My readers will hopefully forgive me for my newfound obsession with what the Federal Reserve is doing in the financial markets. There used to be a time when quants like myself would spend lots of time deciphering data and mispricing in security pricing. Like drinking in bars and going mask-less, it would appear those times are long gone since the Fed’s action is maybe the only game worth analyzing in town these days.
If you have read my recent post on the Fed buying corporate bond ETFs (here), then surely you might have wondered that when and if the Fed switches from buying ETFs to buying individual bonds, what bonds will it buy and how it will it decide? Well, the wait is over. The Fed posted the data on its transactions this week (here). It is Christmas in July for bond geeks like myself.
To wit, here are a couple of transactions that caught my eye from the trade-level data posted by the Fed in that spreadsheet (I verified the transaction itself happened on FINRA’s Trace data). On June 17th, 2020 the Fed bought $3 million face value of MicrosoftMSFT Corp’s 2.4% bond (CUSIP 54918BW3) maturing on 02/06/2020. It paid a price of 103.367 (I confirmed on my Bloomberg that indeed 3 million of face traded on that day at that price at around 11 am PST). The yield was 0.219 percent, and the spread to the Treasury bond maturing on May 31, 2022 was 1.9 basis points, or 0.019% higher than the corresponding Treasury. Around the same time, another Microsoft bond (CUSIP 594918BA1) with a coupon of 2.375 and maturing on 02/12/2022 traded at a price of 103.303 for a yield of 0.257% with a spread to the same treasury bond of 5.7 basis points. This trade is also listed in the trade file recently published by the Fed.
Now there is absolutely nothing wrong, to be clear, if the Fed wants to buy Microsoft, or for that matter WalmartWMT, Ares Capital Group, Toyota Motor Credit Corp (or any of the hundred or so trades listed in the spreadsheet they published).
But I wonder if the Fed’s corporate bond buyers really know what they are telling the markets, and what investors are really hearing.
Let us focus on Microsoft’s bonds for this article, though I highly recommend readers take a close look at the rest of the list of sixty or so bonds. Microsoft is AAA rated by Moody’sMCO and Fitch. Its stock price is at a record of $206, which is up 30% YTD and over 50% in the last year alone. It made over $56 billion in income (EBITDA). Its pre-tax margin is 34.7%, and its PE is 36.4. It has free cash flow of almost $5 per share. The company’s market cap is over $1.5 TRILLION! (Source for all data: Bloomberg). Whichever way an investor looks at it, this is a massively profitable company producing noteworthy profits and cash, with or without the COVID-19 shock.
The Fed’s bond purchase amounts are tiny, and the maturity is short; so in the big picture the financial impact appears to be negligible and the risk to the taxpayer is essentially nonexistent.
But the signaling aspect is just huge. If the US Central Bank, with its new-found bravado of purchasing private assets is crossing many “red lines” (as per Powell’s interview admission a few weeks ago), by buying AAA bonds of a company that does not obviously need its cash, the Fed is sending clear signals to the markets that this is a time to back up the truck and take that newly printed money to the bank. In other words, the money spigots are wide open, and investors are being encouraged to throw caution to the wind, for now. Please speculate, already!
At some point someone will ask whether buying bonds of AAA rated companies who do not need the money, or ask for that money, is similar to sending checks to dead people or to those who use it to day-trade stocks, and whether it really achieves any economic purpose.
But for now, we are seeing how blunt the tools of monetary policy makers are, especially when they try to move fast and quickly solve economic problems with just more cash and more credit.
As always, savvy investors will see the bluntness of the tools, and will take advantage of it before someone thoughtful figures all of this out. Right now, we have a bull in the china shop. And in financial markets, unlike Silicon Valley, when you move fast, things break.
And by the way, what’s so special about MSFT?
AMZN, GOOG and NFLX also seem to have some eligible bonds for the Fed to buy. Maybe FB should issue some as well?
Like Microsoft, they clearly need all the financial help they can get.