Are America’s Financial Markets Still Free?
By: Andrew J. Willms
President and CEO of The Milwaukee Company
In this week’s Market Commentator’s podcast (which you can find here), Mike and I discuss Federal Reserve Chairman William Powell’s recent comments about the Fed’s willingness to pump money into the economy for the foreseeable future.
From the outset of the Covid-19 pandemic, the Federal Reserve has pumped massive amounts of money into the U.S. economy in an effort to prevent its collapse. Its quick action provided much needed liquidity to the U.S. economy. It also lowered interest rates to the detriment of savers and retirees, while disproportionately boosting the wealth of investors and homeowners through asset price inflation.
There’s little room for doubt that the Fed’s initial steps have played a critical role in limiting the immediate harm caused by the coronavirus. That seems especially clear given the political gridlock that has curtailed Washington lawmakers’ effectiveness.
That said, there are concerns that the Fed may be going too far. In the eyes of some (including yours truly) the Fed is now at a crossroads: Should it continue to backstop the economy today, at the risk of seriously disrupting the stock and bond markets for years to come?
Officially, the Fed operates under a mandate from Congress to "promote effectively the goals of maximum employment, stable prices, and moderate long-term interest rates" — what is now commonly referred to as the Fed's "dual mandate." Absent from that mandate is a direction to backstop the stock and bond markets. And yet, that is exactly what the Fed has done.
The Fed has pledged to buy an unlimited amount of government-backed debt to create demand for mortgage backed and Treasury bonds.
The Fed has also been buying up corporate bonds, including the riskiest investment-grade debt, for the first time in its history.
By cutting interest rates to record lows, the Fed increased demand, and thereby prices of riskier investments, including high yield bonds and stocks.
One of the consequences of all of this market involvement by the Fed has been historic rallies in both the stock and bond markets. And while these rallies have given stock and bond investors reasons to celebrate, the concern is that the celebration on Wall Street may be followed by the mother of all hangovers.
The Fed recently backed-off its longstanding commitment to keep the inflation rate to 2%, which could spell trouble down he road for the poor and middle classes, especially those living on fixed incomes. The expansion in the money supply has already triggered a drop in the value of the dollar. And interest rates will presumably rise at some point, which will harm investors holding longer dated bonds.
Moreover, the Fed has said nothing to suggest it intends to scale back its market involvement anytime soon. To the contrary, Chairman Powell recently said "We think that the economy's going to need low interest rates, which support economic activity, for an extended period of time. It will be measured in years".
The tremendous and undeniable impact the Fed’s actions have had on both the stock and bond markets raises the very important question as to whether America’s financial markets are still free? And more pointedly, if the Fed is given a free hand to manipulate our securities markets, what will that mean for the future of America’s free market system?
The answers are unclear, but it seems that America – and perhaps the world – is headed into strange economic waters in the years ahead.
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