June 16, 2020
Yesterday’s intraday rally followed a Fed announcement about removing structural hurdles on corporate bond purchase eligibility for its facility originally announced in March. The Fed had been requiring that companies register their bonds for inclusion, but the associated stigma kept companies from proactively enlisting. To date, only $5.5B in bond ETFs have been purchased, but the actions yesterday should unlock about $250B in incremental IG bond buying. Why do equities rally on this type of announcement? Holding everything else constant, the increased demand should drive corporate bond prices higher/yields lower. And lower corporate bond yields will: 1) lower the cost of capital for companies; 2) lower the discount rate in the DCF valuation model (all assets go up in price) and; 3) possibly encourage substitution to bond like equities.
Still light equity positioning and elevated bearish equity sentiment are keeping the pain trade aimed higher. Yesterday, I mentioned light equity positioning amongst professional CTA and Hedge Fund investors. Today’s WSJ cited last week’s Lipper fund data (from week ending 6/10) showing money market balances rising to an all-time record of ~$4.62T, up ~$1T year-to-date.