The S&P/ASX 200 Index (ASX: XJO) is rallying hard today. At the time of writing, the ASX 200 is up a hefty 4.10% and back over 5,954 points.
As of yesterday, ASX 200 shares were down more than 7% since last Wednesday. But now it seems whatever brought this panic about has suddenly abated. Hallelujah… right?
Don't get me wrong, I'm an investor who enjoys seeing ASX shares rise. Rising shares normally translates into rising wealth for me and anyone else who is invested in the ASX share market.
But this ASX market rally today has got me worried.
To understand what's occurring, let's look at the could-be reasons for the market's rally. We can never be absolutely certain with these things, but signs point to the announcement by the US Federal Reserve overnight as the primary catalyst for today's market moves.
Image source: Getty Images
Risk-on, risk-off for ASX market rally
According to reporting in the Australian Financial Review (AFR), last night (our time), the US Fed announced that it will be buying corporate bonds on the secondary bond market. In English, this means that the US central bank is now purchasing the debt of individual companies on the bond markets.
Now, this state of play is highly unusual, if not unprecedented. Normally, central banks like the Fed have stuck with tinkering in the government bond markets. This does have an impact on financial markets, albeit not directly. But buying bonds of individual companies do. Normally, a company's debt is priced using a classic risk and reward market mechanism. 'Safer' companies offer less interest on their debt, and 'risky' companies more. If no one wants to pay for a company's debt, it could be the start of bankruptcy.
But the Fed stepping in and buying up corporate bonds immediately distorts the normal market operation. In my opinion, it signals to companies that they don't have to worry about being prudent with their capital. It gives hope that the government will always be there to lend them money. Of course, investors (both in the USA and Australia) are cheering this on and sending ASX shares up today.
But I don't think it's a cause for celebration. Historically, government intervention in financial markets doesn't end well. We have a market for a reason – it's the most efficient (although not completely) mechanism to regulate risk and reward on the bond markets and price and value on the share markets. Messing around with these mechanisms may bring a short-term sugar hit for asset prices, but I see it as a long-term problem.
I'm still investing in ASX shares, of course. History has also taught us that trying to move your money around based on what you think might happen is fraught with danger. But I'm not excited about the Fed buying corporate debt. And I'm certainly not cheering today's ASX market rally as a result.
