Doug Noland: Very Dangerous

The Fed says QE is to lower rates and market yields. The stock market hears that QE is to bolster equities prices. The corporate Credit market hears QE is to narrow risk premiums, support issuance and ensure liquidity for the vulnerable ETF complex. Derivatives markets hear QE is to ensure liquid and continuous markets – to backstop securities markets and quell dislocation and panic. The Democrats hear that QE is to finance fiscal stimulus and programs to mitigate inequality.

The Fed was always content to play fast and loose with QE. It was supposed to be a temporary emergency measure – get in and out and there’s not a lot of explaining to do. But it somehow morphed into an instrumental, permanent policy fixture – and there remains a tremendous amount that needs to be explained. You can’t just go about creating Trillions of “money” on an impulse – allocating wealth on a whim. And in this strange new Covid world, everyone’s going to want a piece of them – of their electronic printing press – the Dems, the markets, the Republicans and the American people. What are you going to tell them?

Former Fed chair Janet Yellen: “So, the Federal Reserve’s asset purchases – they [the Fed] have not made clear their plans going forward. I’m expecting them to offer more guidance. But their objective there is going to be to try to keep both long and short interest-rates at low levels to support an economic recovery. It is not their objective – ever – to directly try to help the federal government finance its budget deficit. And that would be a Very Dangerous kind of support to provide. But I do expect – I think asset purchases have worked. They’re holding down longer-term rates, and I expect there to be ongoing purchases. But probably not geared to the federal deficit.

Michael Bond: Janet Yellen’s answer is why I do not trust the Fed. Lowering yields below inflation, then to keep them there requires ramping up QE to whatever level is needed to hold them low. If the Gov’t runs trillion dollar deficits because they cut taxes as they did before COVID, the amount they buy is less than when those deficits hit multi-trillions in a deep recession. It does not matter how the Gov’t spends money, they will be financing the budget.

So which is it? We only prop up financial asset prices and blow bubbles that the top 1% hold over 50%. Or do we fund unemployment to meet 70% of lost income, pay school budgets, and other social spending (federal & military pensions, social security) the economy desperately needs. I am shocked Janet Yellen would say “probably not geared to the federal deficit”. What does she think all those Treasuries they are buying with printed money are for?

And don’t get me going on the Federal Reserve’s buying Apple’s corporate bonds when credit card rates are 17%.


Very Dangerous

by Doug Noland

We’re now only a few days from the most pivotal of elections. Meanwhile, new U.S. Covid infections have surged to pandemic highs (Friday surpassing 100,000 on worldometers), with the virus running rampant throughout the country. The early-winter season spike in European cases is nothing short of shocking. Across the continent, governments are being forced to move swiftly to impose restrictions and limited lockdowns.

A few data points: Daily infections in France averaged about 550 during June. They had surged to 13,970 by the first day of October. A record 52,013 infections were reported last Sunday and 49,000 on Friday. Daily Italian infections peaked at 6,557 on March 21st and then averaged below 300 for much of the summer. Infections jumped to 2,548 on October 1st and were a record 31,084 Friday. Spain has observed daily infections surge from several hundred in June to Friday’s 25,595. After beginning the month at 2,503, German cases Thursday rose to 16,774. Cases have spiked to 24,000 in Belgium, 22,000 in Poland, and 9,000 in Switzerland. In the UK, after averaging below 1,000 during the summer, new cases averaged about 25,000 over the past week.

Covid cases here at home remained highly elevated all summer. And if U.S. infections now follow Europe’s trajectory, our nation is facing a dark and challenging winter. By the look of new infection trends in the likes of Michigan, Ohio and Illinois, a worst-case scenario appears increasingly probable. This is a highly infectious virus that now permeates the entire country – cities large and small, the suburbs and rural communities.

This gloom will be compounded by about half the electorate suffering post-election dejection. Emotions are running deep – anger appears poised to boil over. There is clear potential for large nationwide protests, violence and general social strife. Our nation desperately needs to commence a healing process. Yet this seems especially improbable during the acute phase of a historic pandemic – that is proving wickedly divisive. Trump or Biden at the helm on January 20th, a precarious government lame duck session awaits.

And this week we saw the return of market instability. The S&P500 dropped 5.6%, the biggest weekly sell-off since March. The Nasdaq100 (NDX) sank 5.5%, with the beloved Wall Street darling, “growth,” “defensive,” all-everything (most Crowded Trade ever?) big technology stocks under intense selling pressure. Apple dropped 5.4% for the week, with Amazon down 5.3%, Facebook 7.6%, Tesla 7.8%, Nvidia 7.8%, Microsoft 6.4% and Zoom 9.9%.

