In part one of this piece, I pointed out what ETFs the Federal Reserve had purchased as of May 19th. Since then, the Fed has purchased more of these ETFs and began buying corporate bonds directly, not through an ETF.
In this piece, we will look at whether or not you should follow the Fed’s footsteps and buy these funds or other bond ETFs, or whether you should find your own path and buy non-bond ETFs in the days, weeks, and months to come.
The first issue with the Fed buying bond ETFs is that the demand for said ETFs likely rose when the Fed was buying. This is simply a supply and demand issue, especially when the bond ETFs wasn’t able to issue new shares. Issuing new shares can only be done when the fund was able to purchase more bonds to bundle into its ETF. And since the Fed was dumping large amounts of money into the market in a rather short period of time, the likelihood that these funds where all able to increase their asset bases are not high.
So, the Fed has probably already pushed the price of these ETFs higher than where they would typically be trading. This is not good for new investors.
So, what if you went out and purchased another bond ETFs? Well, unfortunately, other investors may have already done that, and therefore pushed those prices higher than where they should or would normally be if the Fed had not acted.
Another issue we may have in the future for the bond ETFs the Fed did purchase is that when the Fed goes to sell these funds, there may be again a supply and demand issue. When the Fed bought these funds, they built sizable positions in each one of them. For example, the Fed owns 6.5% of the SPDR Portfolio Intermediate-term Corporate Bond ETF (SPIB). It owns 4.9% of the Vanguard Short-Term Corporate Bond ETF (VCSH). It is going to take time and precision to unload these positions without causing the price to bottom out. A handful of the funds the Fed owns roughly 3% or more of the fund, while others are minimal amounts, around 1% or less. But even still, if those funds are thinly traded, the Fed could have issues unloading their positions without causing supply and demand imbalances.
Lastly, the Federal Reserve purchased bond ETFs and now bonds themselves for a number of reasons. First, because these purchases helped sure up confidence in the financial markets, two, these purchases helped give business’s the funds they may need to survive a difficult recession. Three, these purchases helped keep interest rates low, and therefore helped offer cheap borrowing options for businesses. And finally, because these purchases helped lower interest rates, that pushed other investors into stocks and out of bonds as they searched for higher yields. Pushing investors into stocks, in essence, helps the economy because it boosts confidence and increases wealth during a time of economic turmoil.
While its hard to say what the Fed will do in the near future, it’s unlikely that if you follow the Fed down the path of bond buying, you are going to be maximizing your investment returns. The Fed isn’t doing what it is doing “to make a healthy return.” They are doing what they are doing to help save the economy. So, if you follow the Fed into bonds and they buy more bonds, its hard to see how you benefit if interest rates continue to slide lower. Furthermore, if you get into stocks, and the Fed continues to buy bonds, that will likely only push other investors into stock, and therefore further increase share prices.
Regardless of whether you agree with what the Fed has done or will do in the future, you need to remember the ‘Don’t F’s’ when it comes to the Federal Reserve. Don’t Follow the Fed and Don’t Fight the Fed.
Disclosure: This contributor did not hold a position in any investment mentioned above at the time this blog post was published. This article is the opinion of the contributor themselves. The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. This contributor is not receiving compensation (other than from INO.com) for their opinion.