Tag Archives: #SMCCF

Looking Distressed

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The market was looking distressed
So, Jay clearly thought it was best
To tell everyone
The Fed had begun
To buy corporates at his behest

Frankly, I’m stunned. Anyone who believes that the Fed is focusing on any variable other than the S&P 500 was completely disabused of that notion yesterday. While I know it seems like it was weeks ago, yesterday morning there was concern that Chairman Powell’s comments last week about a long, tough road to recovery were still top of mind to market participants. Concerns over a rising infection rate in some states and countries were growing thus driving investors to react negatively. After all, if the mooted second wave of Covid comes and the nascent economic revival is squashed at the outset, the case for the V-shaped recovery and stratospheric stock prices would quickly die. And so, Chairman Powell responded by explaining that the Fed would expand the SMCCF* program to start buying individual bonds today. Remember, the initial story was ETF’s were the only purchases to be made. Now, the Fed is effectively cherry-picking which investors it wants to help as certainly the companies whose bonds the Fed buys will not be getting any of that money. Or will they? Perhaps the hope is that if the Fed owns individual corporate bonds, in the coming debt jubilee, they will tear up those bonds as well as their Treasuries, thus reducing leverage in a trice.

A debt jubilee, for those who are unfamiliar with the term, is a government sanctioned erasure of outstanding debts. Its origins are in the book of Deuteronomy in the Old Testament, when every 50 years there was a call for the release of all debts, both monetary and personal (indenture). Of course, in the modern world it is a bit more difficult to accomplish as all creditors would be severely impacted by the concept. All creditors except one, that is, a nation’s central bank.

Now that we are in a fiat currency system where central banks create money from nothing (paraphrasing Dire Straits), any public debt that they hold on their balance sheets can simply be forgiven by decree, thus reducing the leverage outstanding. While there would seem to be some inflationary consequences to the action (after all, an awful lot of funds would be instantly freed up to chase after other goods, services and investments), the modern central bank viewpoint on inflation is that it is dangerously low and a problem at current levels, so those consequences are likely to be quickly rationalized away. Thus, if the Fed owns individual corporate bonds, especially of highly indebted companies, they will be able forgive those, reduce leverage and support those companies’ prospects to maintain a full-sized staff. You see, the rationalization is it will support employment, not help investors.

To be clear, there is no official plan for a debt jubilee, but it is something that is gaining credence amongst a subset of the economics community. Especially because of the inherent concerns over near- and medium-term growth due to Covid-19, as future consumer behavior is likely to be very different than past consumer behavior, I expect that a debt jubilee is something about which we will hear a great deal more going forward. Nonstop printing of money by the world’s central banks is not a sustainable activity in the long run. Neither is it sustainable for governments to run deficits well in excess of GDP. A debt jubilee is a potential solution to both those problems, and if it can be accomplished by simply having central banks tear up debt, other creditors will not be destroyed. Truly a (frightening) win-win.

It can be no surprise that the stock market reacted positively to the news, turning around morning losses to close higher by 0.85% in the US with the sharpest part of the move happening immediately upon the statement’s release at 2:15 yesterday. This euphoria carried over into Asia with remarkable effect as the Nikkei (+4.9%) and KOSPI (+5.3%) exploded higher while the rest of the region merely saw strong gains of between 1.4% (Shanghai) and 3.9% (Australia). And naturally, Europe is a beneficiary as well, with the DAX (+2.8%) leading the way, but virtually every market higher by more than 2.0%. US futures? Not to worry, all three indices are currently higher by more than 1.1%.

In keeping with the risk-on attitude, we also saw Treasury bonds sell off in the afternoon with yields rising a bit more than 4bps since the announcement. In Europe, bund yields are higher as are gilts, both by 2.5bps, but the PIGS are basking in the knowledge that their future may well be brighter as we are seeing Portugal (-2bps), Italy (-5.5bps), Greece (-6.5bps) and Spain (-3bps) all rallying nicely.

And finally, the dollar, which had started to show some strength yesterday, has also reversed most of those gains and is broadly, though not deeply, softer this morning. In the G10, the pound is the leader, higher by 0.45%, as the market ignored Jobless Claims in the UK falling by 529K, only the second worst level on record after last month’s numbers, and instead took heart that a Brexit deal could well be reached after positive comments from both Boris Johnson and the EU leadership following a videoconference call earlier today. While nothing is confirmed, this is the best tone we have heard in a while. However, away from the pound gains are limited to less than 0.25% with some currencies even declining slightly.

In the emerging markets, the leading gainer is KRW (+0.75%) despite the fact that North Korea blew up the Joint Office overnight. That office was the sight of ongoing discussions between the two nations and its destruction marks a significant rise in hostility by the North. In my view, the market is remarkably sanguine about the story, especially in light of its response to the news out of India, where Chinese soldiers ostensibly attacked and killed three Indian soldiers in the disputed border zone. There, the rupee fell 0.25% on the report as concerns grow over an escalation of tensions between the two nations. But aside from those two currencies, there were many more gainers in APAC currencies as funds flowed into local stock markets on the Fed inspired risk appetite.

On the data front, we see Retail Sales (exp 8.4%, 5.5% ex autos) as well as IP (3.0%) and Capacity Utilization (66.9%), with all three numbers rebounding sharply from their lows set in April. We saw a similar rebound in German ZEW Expectations (63.4 and its highest since 2006), but recall, that is based on the change of view month to month.

Chairman Powell testifies to the Senate this morning, so all ears will be listening at 10:00. Yesterday we heard from two Fed speakers, Dallas’s Kaplan and San Francisco’s Daly, both of whom expressed the view that a rebound was coming, that YCC was not appropriate at this time and that the Fed still had plenty they could do, as they made evident with yesterday afternoon’s announcement.

