- Powell testifies today as Fed expands corporate bond buying and begins its Main Street Lending program
- Markets expect a partial recovery of U.S. retail sales in May
- U.S. manufacturing production expected to partially rebound
- PM Johnson expresses optimism about Brexit deal, although no movement on red lines as yet
Powell testifies today as Fed expands corporate bond buying and begins its Main Street Lending program — The Fed on Monday sparked a rally in the stock and corporate bond markets with its announcements on corporate bond buying and the Main Street lending program. That set up a more positive market environment for Fed Chair Powell’s appearance today and tomorrow before Congressional committees to deliver his semi-annual report to Congress. The Fed on Monday announced that it will begin buying individual corporate bonds effective today and that banks can begin lending effective immediately to corporations under the Fed’s Main Street Lending program.
The Fed’s corporate bond announcement was somewhat of a surprise since the Fed has so far purchased only corporate bond ETFs. Conditions in the corporate bond market have recently been favorable, and it isn’t clear the Fed even needs to purchase any more corporate bonds to keep that market functioning well.
Nevertheless, the Fed expanded its program to include the purchase of individual corporate bonds, which likely means that the purchases will now be spread out across more companies than those included in the corporate bond ETFs that the Fed has been buying. The Fed said that it will buy individual corporate bonds to match an in-house index that it developed. The Fed did not specify the criteria for what will essentially be its own custom ETF.
The index structure is favorable for the Fed since it makes sure that the Fed cannot be accused of favoring one company over another and is following the broad strategy required by legislation. The structure will also help the Fed to make sure that it doesn’t concentrate its purchases too much in a single industry. The index structure also eliminates the need for companies to certify that they meet certain requirements, which some companies might be reluctant to do.
The Fed on Monday also announced that banks can begin making loans to mid-sized companies under the long-awaited Main Street Lending program. The Fed said it will begin buying from banks its 95% share in those loans “soon.” Banks will be able to make loans ranging from $250,000 to $300 million to companies with up to 15,000 employees. That should provide strong support for mid-sized companies that have taken a sharp hit from the pandemic and perhaps reduce their need to lay off employees.
Fed Chair Powell today in his semi-annual policy report to the Senate Banking Committee is expected to reiterate the themes he presented last Wednesday in his post-FOMC meeting press conference. The markets reacted dovishly to last week’s FOMC meeting because the Fed unexpectedly said that it would stop tapering its securities purchases and peg its QE program at $120 billion per month for the indefinite future ($80 billion of Treasury securities and $40 billion of MBS securities). The Fed’s current QE program is far larger than any of the QE programs that it ran in the aftermath of the Great Recession.
The markets were also encouraged by last week’s Fed-dot forecast that the funds rate will remain at its current near-zero level at least through the end of 2022. The market is expecting the funds rate to remain at its current level at least through the middle of 2023, according to the federal funds futures market.
Markets expect a partial recovery of U.S. retail sales in May — The consensus is for today’s May retail sales report to rise by +8.0% m/m and +5.2% ex-autos, recovering part of April’s plunge of -16.4% and -17.2% ex-autos.
The market is expecting pent-up retail spending to emerge in May as states started to reopen from the widespread lockdowns in April. However, the real test is whether that retail spending will continue in coming months after the initial surge wears off. The markets are hoping for a sustained recovery, but the fact remains that millions of Americans are unemployed or have had their income reduced. Many Americans are falling behind on credit cards, auto loans, and mortgages, forcing them to slash their retail spending.
U.S. manufacturing production expected to partially rebound — The consensus is for today’s May manufacturing production report to show an increase of +5.0% m/m, partially recovering from April’s plunge of -13.7% m/m. The broader May industrial production report is expected to show a smaller increase of +3.0% m/m, recovering part of April’s plunge of -11.2% m/m. The U.S. manufacturing sector is in very bad shape since it was in a recession even before the pandemic arrived and decimated domestic and overseas demand for U.S. manufactured products.
PM Johnson expresses optimism about Brexit deal, although no movement on red lines as yet — Prime Minister Johnson somewhat surprised the markets on Monday by saying that he sees no reason why a Brexit deal cannot be reached by summer or autumn. However, Mr. Johnson may have meant that he sees no reason why there can’t be an agreement as long as the EU agrees with his bargaining position. Yesterday’s meeting between PM Johnson and EU officials was not a negotiating session, but at least sparked some optimism that a deal can potentially be reached to avoid a hard-Brexit at year end.
The UK and EU will resume formal negotiations on June 29, which are expected to last until late July. Another negotiating round is set for mid-August. If a deal can be reached by early October, then the EU countries can approve the deal at their October 15-16 summit, leaving time for national parliaments to ratify the deal before the end of the year when the UK’s transition period expires. The UK government last Friday reiterated that there will be no extension of the transition period that expires at the end of 2020.
