Another week, another bazooka announcement from the Fed, it seems, each one leaving the investor more bedazzled than before. The speed at which the free money printing press is being churned is astonishing. Friday jobless claims number showed another horrendous 6.6 million Americans filed for unemployment, making it a total of 16 million Americans that have lost their jobs in the last three weeks. It seems that the Fed was all too aware of this headline, and just moments after the headline was released it announced plans to inject another $2.3 trillion into the economy. Part of this announcement was to help Main Street business lending program be more efficient in lending to smaller businesses.
The real eye opener was that the Fed, as part of its corporate bond buying program, would now start buying high-yield Bonds, aka junk bonds.
On that news, the S&P 500 shot up towards 2800. After causing a massive squeeze in the Investment Grade Bond ETF (LQD) in the last few weeks, now the Fed was putting a floor under the riskier companies close to defaulting, i.e. offering to buy out the junk-rated companies. It seems the Fed is one by one adding all sorts of risk to its balance sheet without considering the burden of responsibility for the quality and inherent defaults that will ensue. So, what can it possibly buy next?
During the GFC in 2008, banks and proprietary trading desks were slapped on the wrists as the structures and Fed's liquidity permitted them to take too much risk with respect to their balance sheets. Regulations were put in place to make sure history did not repeat itself. However, it just manifested itself in other ways. That is the beauty of the financial system, it evolves and mutates like a very smart virus, always able to adapt and outsmart the current system.
Today, we are in a brave new world. The Fed has shown that companies, whether prudent or not, would be treated the same way -- i.e. always be cradled and bailed out by Momma Fed regardless of how responsible they have been. The last thing left for the Fed to buy is outright equities. Make no mistake, if the market retreats or retests its March lows, it is almost certain we will hear that announcement. Then it will be complete, we will be Japan.
As we surpass 2 million Covid-19 cases globally, the market rejoices on the global rate of new infections data showing early signs of slowing, at 53% week on week, vs. 95% week on week two weeks ago. It seems relieved that we may be past the peak. This dropping rate of change is what has helped the S&P 500 to grind higher, causing shorts to cover their bearish views. Of course, throwing trillions at the market via QE does not hurt either. It is as though the Fed is artificially trying to engineer the market to recapture its upward momentum trend, to then convince the algos and CTAs to rush and chase the market higher, creating a self-fulfilling prophecy.
Let's take a look at the U.S. Fed's balance sheet expansion. In just one month, the balance sheet has gone from $4.3 trillion to $6.08 trillion, an increase of $1.77 trillion. Although last week the Fed only increase its balance sheet from $5.811 trillion to $6.083, an increase of $272 billion, vs. the previous two weeks rate of change at around $600 billion. Is it conceivable that perhaps the Fed is slowing down its aggressive purchasing, as the S&P 500 veers towards 2800? Judging by the aggressive reaction on the Fed's part as the market hit certain levels, could the range be 2200 to 2800 for now until we see improvement economically?
We all know that QE does not produce growth, it just delays the inevitable problem and kicks the can further down the road. But does the Fed care? Not really, as long as asset prices are inflated and the S&P 500 hits new highs -- even if the real economy is suffering, as we will continue to see businesses shut down, jobs being lost, a serious recession in the U.S. and globally. The market is not the economy, it has never been and the Fed can continue with its lies to the general public. But at some point, as we enter earnings period, perhaps that fundamental reality check might cause equity prices to reconnect with their true valuations, despite the Fed's liquidity injections.
Another boost for the market has been the massive 40% rally in Brent oil prices, as the U.S., Saudi and Russia engineered a global oil production cut last week. After endless hours of virtual conference calls, the OPEC+ group agreed to cut output by 9.7 mbpd (about 300k bpd shy of the magic 10 mbpd number), as little Mexico decided to stand firm and agree only to cut 100k bpd as opposed to its 23% allocation amounting to a cut of 400k bpd. Who would have thought after getting Saudi and Russia to agree, that Mexico would cause the entire deal to be in jeopardy with its measly 400k bpd cut? After all they had been hedging smartly over the past few years, so it is entirely acceptable they should not have to pay the price for other countries' negligence. The U.S. said it would compensate for Mexico's 300k bpd shortfall, but that is in itself a hoax, as the U.S. cannot force any company to cut and Trump knows it.
As part of this cut, Saudi Arabia would be cutting its production by 2.5 mbpd, but in reality, that is only a real cut of 1.2 mbpd given they flooded the market by 3 mbpd in March. Russia agreed to cut up to 2.5 mbpd as well, which is down from their average of 11 mbpd. The group is quite cheeky to call this a 20 mbpd cut, if you take OPEC's inflated March production figures, assuming U.S., Brazil and Canada cut up to 5 mbpd and then the U.S. SPR purchasing about 2.5 mbpd.
Algebra is great on page, but these are far from reality. The 5 mbpd cut is dependent on lower oil prices as these are real shut-ins, not cuts. At the end of the day, there is an excess supply of 25-30 mbpd of oil in April and May, this cut of 9.7 mbpd will go far to resolve that problem. Now that the cut is decided, the bigger question is one of compliance -- can this group really be trusted? More importantly, can the economy come back in full swing like nothing ever happened? I think there will be a secular demand decline in oil, and it will take time for the global economy and people to start to travel and consume, no matter what the Fed has thrown at the problem.
For now, the focus remains on market technicals. Moving averages, by default, are "moving". The market is at make-or-break levels. Last week, we managed to hold onto the 2780 close, we need to see more days/weeks of regaining this weekly positive average to then allow for a positive move higher. If economic reality and earnings are bearish, that can give the bears enough ammunition to take the market back down and retest its 2600 level. Only time shall tell, but we have a curve ball (the Fed) that keeps throwing trillions at the market, buying riskier assets each time, as soon as a negative headline appears.