Yet the U.S. equities sell-off was rather bland compared to the shellacking in Europe. Germany’s DAX sank 8.6%, with a two-week drop of 10.5%. France’s CAC fell 6.4%, with major indices down 7.0% in Italy and 6.4% in Spain. UK’s FTSE 100 sank 4.8%. Italian bank stocks fell 7.4%.

The European Covid spike right into U.S. elections complicates an already complex market environment. The euro dropped 1.8% this week, with the Norwegian krone down 2.9% and the Swedish krona falling 1.6%. European currency weakness supported the dollar. At risk of breaking key technical support, the dollar index reversed 1.4% higher on the week. Newfound dollar strength – in concert with Covid fears – weighed heavily on commodities markets. Crude oil was hammered $4.06, or 10%, closing the week at the low since June 1st. The precious metals suffered as well. Silver dropped 4.2%, and Platinum sank 6.4%. Gold was a relative winner, with losses limited to 1.2%.

The struggle to find decent hedges ahead of critical elections turned only more futile. First, it was U.S. equities rallying over recent weeks, as odds rose for a decisive Biden win (and, supposedly, lower odds of the ugly contested election outcome). Many likely pulled back on hedging and/or boosted equities exposure. And then equities abruptly tank just ahead of the elections, with various hedges and the safe havens malfunctioning. Some likely were long European equities as a partial hedge against U.S. election risk. The metals seemed an attractive hedge. Commodities appeared a reasonable hedge against a Democrat clean sweep. Others were positioned short the dollar heading into possible election turmoil

Covid garbled any possible message this week from currency and commodities markets. The Treasury market seemed to speak loudly and clearly: “Don’t look to me for a hedge – not with Trillions of new supply coming!” In what must be alarming to many, Treasury bond prices suffered marginal declines in the face of a potent “risk off” dynamic in equities and corporate Credit. If you can’t trust Treasuries (as a hedge), whom do you trust? The iShares long-term Treasury ETF (TLT) declined 0.3% this week. Whereas the TLT ETF surged 4.0% (Treasury yields sinking 18 bps) on the S&P500’s last major (4.8%) drop during the week of June 12th.

Ten-year Treasury yields increased three bps this week to 0.875%, the high since June 8th. Corporate Credit was under pressure. Investment-grade Credit default swap (CDS) prices (Markit CDX) surged 10 to 79 bps, the high since May. More dramatically, high-yield CDS surged 48 to 421 bps, the high going back to late-July. Ominously, junk bond funds suffered a $2.5 billion outflow over the past week. Debt deals were cancelled, including PetSmart’s chunky $4.65 billion junk offering.

Corporate Credit was not a good equities hedge. The iShares Investment-grade ETF (LQD) declined 0.7% this week, with the iShares high-yield ETF (HYG) dropping 1.2%. High-yield CDS prices were sharply higher across the board – energy, utilities, industrials, communications, financials as well as consumer discretionary.

I remain skeptical of the bullish “‘blue wave’ is great for equities” narrative. Ceteris paribus – all things being equal – perhaps massive stimulus would support the equities speculative Bubble. But there are many facets to Global Bubble Analysis. All things are not equal. “Blue wave” runaway fiscal deficits will not be viewed positively by a vulnerable bond market. In particular, a backup in yields poses a major risk to the speculative Bubble raging throughout corporate Credit. And while mounting Covid risks could be viewed supportive of an even larger “blue wave” stimulus package, a dark winter scenario would ensure festering Credit issues poison the entire market environment.

Corporate Credit exceeds even equities in terms of Bubble Markets divorced from fundamental prospects. And it’s difficult for me to believe equities can sustain their fairytale run if the corporate debt market stumbles. Of course, central to the “nothing matters but the Fed” narrative is that our central bank is standing ready to inject whatever liquidity is necessary to preserve the boom.

Bloomberg Television’s Lisa Abramowicz (October 19, 2020): “Steve Ricchiuto from Mizuho was just on and he said that if Congress were to pass a $2 TN fiscal support plan that he expects the Federal Reserve to potentially buy up all of that in order to help things along. Do you think that’s an advisable step?

Former Fed chair Janet Yellen: “So, the Federal Reserve’s asset purchases – they [the Fed] have not made clear their plans going forward. I’m expecting them to offer more guidance. But their objective there is going to be to try to keep both long and short interest-rates at low levels to support an economic recovery. It is not their objective – ever – to directly try to help the federal government finance its budget deficit. And that would be a Very Dangerous kind of support to provide. But I do expect – I think asset purchases have worked. They’re holding down longer-term rates, and I expect there to be ongoing purchases. But probably not geared to the federal deficit.

