Good morning. It’s a nice morning down here in Kent. What with the UK now in full-blown “stay in your house unless you absolutely have to leave” mode, it feels as though the Spring is teasing us slightly.
Anyway. Yesterday we saw the biggest central bank intervention yet. The Federal Reserve – America’s central bank – came out all guns blazing. It still probably wasn’t enough to start the turnaround. But I suspect it’s enough to put a floor under things.
The Fed goes up to 11
Yesterday the Federal Reserve, to quote Buzz Lightyear, went “to infinity and beyond”. Or to quote Spinal Tap, as Capital Economics did, the Fed turned the easing “up to 11”.
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Here’s what the Fed did. It is already buying $75bn a day of US government bonds. It will now buy $50bn a day of mortgage-backed securities. It will also now buy a wider range of these securities. And it made “repo” operations cheaper. (Without getting into the details, it just means it’s even easier for those who need it to get access to cheap cash fast).
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The Fed has also relaxed accounting rules. In short, banks won’t need to keep as much money to one side in case of emergencies, because we are now in an emergency. So that makes life easier for the banks as well.
The biggest change is that the Fed will buy up corporate bonds rated BBB or higher (investment grade) and with a maturity of five years or less. That will help a lot with fears of a massive corporate bond market meltdown.
So here’s where we are: the Fed is now lending as much money as financial institutions need, and it is also pumping money into government bond markets. It is making dollars freely available to central banks around the world. And it is now moving to prop up the market for private sector debt as well.
This really is massive. So how come stockmarkets didn’t surge? Did the Fed fail?
Not at all. The Fed succeeded. You know how I can tell? Because the dollar has turned around. The dollar index (a measure of the US dollar against a basket of the currencies of its major trading partners) started to fall and it has continued to do so today.
That is the best news the Fed could get. Because if anything is going to break the global financial system, it’s a run for the safety of dollars. The fact that investors are no longer desperately scrabbling for dollars indicates that monetary conditions have loosened (relative to where they were a week ago) and there is some confidence that there is a floor under this market.
We aren’t back to rampant “risk-on” by any means. But if you look at what’s happening to asset prices today (including stocks, which are rising in the UK and are now “limit up” in the US at the time of writing), then you can see this change in mood.
Copper is rallying. Oil is rallying. Gold – benefiting both from the slightly weaker dollar and the prospect of endless money printing – is back up close to $1,600 an ounce.
In short, the Fed’s blast is a clear promise to do “whatever it takes” and it’s one that seems to be working.
What matters now for markets
Given the Fed’s clear goal of not allowing anything within the financial system to break, it’s hard to see how we can end up with a 2008-style financial crisis on top of everything else. That already seemed unlikely (because we all knew that central banks would step in). Now it seems highly unlikely. That helps with confidence.
So what’s missing now? Well, we have yet to see the full damage from coronavirus. The economic numbers are already horrific and they are going to get worse. Evidence from other countries, including now poor old Italy, suggests that a peak will occur and that there is life beyond corona, but it’s going to be hard to see that when we’re in the throes.
More importantly though – for markets looking for an excuse to rally – is that the Fed is laying the ground for the US government’s stimulus package, so that whenever this gets past all the back and forth in Congress, it lands in an environment in which everyone is primed to take advantage of it.
The next significant moment for markets is probably dependent on whether this agreement can end up being full-on “shock and awe” or if it disappoints. But whatever happens, as Will Denyer and Yanmei Tie point out for Gavekal, “Congressional agreement is highly probably in the coming days, and when the acceleration in Covid-19 cases begins to slow, the Fed’s measures should help markets to find a floor, much as they did in 2009.”
What happens after all this is a separate issue of course. Where will all that money go in a world where supply has been constrained while the kitchen sink has been flung at keeping demand as strong as possible?
We’ll be writing about that in the next issue of MoneyWeek magazine. Subscribe now to get your first six issues absolutely free.
