Positive, Not Negative Rates “For Now”

Markets remain mixed. The focus is still on the economy and reopening. We still believe the employment data will be paramount as the economy reopens. We need to find a bottom with the numbers and reversal back the other way as businesses come back online. Chairman Powell was in the hot seat this week regarding a formal negative rate policy.

US continuing claims

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Chairman Powell

We were not surprised by the Chairman’s assessment across the board. The Fed has been very sobering in their assessment of the economic fallout from Covid-19. Leading up to this year, the Fed had conducted a great deal of “on the ground analysis” of the economy through the “Fed Listens” program. And for those that listen to Powell closely, he consistently made reference over time for the need to keep the recovery going. Essentially, workers that were displaced since the last crisis (2008) were finally seeing daylight. Now this. 

This week brought two different perspectives: sobering from Powell and optimism toward a quick recovery from Secretary Mnuchin. In the end, our view remains in the camp that this recovery and reopening will be slow and uneven. 

A few additional thoughts on Powell this week:

1. Negative rates right now go against the grain of all that the Fed has embarked on. Period. The Fed needs the banks more than every right now with all of the lending programs its enacting. If anything, they have spent a great deal of time relaxing certain regulatory constraints on a temporary basis. Negative rates would be detrimental for the banks. 

2. Negative rates have no real practical success. We understand the models likely call for rates below zero right now. Look at the evidence globally. The economic results in countries that have deployed negative rates are poor. Furthermore, there is no strong argument that negative rates would help combat the fallout from Covid-19. We need to get people back to work. 

3. Between money market funds and bank reserves, roughly $8 Trillion would be impacted by negative rates. As the Fed flushes the banks with reserves through their purchase programs and investors seek safety in money market funds, adopting a negative rate policy would be counterproductive. 

Growth in overall money funds from 2000-2020; gov funds have led;

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4. Employment will determine where the global economy goes. Jobs will come back but we need to see a bottom. The Chairman’s assessment of bottoming in the next month and a half sounds aggressive. Similar to the fiscal programs in place, there continues to be a mindset of reopening within a set time period around many of the programs. We see inherent risk in that thinking. 

5. The Fed “put” is not over. But caution should be very and clearly in mind. This is a very different downturn. Clearly from late March, the Fed’s influence is clear. Very unlikely risk assets are where they are without the Fed. Even Warren Buffet acknowledged this much with deals that went away because of the Fed’s programs. Liquidity is winning short-term. 

S&P bottom, March 23, 2020 

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The Fed’s bazooka announcement on March 23, 2020, including credit facilities:

“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 FOMC had previously announced it would purchase at least $500 billion of Treasury securities and at least $200 billion of mortgage-backed securities. In addition, the FOMC will include purchases of agency commercial mortgage-backed securities in its agency mortgage-backed security purchases.

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 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 employees – the Primary Market Corporate Credit Facility for new bond and loan issuance and the secondary corporate credit facility to provide liquidity for outstanding corporate bonds.”

Negative rates are not a priority

The work from the Fed short-term has been about bringing previously announced programs online and live. It really hasn’t been about new tools at this point. Below is a look with links to some of the previously announced programs with recent updates from the New York Fed: 

Primary and secondary credit, including the beginning of ETF purchases

 Municipal liquidity facility

Terms Asset-backed loan facility

Repurchase operations (scaled back)

In the end, within the confines of the existing programs, the Fed has used a little over 40% of the money designated through the CARES Act. Powell indicated the Main Street Lending Facility would be up and running within a few weeks. 

 The market

Record week of Treasury supply with the quarterly refunding. There is still solid demand for Treasuries despite absolute yield levels. Nominal yields abroad, better funding levels and the uncertain global economic backdrop continue to support Treasury demand. The demand has been spread across the curve including a deluge of short end paper as well.

The Treasury’s general account

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The range in 10-years has been 55-80 basis points. Yet, that range is coiling within this very low rate environment. We are still in a highly uncertain environment. Today’s economic data a stark reminder. We are spending more time toward the lower end of the 10-year range with volatility close to the lows. Both equity and rate markets are in search of the next catalyst. 

10-year U.S. Treasuries

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BOA ICE Move Index

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S&P: nothing right, nothing wrong

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