I agree it would be “Very Dangerous” to “directly try to help the federal government finance its budget deficit.” History is unequivocal on the matter. Yet Janet Yellen, Jerome Powell and other Fed officials these days face quite a challenge explaining why this is indeed the case. After all, the Fed’s balance sheet expanded from $900 billion to $4.5 TN between 2008 and 2014. I don’t recall anyone at the Fed suggesting this was “Very Dangerous.” In Yellen’s words, “asset purchases have worked.” And chiefly because of Treasury purchases, Fed assets are up about $3.0 TN in 34 weeks. Again, no one associated with the Federal Reserve is warning “Very Dangerous.”

Our nation could well be on the cusp of a historic “blue wave.” In the event of a Democrat controlled Washington, a massive fiscal spending program early in 2021 is guaranteed. And there’s a reasonably high probability for a scenario where stimulus approaches $3 TN: A tough Covid winter would see recovery succumbing to another distressing leg down for the real economy. Faltering markets would significantly worsen the crisis. If fragile debt markets buckle, a resulting tightening of financial conditions would spur downside economic risk.

The Fed could well be on the cusp of a historic predicament. They are in the throes of massive monetization. But their approximately $100 billion of monthly purchases will be woefully inadequate to sustain Bubble markets in the event of another major de-risking/deleveraging dynamic. With unprecedented Fed support, speculative Bubbles have further inflated over recent months. And now there’s the prospect of the Democrats passing a second massive stimulus package – fiscal stimulus Fed officials have been publicly endorsing.

How much of the resulting deficit does the Fed monetize? The Democrats will be infuriated if the FOMC balks at monetizing most of it. When it appears the Fed is accommodating a liberal agenda, the (newfound fiscal conservative) Republican party will be enraged. Once Covid is controlled, debt and deficits move to key issues for the 2022 mid-terms. For now, of course the equities market expects the Fed to do whatever it takes to sustain the market boom. Meanwhile, an anxious Treasury market must be thinking some market discipline pointed Washington’s way is long overdue. And if Treasury yields surprise to the upside on an announcement of larger QE Treasury purchases, the Federal Reserve’s job turns a lot tougher.

The Fed has never been transparent with QE. Specifically, in what circumstance is it appropriate? In what situations would it be inappropriate? How exactly does it operate? What are the benefits? The risks? What limits should be placed on the scope and duration of QE programs?

The Fed says QE is to lower rates and market yields. The stock market hears that QE is to bolster equities prices. The corporate Credit market hears QE is to narrow risk premiums, support issuance and ensure liquidity for the vulnerable ETF complex. Derivatives markets hear QE is to ensure liquid and continuous markets – to backstop securities markets and quell dislocation and panic. The Democrats hear that QE is to finance fiscal stimulus and programs to mitigate inequality.

The Fed was always content to play fast and loose with QE. It was supposed to be a temporary emergency measure – get in and out and there’s not a lot of explaining to do. But it somehow morphed into an instrumental, permanent policy fixture – and there remains a tremendous amount that needs to be explained. You can’t just go about creating Trillions of “money” on an impulse – allocating wealth on a whim. And in this strange new Covid world, everyone’s going to want a piece of them – of their electronic printing press – the Dems, the markets, the Republicans and the American people. What are you going to tell them?

October 28 – Bloomberg (Bill Dudley): “No central bank wants to admit that it’s out of firepower. Unfortunately, the U.S. Federal Reserve is very near that point. This means America’s future prosperity depends more than ever on the government’s spending plan… There’s always something more that the Fed can do. It can push down longer-term interest rates by buying more Treasury and mortgage-backed securities, or by committing to keep buying for a longer period of time. It can promise to keep short-term interest rates lower for longer… It can put a specified ceiling on long-term interest rates (a maneuver that economists call yield-curve control). It can even take interest rates negative (a move that Fed officials have so far rejected). But this misses a crucial point. Even if the Fed did more — much more — it would not provide much additional support to the economy.

Is the Fed almost out of firepower? Mr. Market – with both fists clinched – would blast “HERESY!” “Open-ended” QE means unlimited balance sheet expansion and unending market support. But is it really that simple? The past six months have experienced about the loosest financial conditions imaginable. Equities surged back to record highs, with the most intense speculative excess since 1999/early-2000. A booming corporate Credit market saw collapsing risk premiums and a record $1.4 TN (y-t-d) issuance.

How much speculative leverage has accumulated throughout the securities markets, especially corporate Credit? How wide is the gulf between market prices and fundamental prospects? How powerful is the derivatives time bomb? What really has the Fed accomplished with $3 TN of QE? At what risk? Have we reached the point where $3 TN buys a good six or seven months of “stability”?

If President Trump wins reelection, Joe Biden needs to offer words of support and national unity. He must appeal to his base to remain calm and resist violence. If Joe Biden wins the presidency, President Trump should respectfully concede while offering conciliatory words of tolerance and national cohesion. Our nation’s interests must be placed above his own. It is imperative that he instruct a segment of his supporters to renounce violence. The armed militias need to stand down. Now those are words I never imagined writing…

Original Post 31 October 2020


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