Market Overview

13 May 2020

The Fed Maybe a Lady But Definitely Not a Diplomat

Slight swoon of the US stock indexes last night was caused by the sentences of the White House main medical advisor Dr. Fauci who shared his worries about a possible powerful second wave of infection in summer due to the opening-up of economies too early in some heavily populated American states. In addition, he cooled the ardor of optimists by telling them that if vaccine candidates are successful, it would be known by late fall or early winter, even despite the fact that phase 2 and phase 3 of clinical trying on people will already have started in late spring and early summer. A bill authorising the President, but fortunately not obliging him to impose tariffs and other sanctions against China in retaliation for the origin of the coronavirus, introduced by a couple of US senators, could have also played a role.

As markets continue to wonder whether Tuesday's more than 100 points drop in the S&P500 stock index could be a start of a larger correction, or further movements could just continue to evolve inside the ascending channel, which has been taking place since April 21, there are more meaningful and rather interesting discussions around negative interest rates suggestions being had. Many officials from the US Federal Reserve (Fed), including Chairman Jerome Powell, rejected contemptuously any public questions about the very possibility or feasibility of switching to negative interest rates since s sharp interest rate cut to the present 0.25% level was announced. Meanwhile, the markets have increased bets on the theoretical probability that the Fed may give up and finally introduce negative rates at least before the beginning of next year, as may be evident by a new wave of declining yields in the Treasury bond market.

Surprisingly today the Reserve Bank of New Zealand (RBNZ) fuelled the fire of discussions. New Zealand's central bank on Wednesday not only doubled the amount of bonds it will buy as part of its quantitative easing (QE) programme but also flagged a possible shift to negative interest rates in spite of the fact that New Zealand is among a few countries to have successfully suppressed the spread of the COVID-19 infection. Most businesses and offices there are working already or are set to reopen right now after weeks of disruptions. The disease was not so widespread in New Zealand and was quickly localised as in neighbouring Australia.

Over the past two weeks, only two people who died were tested positive for COVID-19 in New Zealand, and there were only 21 fatalities registered altogether, as 1,402 patients out of 1,497 infected have already been treated and released from hospital. But the country's economy depends essentially on the outer environment, so the RBNZ predicted a massive 21.8% contraction in Q2 2020 gross domestic product, followed by a 23.8% expansion in the next quarter. And it said that it was prepared to use additional tools "if and when needed" including further rate cuts and even expanding its quantitative easing programme to include foreign assets.

"The real challenge for us is to make sure that all options are available," RBNZ Governor Adrian Orr told reporters adding that negative rates "will become an option in future" and "we will be assessing the use of negative interest rates along with the other tools...one hopes we don't have to use all options." The New Zealand Dollar fell over 1% to $0.5999 soon after the RBNZ's announcement. But the main issue is that the RBNZ statements could have been made in anticipation of some further steps to reduce interest rates from the US Federal reserve, as New Zealand authorities do not want a possible strengthening of their national currency, which would prevent them from increasing export revenues.

US President Donald Trump is the only person in the United States who officially has no influence on the independent Fed, but strongly advocates the idea of negative rates. On Tuesday, @realDonaldTrump tweeted: "As long as other countries are receiving the benefits of Negative Rates, the USA should also accept the "GIFT". Big numbers!" Fed officials shrugged off denying everything. Dallas Fed president Kaplan remarked yesterday: "Negative interest rates would impact intermediaries, money market funds... [they] would have benefits that would outweigh harm, I would be against negative interest rates". St. Louis Fed president Bullard talked up on the same day: "Negative rates are not a good option for US".

Perhaps the most careful in words was Minneapolis Fed president Kashkari who has commented: "Policymakers have been "pretty unanimous" against negative rates... US government can borrow cheaply and has ability to raise funds to help American people... and there are other tools that Fed could use before introducing negative rates but I do not want to say never on the possibility". Philadelphia Fed president Harker declined to comment on negative rates limiting himself to mentioning concerns on "a scenario where economy opens too quickly and leads to second wave of virus would reverse the recovery".

Fed's Chairman Powell will be a guest at an event hosted by the Peterson Institute for International Economics at 09:00 am ET (13:00 GMT), but he is unlikely to shed more light on this topic right now. At the same time, markets saw how the Fed jumped the gun in March and rather caused more panic themselves in the markets, unable to wait for a rate cut for even three days at a time when stock prices had already fallen, but behaved calmly enough. Persistent rumours have been floating around the market since the fall of last year after a notable meeting between Jerome Powell and Donald Trump and long before all the pandemic news that the Fed would now use any excuse to cut rates urgently just to refinance multi-trillion Dollar US debt at close to zero percent, and that they are eager to bring more horror to the those involved in the markets in order to push more buying of Treasury notes to finance the country's deficit. The same tactic may well be used to inflame passions around a possible second wave of infection, which will almost inevitably manifest itself later in one form or another, but the scale of the second wave may be deliberately exaggerated in order to justify the necessary financial decisions of the authorities.

As for today's denial by Fed officials about such scenarios with negative rates, one can recall that earlier they also resented the idea of zeroing rates, defending the correctness of their increase. But later everything turned out exactly as Mr Trump wanted it. Charles-Maurice de Talleyrand, who was a French politician and top diplomat under three regimes including Napoleon Bonaparte time, is credited with saying once: "A diplomat who says "yes" means "maybe", a diplomat who says "maybe" means "no", and a diplomat who says "no" is no diplomat. A married man with a family will do anything for money. Regimes may fall and fail, but I do not." And a comic continuation of this sequence is also well-known: "When a lady says no, she means maybe; when she says maybe, she means yes; when she says yes, she is no lady".

The Fed is definitely not a diplomat if it says no, but it's probably not a lady either, based on previous market experience. Today's no may easily transform into a maybe and then into a yes later, over the course of the year. And if at some point these thoughts meet with some confirming external signs, and this may happen in case of some economic negativity and evidence of the notorious second wave, then negative rates would not soften the life of the markets, but rather help them collapse once again, drawing the right half of the W letter recovery pattern finally. And this may affect the US Dollar price against the major currencies - not right now but only much later - when it may become negative for the US Dollar in the years to follow but may even benefit American exporters to diminish the country's extremely negative trade balance. All these scenarios may seem like science fiction today, but isn't this entire year a semblance of a movie in this genre?


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