The Fed Has Gotten Its Way in 2012

Since the first quantitative easing program announcement in 2008, the Federal Reserve has been on a quest to keep rates low and drive investors into riskier assets to help stimulate economic growth.  This quest has continued in 2012 with the announcement a few months ago of a third round of quantitative easing, where the Fed is buying $40 billion per month in government agency mortgage-backed securities.  In conducting these programs, the Fed is encouraging investors to chase income and take risk.  To date, investors have done just that, and despite what is a weaker economy than in 2007, credit markets are back to pre-crisis levels.  According to the Financial Times, high-yield bond and loan issuance has totaled $570 billion this year, on par with the 2007 peak.  In addition to this robust issuance, 30% of the deals are coming with light covenant structures (providing less protection for bondholders), a new high.  We are seeing this yield chase in other markets as well.  Last week, Mongolia, a country that has been financially rescued by the IMF five times in the last 22 years, was able to sell $1.5 billion in bonds at relatively low rates of 4.125% for five years and 5.125% for ten years.  This deal alone represents nearly one-fifth of Mongolia’s entire economy.  As rates collapse despite economic turbulence, we remind our investors that, while the Fed can encourage certain behavior, it makes no promise to buy these risky assets from investors should the market turn.  It is for that reason that we tread carefully when allocating capital in a market where trading levels are not aligned with fundamentals.