Markets Better Not Lose Their Fed

3rd May '20 by Viacheslav Buchkov

4 comments 347 reads

The coronovirus shock indeed has come as something truly unexpected, as no thoughtful analysis or a mad guess could've forseen such consequence of events. However, as for now, we are situated right in the point on the timeline, where prediction is not a guessing game anymore.
As fast as the virus broke into our life, the authorities claimed that it is largely under control: both from medical and from economic point of view. Every negative news started to be percepted as just another reason for new exceptional stimulus. As the market sentiment suggests, the unprecedental and, so to say, mind-blowing Fed and US Government injections are widely presumed to be the end of the story. Nevertheless, there are investors that were waiting for the "blood in the water", but didn't manage to actually taste one. Will they have a chance to do so?

THE INFLATIONARY SCENARIO

Well, with all of responsibility that an analyst (ideally) must possess, I should say that I don't know. But while there are scenarios that make me agree with the existing optimism at the market, there is a certain one that does seem to be an actual crisis. And it is going to be the topic of this article.
The "helicopter money" injections that we see indeed seem to be a solution of every single concern that investors have. However, does US economy really possess a flawless weapon, sort of Thor's Stormbreaker that only US is worthy to hold? Unfortunately, not a single item in the economy comes at the zero price, as the functioning of such a complex system is undoubtedly a zero-sum game. Therefore, while the US citizens gain from such injections, someone should suffer the identical losses? It turns out that it will be the same US citizens, but in the future. The returning all over again story about incredible growth at the expense of the future failure seems to be at the door again.
Every undergraduate student with Economics as a major will definitely tell you that money printing spending is an inflationary scenario due to increase in the money supply that pushes interest rates lower, thus, causing the positive aggregate demand shock, ending in the acceleration of the inflation. However, the coronovirus situation has caused a quite strong negative demand shock, thus, causing the temporary (very temporary) slow down in the inflation.…

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Howard Marx

3rd May '20

An interesting read, Dr Buchkov.

As things stand, the US bank (Federal Reserve) can only lend.. it cannot spend.

A paradigm shift would occur if/when the Fed's remit changes & it is then allowed to conduct the so called 'helicopter money' (MMT). This would allow the Fed to 'spend' .. it could create money to directly fund public expenditure or tax cuts.. rather than (as now), just be allowed to print money to (lend to)/buy financial assets.

As things stand today we are arguably in a DEFLATIONARY environment:
- HOLD : AAA bonds, cash
If MMT/helicopter money arrives, then INFLATION will soon follow:
- HOLD : Equities (especially those companies with Debt), Commodities, Real Assets (property, land), Index-linked bonds.

Currently I'd say it's a 40/60 chance split between these two outcomes.

dfs12

4th May '20

Interesting read (although a little challenging)... I struggle to get my head round the long/medium term impact of government debt cancellation, money printing, debt issuance and debt purchase. In the short term it should help increase economic activity and demand.

You can can find yourself thinking that the fed can manipulate itself out of all disaster scenarios at no cost. I like your comment that "the complex system is a zero sum game". I have an alternative way to bring myself back down to earth by considering productivity - "is the world's productivity going to be enhanced or reduced by the current situation?" In my mind it's not going to be enhanced.

So regardless of the future price tag each item of consumption has going forwards - we will be in a worse place - our income in real terms is likely to be lower.

The idea that we are going to see excessive consumption as soon as lockdown is eased does not seem a foregone conclusion. It is equally likely consumption returns in a muted fashion. Therefore inflation seems a low probability risk to me (certainly in the short/medium term). Where does the other side of the zero sum game come from? (I have no idea!)

Lets hope the financial chicanery that governments are entering into doesn't start feeling like the clever tricks of the US mortgage debt market in the period prior to the great financial crash. It all seems like a good idea at the time although the ultimate outcome isn't quite so good.

mojomogoz

Later in 2020 will feel like an economic boom time:

1) The bug is not as bad as we feared but our shared narrative hasn't got round to realising that yet. In particular, sub 40 close to zero prob.... and sub 60 not much. Its hard to see why it will be necessary to keep much closed down or have over intrusive social distancing.

2) We now have a coping strategy with an enemy we understand a bit more

3) In major western economies governments have stepped in to prevent the destruction of capital. We have depression looking economic activity numbers but without the depression carnage. Its like an extended break. If August in Europe where to happen in April out of the blue the numbers would scream massive recession. Obvs there is real damage too and some weaker/unlucky businesses are going to the wall...

4) But that's good from an economic perspective and something lacking from the post 2008 recovery. Govt, markets and banks will have and make available capital to eat up or replace these businesses and also provide much pivot/growth capital

5) We have gone through the looking glass on debt at the state level and either forgiveness or inflation is the next step. Rates and yields will be held down by whatever means necessary. A real money rate rise cycle is not tolerable. MMT will come in some way (it has in the UK with BoE monetising spending directly). In US there are legal impediments...but there will be bipartisan support for getting round it (particularly with the 'wars' against the bug/China, make america great again, support for the low value front line, need to re fire employment in areas, etc)

The 2020s are going to be like the economic healing we should have had after 2008 but suppressed with a rather lopsided debt/financial market support perspective. The real economic potential with US and European countries is rather large. In equity markets that won't make for a straight up of course. Lots of rotation and revaluation to occur.

That's my roughly worked out story anyway

Terry Dickens

A very good read, but you refer to yourself as WE.

May I ask who WE are

Markets Better Not Lose Their Fed

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Viacheslav Buchkov

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