We’re at the point in the meltdown when you get emails like this one:
John — Anarchy and rumors that large hedge funds are in trouble. No idea if true.
What I do know is that people came into this loaded to the gills and almost no-one has had any chance to take their exposures down. So this has the potential to get much, much worse. The areas of potential disaster are all too many — high yield debt, venture capital (all those expensively valued loss making start-ups are probably zeros — literally), heavily indebted companies that cannot service their debt, private equity etc.
At the same time there are scenarios where things could explode. If we get fiscal package, more easing and the virus inflects then we are off and away to the races. So I have started to buy and will get fully invested between here and 50% down. We will get through this and life will go on — if not it doesn’t really matter if you lose all your money anyway!
This is just one of today’s emails, but it covers the main point, which is that the markets have been sailing along on an ocean of debt, an imperfect storm has struck, a rogue wave or two (coronavirus, oil price war) may cause those markets to capsize.
Last Friday, The Wall Street Journal reported:
Federal Reserve Bank of Boston President Eric Rosengren said on Friday the U.S. central bank may need the power to buy a broader array of bonds to provide stimulus given the sharp and historic decline in Treasurys yields amid the coronavirus outbreak.
He said the declines in U.S. government debt, most notably in the 10-year note, means that if the Fed runs out of room to lower rates, it also faces a very strong chance that Treasury bond buying — which featured prominently in the financial crisis and its aftermath as a stimulus tool — won’t provide much of an economic boost either.
“There would be little room for the Federal Reserve to lower rates through large purchases of long-term Treasury securities — like it did to make conditions more accommodative in and after the Great Recession — if a recession occurred in this rate environment,” the official said in the text of a speech for delivery at the gathering of the Shadow Open Market Committee, a group that weighs in on central bank issues, in New York. He did not offer a prediction for the path of monetary policy.
In such a situation, the Fed may need the ability to buy securities beyond the Treasury, mortgage and agency debt it can now hold. “We should allow the central bank to purchase a broader range of securities or assets,” Mr. Rosengren said.
Clearly, what’s happened this week did not catch the Fed by surprise. They saw the storm coming. They signaled (via Mr. Rosengren) how they would respond (at least in part).
But no one expected this:
The Federal Reserve said it would inject more than $1.5 trillion of temporary liquidity into Wall Street on Thursday and Friday to prevent ominous trading conditions from creating a sharper economic contraction.
“These changes are being made to address highly unusual disruptions in Treasury financing markets associated with the coronavirus outbreak,” the New York Fed said in a statement on Thursday
The Fed said it had made the changes for short-term funding markets following instructions from Chairman Jerome Powell, who was in consultation with the rate-setting Federal Open Market Committee.
The Fed took initial steps earlier this week to boost the volume of lending for overnight repurchase agreement operations, or repo. It had announced plans Wednesday to increase lending to more than $500 billion, from less than $200 billion, before announcing the additional expansion on Thursday.
The New York Fed said it would conduct three additional repo offerings worth an additional $1.5 trillion this week, with two separate $500 billion offerings that will last for three months and a third that will mature in one month.
If the transactions are fully subscribed, they would swell the central bank’s $4.2 trillion asset portfolio by more than 35%.
One assumes that the Fed can continue such “innnovations” to keep markets functioning “appropriately.” But as Fed Chairman Jay Powell has said on numerous occasions, the Fed cannot restart the economic engines all by itself. All it can really do (at this point) is steady the ship.
His colleagues around the globe agree. From a Financial Times article entitled “Coronavirus: why central bankers say it is time for fiscal stimulus”:
“It is all about fiscal policy now,” says Olivier Blanchard, a former IMF chief economist. “We should not hesitate to spend even 5–10 per cent more of gross domestic product and that should not create any worries about debt sustainability, providing it is spent sensibly.”
In his speech to the nation last night, President Trump offered some ideas on where fiscal stimulus might begin (payroll tax suspension, IRS filing deadline postponement, etc). The reaction was swift and surly: Futures fell, Asian markets swooned, you know the rest.
So this is where we are as of 3:52pm this Thursday afternoon:
- Markets are melting down.
- The Fed is stepping up.
- Fiscal Policy (except in the UK) is inchoate or incoherent or both.
Item #1 won’t stop until there are signs of progress on Item #3. Item #2 keeps the ship afloat for the time being.