Til now the direction’s been clear
As Jay and Mnuchin did fear
If they didn’t spend
The US can’t mend
And things would degrade through next year
But now, unless there’s a breakthrough
It seems Treasury won’t renew
Which likely will thwart
A rebound til late Twenty-Two
Just when you thought things couldn’t get more surprising, we wind up with a public disagreement between the US Treasury Secretary and the Federal Reserve Chair. To date, Steve Mnuchin and Jay Powell have seemed to work pretty well together, and at the very least, were both on the same page. Both recognized that the impact of the pandemic would be dramatic and there was no compunction by either to invent new ways to support both markets and the economy. As well, both were appointed by the same president, and although their personal styles may be different, both seemed to have a single goal in mind, do whatever is necessary to maintain as much economic activity as possible.
Aah, but 2020 is unlike any year we have ever seen, especially when it comes to policy decisions. The legalities of the alphabet soup of Fed programs (e.g. PMCCF, SMCCF, MMLF, etc.) require that they expire at the end of the year and must be renewed by the Treasury Department. And in truth, this is a good policy as expiration dates on spending programs require continued debate as to their efficacy before renewal. The thing is, given the rapid increase in covid infections and rapid increase in state economic restrictions and shutdowns, pretty much every economist and analyst agrees that all of these programs should continue until such time as the spread of the coronavirus has slowed or herd immunity has been achieved. Certainly, every FOMC member has been vocal in the need for more fiscal stimulus as they know that their current toolkit is inadequate. (Just yesterday we heard from both Loretta Mester and Robert Kaplan with exactly that message.) But to a (wo)man, they have all explained that the Fed will continue to do whatever it can to help, and that means continuing with the current programs.
Into this mix comes the news that Secretary Mnuchin sent a letter to the Fed that they must return the funds made available to backstop some of the Fed’s lending programs, as they were no longer needed. The Fed immediately responded by saying “the full suite” of programs should be maintained into 2021.
Let’s consider, for a moment, some of the programs and what they were designed to do. For instance, the Primary Market Corporate Credit Facility and Secondary Market Corporate Credit Facility do seem superfluous at this stage. After all, more than $1.9 trillion of new corporate debt has been issued so far in 2020 and the Fed has purchased a total of $45.8 billion all year, just 2.4%, mostly through ETF’s. It seems apparent that companies are not having any difficulty accessing financing, at very low rates, in the markets directly. In the Municipal space, the Fed has only bought $16.5 billion while more than $250 billion has been successfully issued year to date. Mnuchin’s point is, return the unused funds and deploy them elsewhere, perhaps as part of the widely demanded fiscal policy support. The other side of that coin, though, is the idea that the reason the market’s have been able to support all that issuance is because the Fed backstop is in place, and if it is removed, then markets will react negatively.
In fairness, both sides have a point here, and perhaps the most surprising outcome is the public nature of the spat. Historically, these two agencies work closely together, especially during difficult times. But as I said before, 2020 is unlike any time we have seen in our lifetimes. There is one other potential driver of this dissension, and that could be that politically, the Administration is trying to get Congress to act on a new stimulus plan quickly by threatening to remove some of the previous stimulus. However, whatever the rationale, it clearly has the market on edge, interrupting the good times, although not yet resulting in a significant risk-off outcome.
If this disagreement is not resolved before the next FOMC meeting in three weeks’ time, the market will be looking for the Fed to expand its stimulus measures in some manner, either by increasing QE purchases or by purchasing longer tenor bonds, thus weighing on the back end of the curve as well as the front. And for our purposes, meaning in the FX context, that would be significant, as either of those actions are likely to see a weaker dollar in response. Remember, while no other central bank is keen to see the dollar weaken vs. their own currency, as long as CNY continues to outperform all, further dollar weakness vs. the euro, yen, pound, et al, is very much in the cards.
So, with that as our backdrop, markets today don’t really know what to do and are, at this point, mixed to slightly higher. Asia, overnight, saw further weakness in the Nikkei (-0.4%), but both the Hang Seng and Shanghai exchanges gained a similar amount. European bourses have slowly edged higher to the point where the CAC, DAX and FTSE 100 are all 0.5% higher on the day, although US futures are either side of unchanged as traders try to figure out the ultimate impact of the spat. Bonds are mixed with Treasury yields higher by 1 basis point, but European yields generally lower by the same amount this morning. Of course, a 1 basis point move is hardly indicative of a directional preference.
Both gold and oil are essentially flat on the day, and the dollar can best be described as mixed, although it is starting to soften a bit. In the G10 space, NZD (+0.45%) leads the way with the rest of the commodity bloc (AUD, NOK, CAD) all higher by smaller amounts. Meanwhile, the havens are under a bit of pressure, but only a bit, with JPY and CHF both softer by just (-0.1%). EMG currencies have seen a similar performance as most Asian currencies strengthened overnight, but by small amounts, in the 0.2%-0.3% range. Meanwhile, the CE4 were following the euro, which had been lower most of the evening but is now back toward flat, as are the CE4. And LATAM currencies, as they open, are edging slightly higher. But overall, while there is a softening tone to the dollar, it is modest at best.
On the data front, there is none to be released in the US today, although early this morning we learned that UK Retail Sales were a bit firmer than expected while Italian Industrial activity (Sales and Orders) was much weaker than last month. On the speaker front, four more Fed speakers are on tap, but they all simply repeat the same mantra, more fiscal spending, although now they will clearly include, don’t end the current programs.
For the day, given it is the Friday leading into Thanksgiving week, I expect modest activity and limited movement. However, if this spat continues and the Treasury is still planning on ending programs in December, I expect the Fed will step in to do more come December, and that will be a distinct dollar negative.
One last thing, I will be on vacation all of next week, so there will be no poetry until November 30.
Good luck, good weekend, stay safe and have a wonderful holiday