FED signs open cheque, endorses QE Infinity
Full funk QE Infinity is official.
For some time now I’ve been writing about QE Infinity, and QE+NIR, i.e., quantitative easing with negative interest rates.
No, it wasn’t a concoction of my economically tortured mind, rather, it spawned from the U.S. Treasury and Federal Reserve’s response to the 2007/2008 sub-prime crisis, which we know today as the GFC.
The response? Money printing.
It’s been building up for 12 years and so far the world has not found a fiscal alternative, other than for printing larger quantities of it.
In the last week, the ECB and the U.S. Fed have committed to pump an additional $1.9 trillion of free money into markets - and into corporations. Key central bank balance sheets in the U.S., EU, Japan and China will now increase to at least $21.6 trillion in aggregate.
But that’s not all, the Fed has committed to an unprecedented open-ended asset buying program - it’s a blank cheque for as long as required, so the number may well go up. Also, it appears corporate bail-outs could occur with little to no oversight.
Jerome Powell and ECB President Christine Lagarde have got their full funk on as they appear to be coordinating a monetary assault on COVID-19.
Whatever it takes.
In the last 6 months, the Fed has been busy buying.
In October last year, the U.S. Fed started monthly Treasury purchases (at a rate of US$60 billion per month) in an attempt to supply more liquidity into markets to keep a lid on repurchase interest rates. At the time, Powell said it was in no way QE. No one in this household believed him.
Liquidity injections can be good at the appropriate time, however as Janet Yellen had started, the lakes should have been drained back to an appropriate level - thought to be somewhere between $1 trillion and $2 trillion.
However, as Powell tried to reduce the US$4.5 trillion balance sheet, he was unable to get below the US$3.7 trillion watermark, before topping it back up to US$4.2 trillion by 31 December 2019.
Then, on the 16th of March, the Fed’s open market committee (FOMC) instructed its traders to undertake open market ops to move the Fed Funds rate to 0% to 0.25%.
In addition, they were instructed to increase treasury securities and agency mortgage-backed securities by at least $500 billion and at least $200 billion, respectively.
$700 billion is the biggest instruction the Fed has issued so far.
On 18 March 2020, the Fed’s balance sheet reached its highest ever level of US$4.66 trillion - and given Sunday’s announcement, its going higher.
Fed Balance Sheet as of 18 March 2020.
Stimulus Sunday - Powell’s Monster Put.
On Sunday, Jerome Powell replaced Mario Draghi as the dove for all seasons, finally acknowledging what had started many years before - QE Infinity.
Effectively, the Fed signed an open-ended blank cheque.
“Support for critical market functioning. The Federal Open Market Committee (FOMC) will purchase Treasury securities and agency mortgage-backed securities in the amounts needed to support smooth market functioning and effective transmission of monetary policy to broader financial conditions and the economy.” The Fed.
In addition, the Fed said it will buy bonds and paper from corporations. Yikes!
This effectively bypasses the scrutiny of individual bail outs which occurred in 2008, and again when 22 banks were rescued in 2009.
In other words, if you can’t sell it elsewhere, sell it to Fed, they’re open for business again.
President Trump will no doubt be delighted.
This represents an unprecedented firing of all ammunition (not that there was much left) at COVID-19, in one big bang.
Specifically, here’s what was announced on Sunday:
“Supporting the flow of credit to employers, consumers, and businesses by establishing new programs that, taken together, will provide up to $300 billion in new financing.
The Department of the Treasury, using the Exchange Stabilization Fund (ESF), will provide $30 billion in equity to these facilities.
Establishment of two facilities to support credit to large employers – the Primary Market Corporate Credit Facility (PMCCF) for new bond and loan issuance and the Secondary Market Corporate Credit Facility (SMCCF) to provide liquidity for outstanding corporate bonds.
Establishment of a third facility, the Term Asset-Backed Securities Loan Facility (TALF), to support the flow of credit to consumers and businesses. The TALF will enable the issuance of asset-backed securities (ABS) backed by student loans, auto loans, credit card loans, loans guaranteed by the Small Business Administration (SBA), and certain other assets.
Facilitating the flow of credit to municipalities by expanding the Money Market Mutual Fund Liquidity Facility (MMLF) to include a wider range of securities, including municipal variable rate demand notes (VRDNs) and bank certificates of deposit.
Facilitating the flow of credit to municipalities by expanding the Commercial Paper Funding Facility (CPFF) to include high-quality, tax-exempt commercial paper as eligible securities. In addition, the pricing of the facility has been reduced.”
This adds to a minimum of $1 trillion from the Fed and $30 billion from the U.S. Treasury.
The signal to markets was twofold. First, the global economy is in big trouble. Second, thanks so much for the Put.
Global $1.93 trillion in top-up, mainly Fed and ECB.
The U.S. Fed will pump in at least $1 trillion and the Treasury an additional $30 billion.
The European Central Bank will buy up to 750 billion euros ($820 billion) in government and private sector bonds as well as commercial paper by year end.
