When one looks past at history and the various Fed chairs, one can tip their hat to the likes of Ben Bernanke and Alan Greenspan, pioneers in their own right. But over the years, as the Fed has embarked on this free money printing spree to buy up risky assets, we have said goodbye to free market capitalism forever.
The years 2007 and 2008 were exceptional times and the amount of leverage built up in the system, together with toxic asset exposure, caused a rumble to epic proportions that blew out risk across financial institutions. Central banks, and especially the Fed with its rampant Quantitative Easing and slashing of interest rates, saved the world from utter collapse.
But lessons were not learned, as debt was used to save the world. The cardinal rule of using this strategy is that as things get better, it is prudent to pay back that debt in good times, and normalize interest rates so that they can prepare for another rainy day.
And what did they do instead? They took the balance sheet from $1.5 trillion to highs of $4.5 trillion and after rates fell down to 0.5%, they could only raise them to about 2.5% before the system started shaking again in 2018, like an old car about to conk off. The S&P 500 is up 400% since lows of March 2009, and the Fed cannot even bring its balance sheet or interest rates to a more "normal" level during a healthy economic cycle. Shocking.
U.S. Fed Chair Powell started off his career with envy as he stuck to the original Fed policy, doing the right thing, normalizing balance sheet and interest rates as is the job of the Fed. Instead he got taunted by a bullying President, and every time markets fell by 5%, he would flip flop on his policy and give the market the fix it was screaming for.
When the markets fell 10% and repo crisis took place, Powell came out guns blazing with non-QE Quantitative Easing (oh but let's not call it that as it is a taboo), and the U.S. Fed expanded its balance sheet by $500 billion in a matter of three months and embarked on open ended daily repo operations that the banks needed, not asking why, but just giving into the daily $50 billion - $100 billion demands. Quite worrying that after the Fed reiterated it was just a "quarter/year-end plumbing issue," in September 2019, they kept it on through April 2020. that does not sound like a healthy market to me in any way. But hey, as they say, don't fight the Fed.
Last night, we heard Powell exclaim, "The fundamentals remain strong, unemployment is at half century lows, wages are rising, and pace of job gains solid." The statement, and the Fed, remain a joke as last week everything was hunky dory, yet this week they come out and do an emergency rate cut of 50 bps? Last time an emergency rate cut was done was back in 2008, when there was a serious crisis, Lehman Brothers and AIG were blowing up, with drastic repercussions to our financial system as we knew it. Today, what is the emergency? A virus that will potentially die down in the next few weeks as Spring approaches, or that the markets fell 15% in a straight line and spooked the Fed, and the President.
Let's call a spade a spade. This Fed is entirely clueless. They do not know how to fix the problem, nor do they understand the problem. They only know how to do one thing, print more money! As the old adage goes, "when the Fed panics, the market panics more."
That is what happened yesterday, as the emergency rate cut did nothing to bolster confidence, instead it caused even more selling across equities. The problem lies in the U.S. bond market. It is not the coronavirus per se, although that helped in tipping the scales in the direction it was leaning towards anyway. U.S. bond yields have been cratering for the past month, and have been screaming deflation and lower rates for some time. Equities ignored this as the Fed was pouring in daily liquidity, which propped up the U.S. market. Anyone who says it was fundamentals is not being truthful.
The extent of the volatility in the U.S. bond market is incredible. The 10-year yields went from 1.6% at the start of February to close at 0.93% last night -- below 1%. We are writing history here. Plus, it went from 1.09%, to 1.17%, back to 1.05%, to then breaking 1%. This sort of volatility is not healthy, as VAR (value at risk) at banks, pension funds and institutions all would be screaming system failure. The speed at which the S&P 500 fell last week, down 15% at one point to then rally 5% the next day, is the fastest sell off since the 1930s.
Markets are broken and trying to figure out their next move -- either back to highs or breaking lower, this time much more ugly.
Every central bank in the world is cutting rates. China is pumping massive amounts of liquidity to bolster economic growth and the ECB and BOE are expected to cut as well. It is and will be a coordinated effort no doubt. It is tempting to call the bottom, but when such volumes and moves occur in a short span of time, the next week or so can be extremely risky as institutions try to square off risk and margin calls. There will be a time to buy, but it is worth being on the sidelines in cash awaiting an entry point as and when things settle down.
If bond markets are correct, they are showing extreme stress and deflation in the system. Only one thing can save the market here. Not rate cuts, but quantitative easing, buying up risky assets, yet again. It is a shame the Fed is starting today with a balance sheet close to highs of $4.18 trillion and rates only around 1.75%; much less ammunition than back in 2008. Whatever will they do when another event happens next time around? I suppose it is just paper, so might as well keep printing it and keep the world swimming in debt.
The S&P 500 bounced off its extreme oversold level of 2860 to hit the first 50% retracement bounce off Fibonacci levels at 3050. We will need to retest lows to see if the rally is sustainable. Most traders these days have a life span of 10 years and just know how to "buy the dip", and so probably do not remember what happened back then. In 2008, the market also fell following the first rate cut, as things had just started getting bad. We broke 3000 yesterday after the Fed press conference and it remains to be seen where it goes next. Value goes out the door when looking at derisking and leverage unwinding. There are trillions and trillions of derivative instruments in the market linked to various asset classes in complex structures, so it is impossible to ascertain how it plays out in the near term.
If you are long-term investor, there are great opportunities to buy and just switch your screens off and come back one year from now, if you can hold on. The key is to look at the U.S. bond market and what happens to yields. The fate of Oil, Copper, Commodities, Equities etc., all lie in the hands of their more sophisticated brethren.
It always has.