It seems that the central bankers and monetary academics of the past century had a better grasp of our monetary system than the empty suits that run our central banks today. They have a set of tools and things done in the past, and when all hell breaks loose, they don’t know what else to do but follow the playbook of the past one by one, hoping to solve the problem. Today, Fed Powell and Steve Mnuchin, rather than understand the problem and why it is happening, are just using the same old measures from 08 and throwing it at the market every 2 hours, hoping that by trial and error one of them will cause some magical reaction and support asset markets everywhere! In less than a week, we have gone through the entire 2008 playbook, and the system is still broken, now what?
There is an old saying, “the markets are always right”, and it could not be truer than it is today. But by markets, I do not mean Equities which are perhaps the least sophisticated of all asset classes being pushed and pulled by multitude of players with tons of liquidity and different mandates. I mean the Bond, Rates, and Swaps markets! These have been and always will be the most sophisticated and intelligent of them all. The Fed would serve itself well, to hear what those markets are telling us, rather than just focus on the S&P 500. Those markets have one by one, been signalling extreme duress over the past 2 weeks.
In the most simplest of layman terms, the Coronavirus was a black swan event, that left no choice but to expose a system that was already tethering on edge. Due to the infectious nature of the pathogen, the entire global economy and businesses have had to shut down and go into lockdown to avoid it spreading further. This has meant that everyone in the supply chain from retailers, businesses, all companies down to the little fruit vendor on the street are all struggling to raise cash fast enough as sales came to a grounding halt. They have fixed costs and expenses so there is a rush for cash across the board, not only from banks but also corporates drawing all their credit lines down to the individual.
It all started with a little market tumble. The Fed did an emergency interest rate cut by 50bps and the market fell as before it was worried, but now it knew something else was happening. The repo market is a vital part of the economy whereby the central banks offer short-term loans to banks against collateral that they have, who are then supposed to lend it out to the real economy. That is how it is supposed to work in theory. So as the repo markets demanded higher and higher dollars initially, the Fed announced $1.5 trillion worth of repo auctions each week for the next 3 weeks ~ $4.5 trillion in all to ease concerns. Markets rejoiced as that was a bazooka repo auction (size of the entire current Fed balance sheet). Then without waiting on Sunday, they announced the mother of all liquidity injections by cutting US interest rates by a 1 full percentage point (100 bps!) down to near 0 as well as saying it would start buying $700 billion worth of Treasury paper (QE 5, and this time it’s official). To the Fed’s dismay, markets fell 13%, utter collapse. Then they come in this week announce a $1 trillion fiscal package to be approved to save the economy.
Repo market despite all this injection was still seeing rates soar higher. The Fed is clueless and literally dumbfounded as they threw the entire house and the kitchen sink at the problem. They may as well add 10 more zeros to that number and it would not matter. The problem is that the money from the central bank is not reaching the economy as banks are unable to actually lend it out as they have their own margin calls and invested in junk and high yield risky assets. There was a sneak preview of this back in September 2019, but the Fed rather than investigate, just said let’s throw more money at the problem, hopefully it will go away. And it did, for a short while, to come back and haunt them three-fold. Since the banks were not lending to the commercial market, the Fed then announced to enact the commercial funding paper market facility to actually give money to the companies to fund their day to day operations (last done in 2008). That is a good start as they need it the most. But how much is enough?
To make matters worse, something snapped further. Yesterday dollar cross currency swap spreads started blowing out, this is the amount of dollar that is short in the system as everyone from banks to companies to small businesses including international companies and borrowers scramble to buy dollars as they are all short cash, and all short dollars. The Fed petrified not knowing how to handle this crisis, did what it only knows to do, more repo auctions. They announced $ 1 trillion in repo auctions in one day (to put it in perspective that is the entire QE1 that was done in 2009 but we did it in 1 hour yesterday!) . To their dismay only $10 billion of it was actually requested by the banks out of $500 billion. If that does not tell you the problem is elsewhere, not sure what will.
The stock market dropped 27% from all-time highs in 16 trading days, we have not seen anything like that in history! Even in 1929, it took 42 days to get a 20% correction from highs. This is not just a US problem. This is a global problem. The central banks have to be the lender of last resort and save not only entire corporate America but now will need to bail out the rest of the world that has also borrowed in dollars and seeing a funding freeze. What started as an economic crisis (demand shock post Coronavirus slowdown) is slowly turning into a Financial crisis worse than 2008. That is the recipe for utter meltdown, and the Fed is not prepared nor ever dealt with it.
Commodities, Bonds, Gold, Precious Metals, Equities, everything is being liquidated, no mercy. There will be casualties, we have yet to hear of them just like in 2008, but this crisis is much worse than that even. These are not investable markets, yet. Containing the peak infection from the virus is first step, then the next is getting the world engine to start, a harder task as the car was as it is stalling over the past two years.
The market in the past decade was labelled as the “Everything Bubble” and what will it take to stem the demise? Everything!