assets that rhyme with those”) means that any of their so-called insights are nothing more than Fed cheerleading garbage. Which is fine – after all that’s the centrally-planned world we live in, but just own up to it and stop pretending to have some deep, premium-pricing insight (which costs $29.95 per month) about the US or global economy which translates into an outlook on prices, investing, the universe and everything.