After three straight up weeks the markets corrected sharply on Thursday. An up-move in COVID-19 infections in some US states triggered worries about a second wave of the virus. Global equities moved broadly lower with only government bonds and precious metals acting as a safe harbors. It is telling that it doesn’t take much risk aversion to push bond yields towards the lows of this cycle. It wouldn’t take much more of a correction to see new lows on the 10-year, especially with the Fed promising to buy bonds as far as the eye can see (more below).
On the economic front there were three main news items
Jobless claims were less bad
In the week ending June 6, initial weekly unemployment claims came in at 1.52mm, a decrease of 357K from the previous week. This was actually slightly better than expected.
The Consumer Price Index fell 0.1% in May after falling 0.8% in April. Over the last 12 months the headline rate is up just 0.12%, as you can see below. If you strip out energy and food, the core rate is up 1.22%. Both numbers are obviously well below the Fed’s target of 2%.
The Fed will be really patient
All of this set the stage for the Fed meeting on Wednesday. No one expected any changes to policy, the focus was on how the Fed would communicate future changes. Well, they were pretty clear – they are going to keep the flood gates open for as long as it takes.
For example, the infamous dot plot showed no rate hikes until 2023 at the earliest. The chart below shows the dot plot from last December (blue dots) and the current forecast (white dots). No one on the Fed board thinks rates will move higher in 2020 or 2021, and only two see a rate hike in 2022.
Probably the best quote from a Fed Chairman in modern history came during Powell’s press conference:
“We’re not thinking about raising rates. We’re not even thinking about thinking about raising rates.”
Well, that is pretty clear.
He was also pretty clear that the Fed won’t tighten rates to deal with a possible equity bubble. He asked himself a rhetorical – ‘what would happen if we decided asset prices were too high and so we stopped providing support to an economy that still needs it?’ The implication is the Fed won’t turn restrictive until it is clear the economy is out of the woods – and we will only know that with some confidence when unemployment falls materially.
The other main point from the Fed meeting was that they would keep their quantitative easing machine running. They basically committed to the following for the foreseeable future:
1) Continue to buy $80bn/month of Treasury bonds.
2) They also committed to buy mortgage securities at a roughly $40bn/month pace.
3) And just to put a sprinkle on top they pledged to buy another $500mm of commercial mortgage securities.
Add it all up and you get $120.5bn of bond buys a month or close to $1.5tn a year. And this doesn’t include the asset purchases they announced to help calm the muni and corporate bond markets.
All of this adds up to a lot of juice, certainly for the markets, and maybe for the economy over time. One way to quantify it is shown below. JP Morgan takes the total of M2 money supply and institutional money fund balances and compares the current growth rate versus the 2008/2009 experience.
Bank Credit Analyst takes a different tact and charts cash balances as a percent of the U.S. stock market capitalization.
Either way there is no question the liquidity backdrop is exceptionally accommodative and will stay that way for at least another year.
Charts We Found Interesting
1. So why the big sell-off on Thursday? It is always hard to know why the markets do what they do hour-to-hour or day-to-day, but certainly fears of a ‘second wave’ are playing a roll. For example, the trend in infection rates in California is moving the wrong way.
2. At least for the time being this isn’t translating into rising hospitalization rates and stressed ICUs nationwide. But this is clearly at lagging indicator.
3. It is interesting to see how quickly some people are returning to restaurants. Apparently, the German’s are totally sick of cooking at home.
4. It is also striking how consumer spending is bouncing back. The chart below shows credit and debit card payment trends in the U.S. They are basically back to where they were pre-lockdown.
5. One consequence of all the liquidity sloshing around the system is a massive chase for yield. Money funds and CD’s pay basically nothing, so there has been a huge rush into corporate bonds. As a result, the yield on the investment grade bond index hit an all time low this week.
6. Have the markets run ahead of the fundamentals? We probably only know with the benefit of hindsight, but a note from Joe Weisenthal this week tackled the topic.
7. There is a long way to go until the elections in November, but the markets will soon start to focus on the possible election scenarios assuming no massive second wave of infections. Will history be made? Only Truman won re-election with a job approval rating of 45% or less.
8. At this point who would really be surprised.
Have a good weekend.
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