While equity markets continue to react very positively to the central bank activities, the dollar seems to be finding a floor. In the end, investment flows into the US still seem to be larger than elsewhere and continue to be a key driver for the dollar. Despite a positive risk appetite, it appears the dollar has limited room to fall further.

Good luck and stay safe
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*Secondary Market Corporate Credit Facility

Make Hay

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The Fed, today’s, finally set
To start to buy corporate debt
Meanwhile the UK
Did start to make hay
With its largest Gilt issue yet

While markets are fairly docile this morning, there are four interesting stories to note, all of which are likely to have bigger impacts down the road.

The first of these emanates from the Mariner Eccles Building in Washington, where the FOMC will begin to implement its Secondary Market Corporate Credit Facility (SMCCF), purchasing its first investment grade bond ETF’s. Ironically, in their effort to stabilize corporate credit markets that are suffering a hangover of excess issuance prior to the Covid-19 crisis, the Fed is going to ramp up margin debt for the purchases. A little ‘hair of the dog’ it seems is the best idea they have. Consider, the process of these purchases is that the Treasury has deposited $37.5 billion into an SPV account which will serve as collateral for that SPV to purchase up to 10x that amount in securities. Talk about speculative! If the SPV purchases its full allotment, then the Fed will effectively be increasing the total amount of margin debt outstanding by nearly 80%. Granted, there is no concern about the Fed being able to pay for these securities in actuality, it’s just the legal questions that may arise if they fall in price by more than 10% and the Fed has actual losses on its balance sheet. Naturally, the idea is that with the Fed buying, there is almost no possibility that prices could fall. However, do not believe that for a moment, just as we have seen in the Treasury market, despite the Fed buying $ trillions worth, bond prices still decline all the time. And don’t forget what we saw in March, when yields rocketed higher for a period of time. Perhaps the most surprising aspect is that US equity futures have been trading either side of flat despite this new money entering the market.

The second interesting story comes from across the pond, where the UK issued gilts via a syndicate for the first time, offering a new 10-year bond and garnering £65 billion pounds of demand, a record amount of attraction. It seems that one of the things that got buyers excited was a comment by BOE Deputy Governor Broadbent hinting that negative rates are not out of the question as the Old Lady seeks to insure sufficient policy support for the economy.

While on the subject of negative rates, it is worth noting that two Fed regional presidents, Bostic and Evans, were both circumspect as to the need for the Fed to ever go down that road. That is certainly good news, but one cannot forget the language change made in September of last year when the Fed stopped referring to the “zero lower bound” and began calling it the “effective lower bound”. Observers far more prescient than this one have noted that the change clearly opens the door for negative rates in the future. There is certainly no indication that is on the cards right now, but it is not an impossibility. Keep that in mind.

From Austria, Herr PM Kurz
Admitted that fiscal transfers
Are what are required
Lest Rome is inspired
To exit, which no one prefers

Another interesting headline this morning comes from Vienna, where Austrian PM Sebastian Kurz explained that the only way Italy can survive is via debt mutualization by the EU, as there is no way they will ever be able to repay their debt. While it is refreshing to hear some truth, it is also disconcerting that in the very next comment, PM Kurz explained there was no way that Austria was comfortable with that course of action. While Austria stood ready to support Italy, they would not take on their obligations. Of course, this is the fatal flaw in the EU, the fact that the Teutonic trio of Germany, Austria and the Netherlands are the only nations that can truly help fund the crisis but are completely unwilling to do so. I once again point to the German Constitutional Court ruling last week as a sign that the euro is likely to remain under pressure for a time to come. While this morning it is now higher by 0.2%, it remains near the bottom of its recent range with ample opportunity to decline further. Beware the ides of August, by which time the ECB will have responded to the court.

And finally, it must be noted that it is raining in Norway. By this I mean that the Government Pension Fund of Norway, the world’s largest wealth fund, is going to be selling as much as $41 billion in assets in order to fund the Norwegian government and its response to the crisis. This is exactly what a rainy-day fund is meant for, so no qualms there. But it does mean that we are going to see some real selling pressure on financial assets as they liquidate that amount of holdings, many of which are in US stocks. NOK, however, has been the beneficiary, rallying 0.8% this morning on the news. Given the krone has been the worst performing G10 currency this year, it has plenty of room to rally further without having any negative economic impacts.

Those are the most interesting headlines of the day, and the ones most likely to have a market impact. However, today, for the first time in a while, there is not much market impact in any markets. Equity prices in Asia were modestly softer, while those in Europe are mixed but edging higher. Bond prices are within a tick or two of yesterday’s closing levels, and the dollar is having a mixed session, although I would estimate that on net it is slightly weaker.

On the data front, it has been extremely quiet overnight with a few Sentiment indicators in France and Japan, as well as the NFIB here in the US, all printing terrible numbers, but none quite as terrible as the median forecasts. My observation is that analysts are now expanding their view of just how bad things are and beginning to overstate the case. As for this morning, we have CPI on the docket, with expectations of a 0.4% headline print and 1.7% core print. While inflation may well be in our future given the combination of monetary and fiscal policy response, it is not in the near future.

Barring some other news story, markets seem pretty happy to consolidate for a change, and I expect that is what we will see today. However, nothing has changed my view that a substantial repricing of risk is still in our future, and with it, a stronger dollar. While we don’t know what the catalyst will be, I have my eye on the ECB response to the German Constitutional Court ruling.

Good luck and stay safe
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