Going the Distance: Appearing on 60 minutes last Sunday, Fed Chair Powell laid out the case that there is much more the Federal Reserve can do to combat the economic impacts of the coronavirus. “We’re really not out of ammunition by a long shot. No, there’s really no limit to what we can do with these lending programs we have.” With a current assets over $7T, the Fed’s monetary stimulus is primarily going to fund the deficit, which the CBO projects will be $3.7T for fiscal year 2020.
It is important to note that assets purchased by the Fed under Sec 13(3) must be: 1) guaranteed by the US government or 2) secured by collateral “sufficient to prevent losses” to the public. But Powell’s comment begs the question, “what is the limit to the size of the Fed’s balance sheet?” Well, as Deutsche Bank pointed out, it depends on what they buy:
Ctrl+P: Powell explained where the money they use to purchase assets comes from. "We print it digitally. So as a central bank, we have the ability to create money digitally. And we do that by buying Treasury Bills or bonds for other government guaranteed securities. And that actually increases the money supply. We also print actual currency..."
The money supply is the total value of money available in the economy at a point in time, commonly measured by household assets, or M2. Veteran analyst Tom McClellan pointed out, when it comes to stocks, “there are only two fundamentals that matter: 1) How much money is there? 2) How much does that money want to be invested. If you bend #1 far enough, then #2 will barely matter (until it suddenly does):”
As Mr. McClellan noted, actions taken to influence the stock of money carry risks, namely financial instability and inflation. Jim Rickards expands on this point. “Stocks were up sharply in the early stages of the 1922 Weimar hyperinflation. People said, "Who cares about inflation; stocks are up!" Then they realized stocks were priced in currency and the currency was becoming worthless ... so the stocks were worthless. Oops.”
No to Negative Rates: Yes, they are actually a thing. Japan has them, as does Europe. With negative rates, you pay to deposit your bank assets and you’re paid to carry debt. Although President Trump referred to them as a “GIFT,” negative rates “zombify” the banking sector. As BlackRock global fixed income CIO Rick Rieder stated, “Astoundingly, despite the evidence that negative rates are not effective at spurring greater economic growth, there have been persistent calls by many market commentators suggesting that the U.S. go down this policy path. We’re thankful that a broad range of Fed leaders (Powell, Bullard, Kaplan, Mester, Evans, Barkin and Bostic) have disagreed with that idea in recent days.”
Inflation or Deflation? The US economy has experienced a deflationary shock given the dramatic losses within employment and household spending. Inflation expectations have risen in recent weeks, alongside stock prices. Can this trend continue? As business cycle researcher Lakshman Achuthan stated, “recessions kill inflation.” That means a break in future inflation expectations as measured by the TIPS/Nominal spread (pictured below) or the 5yr/5yr are keys to watching how the next chapter will unfold:
Tracking the Recovery: Last week we looked at two high-frequency data points to monitor for the pace of the recovery- OpenTable YoY changes in diners and TSA checkpoint travel numbers. Bill McBride has expanded his list to six, adding gross movie sales, hotel occupancy rates, gasoline consumption and mobility trends. You can track updates on the data set here.
Investment Wisdom: Trend-following legend Jerry Parker of Chesapeake Capital said this week that the coronavirus reminds us that portfolios should be structured for both “persistence” and “tail events.”
Mr. Parker makes an important point that can be incorporated into retirement investing. Portfolios should seek to be robust—able to withstand a variety of investment landscapes. For years, the investment industry has instead focused on “optimal” portfolios. Unfortunately, what is “optimal” will only be known with the benefit of hindsight.
I will close here for the week. Have a great weekend.