Market Overview

24 March 2020

The Fed Is Launching More Antiviral Dollar Fireworks. Will Markets Applause?

Stock indexes in the United States, Europe, Asia and many other parts of the world rebounded by values from five to eight % if compared with this week's opening prices after new and unprecedented moves by the US Federal Reserve (Fed) to shore up credit across the economy. The Fed is now committed to use its full range of tools. The Fed announced on Monday that it will begin to purchase DAILY not only another $75-billion Treasury bonds package plus $50-billion agency mortgage-backed securities which would cost $625 billion for the single week - but what is even more important is that the Fed is going to buy UNLIMITED amounts of corporate bonds and other asset-backed securities (ABS), and sometimes even shares. The Fed, however, has not announced the volume of such possible purchases in advance.

The value of this step is even bigger than the fact that the amount of these purchases is definitely several times higher than the largest weekly quantitative easing (QE) ever before. The previous record was $162 billion for one week during the 2008 crisis. It is critical that this is no longer an abstract injection into the financial system as a whole, but that it also does not point to someone or a group or particular people. After all, trillions of electronically printed money provided to the banking system in exchange for Treasuries does not force anyone to invest the same money in shares or to give it to particular companies in a form of credit lines. The 25-year experience of Japan shows that the economy may simply not absorb QE money because nothing encourages banks or funds to dispose them in the interests of the most suffering parts of the economy, and not for the purpose of purely speculative operations. As a result, money from QE usually inflates "bubbles" or goes to those sectors which already have good access to liquidity but failed to return new capital investments because of suppressed consumer demand.

There is a proverb in the Midwest that says that even one cowboy can bring a horse to the river but not even a hundred cowboys may succeed in pushing it to drink. The same may happen with the economy, which is in this case a horse, and money can be considered as the river, in the form of QE.

In the midst of an epidemic and quarantine measures, social distancing of most potential consumers for weeks and probably months, numerous hotels and restaurants, shopping centres and the entertainment industry, a lot of other small and middle-sized business enterprises are experiencing huge troubles with paying rent, employee salaries and regular repayments on their loans. The urgent payments "counter" keeps spinning, and without direct assistance from the government and central banks many companies will simply go bankrupt because of the absence of clients.

Tax holidays or partial compensation of rental payments could be important but they are only partial solutions. Therefore, a direct injection of the Fed's money into corporate securities of the affected companies could really have a much more powerful effect on saving the business. Another thing is that there are a lot of small shops and family businesses that have no "asset-backed securities", and they may rely on subsidies only. Recent Fed moves are no doubt the first real measures to save network companies since all other financial manipulations by the US monetary policymaker were tailored only to solve the problems of the $23.5 trillion US federal public debt or, at best, it was a medicine for stock market investors, but not the real economy. Stock markets funds are not eager to pick up "falling knives" of shares if they expect the business of companies could fall down more and more, even if they get additional billions of US Dollars as a bailout package.

Gold futures happily responded with a sharp growth to the area of $1,600/toz amid expectations of the potential depreciation of the US Dollar as a result of trillions of US Dollars injected into the system and a slowing of the economy. Investors are still very cautious about the idea of buying any shares. After falling to new lows this Monday, a very moderate optimism may be visible on the horizon. The next two or three weeks may unveil whether any encouraging signs would appear to support market growth. However, it's more likely that more portions of optimism could appear on a deeper levels of stock prices.

Meanwhile, US President Donald Trump suggested that he may scale back closures soon despite the fact that the outbreak has not reached its peak. He said on Monday that he is considering how to reopen the US economy and is going to make a decision "as to which way we want to go" at the end of the 15-day shutdown period, which ends next week.

Larry Kudlow, Trump's senior economic adviser, signalled for a possible policy change in an interview with Fox News: "The president is right. The cure can't be worse than the disease. We're going to have to make some difficult trade-offs." Kevin Hassett, another economic adviser in the White House, added that if the shutdowns continue much longer, the United States could slip into depression. Stephen Moore, the economic commentator Trump tried to tap for a vacant Federal Reserve seat last year, told Reuters on Monday: "there is a re-examination in the White House of the wisdom of a full scale … shutdown of the economy", and there were some who thought that "if we go on too long with the economy shutdown, the human toll for that could be greater than the risk of the virus."

The measures set out to ensure that social distancing was carried out were accepted in most of the US 50 states. People spend their time at home and economic activity has grounded to a halt. Donald Trump told reporters last night that it is possible to resume economic activity in the United States with what he said were relatively low rates of infection, citing Nebraska, Idaho and Iowa as examples. However, according to Trump the restrictions would be maintained in the "hot zones" like New York. "If it were up to the doctors, they'd say let's shut down the entire world," said the US President. Ford General Motors and Tesla are being given the go ahead to make ventilators and other metal products, he tweeted later.

The US Treasury secretary Steve Mnuchin and the Senate Democratic leader Chuck Schumer voiced confidence late on Monday for a deal to be accomplished soon on a far-reaching bipartisan $2-trillion economic stimulus package, Reuters reported. Two attempts to approach Republican proposals in the Senate failed over the past two days despite the party's majority. On Monday, the 49-46 vote was short of the 60 needed to advance, as only one Democrat voted in favour. So no final pact has yet to be achieved . "There are still a couple of open issues," Mnuchin said. "I think we are very hopeful that this can be closed out tomorrow."

However, it's not that simple as later on Republicans accused Democrats of obstruction during a national emergency. Donald Trump told reporters that Democrats insist that any agreement must include more oversight provisions of a $500 billion fund for large businesses, to avoid giving corporate leaders a blank cheque. Asked about that, Trump responded, "I'll be the oversight." He also referred to Democrats as seeking to add some more unrelated provisions, such as expanded tax credits for wind and solar power and increased leverage for labour unions after the House Speaker Nansy Pelosi joined the negotiations. Later Trump tweeted: "This will never be approved by me, or any other Republican! The Democrats want the Virus to win? They are asking for things that have nothing to do with our great workers or companies. They want Open Borders & Green New Deal. Republicans shouldn't agree!"

The Senate measures include $1,000 financial aid for each adult American citizen plus $500 for their children, more aid for small businesses and critically affected industries, such as airlines. If these decisions are made they may also support demand and an important part of the economy, which could be favourable for the markets too, whereas if decisions are postponed again this will probably be an additional negative for tired markets.


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Lysakov Sergey
Market Focus
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