Mnuchin's Bomb, Yellen's Call, and the Data Deluge: Let's Make Sense of It All

Major news -- both in markets and politics -- landed over the past week. First, on Thursday night, we heard that that Treasury Secretary Steven Mnuchin had informed the Federal Reserve that funding for several emergency lending programs would not be renewed. Essentially this means that the Fed's municipal and corporate bond buying facilities would subside at the end of the year. The second big news was President-elect Joe Biden naming Janet Yellen as his nominee for Treasury Secretary. I'll give my quick take on both, plus some observations on the deluge of economic data released on Wednesday. The End of the Fed's Bond Buying Facilities My honest reaction to the Mnuchin maneuver was disappointment, but not worry. The most likely outcome is nothing. Markets keep functioning as they have, credit spreads move wider or tighter based on fundamentals, but markets stay liquid and open. Most likely markets will discount any near-term economic weakness knowing that a vaccine is imminent and economic conditions could soon be back to normal. Unfortunately, we should not deny that this creates a tail risk that probably wasn't there before. I think that tail risk is very small, but it is there. Hence, why I'd say I'm disappointed. I don't see why this risk is worth taking. It is like taking off your seat belt just as you pull into your neighborhood. It's probably fine, but why take the risk? In Mnuchin's defense, it seems this decision was partially about convincing the GOP Senate to go along with a Covid-relief package. He seems to think that by pulling back money that had been allocated to the Fed, it will make some GOP Senators more inclined to support a new direct aid package. The Fed will only be returning $70 billion, but there was almost $500 billion earmarked for support of the Fed's programs. Indeed, on Friday Senate Majority Leader Mitch McConnell lauded Mnuchin's decision and suggested the money could be used for targeted stimulus. What Tools Are Left? Of all the impacted programs, the corporate and municipal facilities are probably the most meaningful. Once these programs expire, should one or both of those markets freeze, it will be more difficult for the Fed to directly act to restore normal functioning in those markets. This doesn't mean the Fed doesn't have tools to deal with a bout of illiquidity. In March, remember that the liquidity crunch began with huge mutual fund outflows combined with foreign investors repatriating dollars that had been invested in U.S. bonds. Market makers were overwhelmed by the selling and soon became reluctant to bid anything. Eventually this got exacerbated by leveraged real estate buyers getting hit with margin calls, which when combined with already balance sheet constrained dealers, left these forced sellers with few potential buyers. These special bond buying facilities got a lot of credit for restoring markets, and rightfully so. But the Fed also employed more traditional tactics, like buying Treasury bonds through quantitative easing, that were also highly impactful. By buying up huge chunks of Treasury bonds, the Fed was effectively freeing up balance sheet capacity at banks to allow for more normal customer trading. In addition, it also isn't completely clear the Fed needs any money from Treasury to jump into financial markets in an emergency. The Fed's rule 13(3) lending power is pretty broad. When the bevy of new liquidity facilities were announced in March, many Fed watchers believed the only reason Treasury money was being put into the programs at all was for political cover. It wasn't legally necessary. Now, I personally would assume that if the Fed wanted political cover in March, it'd want political cover in the next crisis, too. But I wouldn't assume such a thing would require congressional action. I could see something like the new administration offering legal advice that such programs are automatically backed by Treasury or some such. In a crisis, where there's a will, there's usually a way. Credit markets brushed off this news. High-yield traded mildly weaker on Friday but has rebounded this week. Municipal bonds have been strong for the last few weeks and didn't react at all to this news. Even the two issuers that tapped the Fed's muni program (State of Illinois and New York Mass Transit Authority) have continued to rally this week. Yellen to Treasury Speaking of the next administration, Janet Yellen's nomination as Treasury Secretary should be comforting to investors on several fronts. First, it tells us something important about President-elect Joe Biden's economic priorities. By picking an economist, Biden is showing us that he's mostly concerned with growing the economy and getting it back to full employment. Not only are those issues right in Yellen's wheelhouse as a researcher, but she can play a crucial role as an advocate. In contrast to all the other Biden advisers who have officially been named, Yellen has a very public profile. When she advocates for fiscal stimulus, it will take on a different tone than had Biden picked some career partisan. Yellen is respected on Capitol Hill, however begrudgingly, and therefore may be the best advocate for expanded fiscal policy measures that Biden could have picked. Yellen is respected on Capitol Hill, however begrudgingly, and therefore may be the best advocate for expanded fiscal policy measures. In terms of the prior section, Yellen would obviously bring a new level of Treasury/Fed cooperation. This is something of a call-back to President Barack Obama selecting Tim Geithner as Treasury Secretary during the Great Financial Crisis. In a moment of crisis, bring on someone who has all the relationships -- and knows where all the bodies are buried.. Wednesday's Economic Data The shocking +33.1% gross domestic product number will undoubtedly be the headline from Wednesday's economic data dump. That isn't, however, really news. We knew 3Q GDP was going to be massively large after 2Q's huge decline. Of the more forward-looking data we got, it was a mixed bag. On the good side, durable goods orders were very strong. This is an important statistic at this point in the cycle, since it indicates orders by firms for long-lasting equipment. Ergo it is a good gauge of company sentiment about the intermediate-term outlook. On both a headline and excluding transportation, Orders were better than forecast and the prior estimate was revised up. All good signs that 4Q is off to a strong start. On the negative side, initial jobless claims (IJC) ticked up. I've downplayed the importance of IJC during this cycle, primarily because continued elevated claims doesn't foot with all other indicators that suggest the labor market is improving rapidly. I stand by that view. But we do need to be on the lookout for how the most recent surge in Covid cases will effect employment. Last week, 30,000 more people filed a new unemployment claim (778,000 vs. 748,000). That could be a sign that Covid-impacted industries are laying people off. It also could be noise. I'm waiting for more evidence before drawing any conclusion. To me, the strength of durables is much more important than weakness in claims. With several promising Covid vaccines on the horizon, any slowdown in employment due strictly to new health restrictions will be short-lived. Right now it is important to look to statistics that give us clues to how strong the post-vaccine economy will be. On this front, durables is a very good sign.

Mnuchin's Bomb, Yellen's Call, and the Data Deluge: Let's Make Sense of It All

Big headlines dropped this past week, including that funding for several emergency lending programs would not be renewed. Here, I'll sort it all out.

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