The People’s Bank of China adds a modest $80 billion on the basis it feels China’s recovery will be quick.
In total, $1.93 trillion of liquidity. However, the U.S. Fed and ECB have promised to do whatever it takes, so the number will likely grow if COVID-19 grows.
Breaking through the ice sheet.
Water in the Rohypnol infused great lakes of free money is breaking through the frozen ice sheet, and overflowing.
And, the US Fed is hoping that the active ingredient in that water (funky money at 0% cost) will kill COVID-19, effectively, printing its way out of a pandemic.
It looks like the central banks will leave their hoses running.
Once stimulus is fully factored into markets and traders and investors have reset, the equities rocket fuel looks set to continue even in the face of this pandemic.
And, it’s probably already happening. At present, we’re seeing a bounce in U.S equities. In fact, as I watch in early trade this Tuesday some stocks are going berserk, with with Mastercard, Visa and Disney up between 14% and 16%.
This is a response to the Fed’s Put and an impending COVID-19 stimulus package, which is currently being debated in the U.S. Congress.
But wait, what about global debt to GDP?
Either no one cares, or no one can do anything about it. I suspect it’s the latter.
Effectively, global debt to GDP before any of this funky money stands at about $253 trillion, based on IIF data.
Conversely, GDP before factoring in COVID-19 currently sits around the $78 trillion level.
Commentators such as Goldman Sachs and Morgan Stanley have suggested U.S. GDP will decrease between 24% to 30% in the next quarter, i.e., April-June.
Our world is 322% geared (on a debt to GDP basis) and up from 318% roughly a year ago in April 2019.
That’s like you owning a $500,000 home in need of a $100,000 renovation, with a $1,600,000 mortgage at 0% interest rate which may roll on forever. But given your bank doesn’t want to see a default when rates increase, it keeps rates low and one day encourages you to roll that mortgage into a longer dated mortgage. In the meantime, it sprays stimulus around the market. Welcome to the new normal.
Just as the world cannot afford to repay its mortgage, the central banks have not been able to normalise (reduce) their balance sheets - so, they will continue to grow and short dated paper will likely get swapped for longer dated paper.
What about corporate earnings?
As we’ve seen even in Australia over the past two weeks, many businesses have withdrawn their earnings guidance. Companies and investors are flying blind.
Trades in those stocks are now based on speculation and bullish spirits looking for bargains, or the view that stocks were oversold in the panic. But those who smell opportunity cannot calculate earnings trajectories accurately because the length and breadth of economic lock down across multiple countries and supply chains is an unknown.
Just at the minute, India’s PM has ordered a lock down of his country for 21 days - that’s 1.3 billion people. What effect will that have?
On the other hand, what those traders do know is that QE will continue to save the day for equities, and as rates come down even further, bonds will rally and can be sold on.
And, what if there’s no one there to buy the financial asset?
No problem, the Fed will!
Today, it’s just different people sitting on those broom sticks.
Stimulus Packages.
Australia’s $189 billion COVID-19 stimulus package passed on Monday.
The U.S. Congress is still debating the $1.5 trillion Republican stimulus package, with the Democrats floating their own $2.5 trillion package. However, it looks like some form of consensus might be reached around the $2 trillion mark. Oversight over a $500 billion loan package to corporations seems to be a sticking point for the Democrats.
With the U.S. roughly 13 times the size of Australia in terms of population, it either means that the Republicans are being too cheap and Nancy Pelosi’s Democrats are closer to the mark, or that Scott Morrison has over spent.
We might have an outcome soon.
Now what for business?
Stay safe, look after and secure your family and don’t panic.
Business is people, so be kind to your staff, as they will always be your greatest asset, and loyal to your suppliers and customers.
Despite the ever growing central bank balance sheets and global debt, there appears to be support for some people and businesses in Australia, with the detail soon to be tested in real life.
Establish whether Government support is available for your business.
Review your business continuity plan and risk matrix.
Review your strategy.
Consider how your competitive (and financing) landscape will change in the months and years ahead.
Focus on building competitive advantage in a post-COVID-19 world.
Consider whether a change in organic strategy might be sufficient, and if so implement it.
If not, dust off that inorganic think-piece that you’ve been sitting on for the past year/s, and which now might be your silver bullet.
Don’t think that M&A and fundraising cannot be done in a crisis market. In our experience, 25% of the transactions we have helped our clients complete have occurred during a crisis - including the SARS outbreak in 2002-2004, the GFC in 2007-2009, and even more recently during this pandemic.
Surround yourself with trusted staff, partners and advisors (which you should do always) and in a collaborative way, plot an efficient way from the old normal to the new normal - and then act decisively.
Best wishes, and stay safe.
Mike.
NextLevelCorporate is a leading financial & strategic corporate advisory firm with a multi-decade track record that speaks for itself. Helping clients in all industries to prepare for, respond to and deliver transformative corporate finance strategies and transactions in and out of Australia, is our passion.