Pro Perspectives 4/28/20

April 28, 2020

The Fed meets tomorrow (virtually).  This meeting should be a review of their ‘whatever it takes’ response of the past two months. 
And it has been a busy couple of months. 

What have they done? 

In a world where revenues and incomes abruptly went to zero, for many, the Fed quickly and decisively resolved what was very likely to be a cascade of insolvencies. 

They did it by flooding the world with liquidity.  In addition to slashing rates to zero, they quickly backstopped the banks (no need to run and take money out of the bank).  They fixed the Treasury market (averting the threat of capital flight from what has been historically the world’s safest investment/ parking place for capital).  They fixed the corporate bond market (averting mass bankruptcies).  They provided access to U.S. dollars for global banks (where global credit was beginning to freeze).  They’ve kept mortgage markets moving (stabilizing the housing market – new buys and refinancing). They’ve kept the municipal bond markets functioning (keeping local and state government debt servicable and accessible). 

How did they do it?  By becoming the buyer of last resort – by threats and by action. 

When a buyer steps into the market with the ability and promise to by unlimited amounts, with money they can create with a keystroke, it tends to resolve fears for those market participants that are natural buyers in those markets, and it tends to invoke fear in those market participants that have been betting against those markets (speculators run for the exits).  

This playbook was written by Mario Draghi (ECB chief) in 2012.  Yields on Spanish and Italian sovereign debt had skyrocketed to unsustainable levels, which put two of the biggest countries in the eurozone on default watch, which threatened more dominoes to fall, and a collapse of the euro (the monetary system).  It was an ominous moment.  But Draghi threatened to do ‘whatever it takes.’ He threatened to buy unlimited Italian and Spanish debt.  Here’s what happened to yields on Spanish bonds …

Draghi’s threat put in the top for yields, without the ECB having to buy a single bond.  Within two years, yields on Spanish debt fell from almost 8% to 1%.  A European collapse was averted. 

With this in mind, as people continue to debate who will be/should be “bailed out” and who will not/should not be, keep in mind that Jay Powell has already stepped over the line.  When the line was crossed, the Fed became a buyer of anything and everything necessary to bridge the economy back to it’s pre-virus existence.  For that reason, it’s hard to see a scenario where companies that were adding value to the economy two months ago, are forced to take the path of bankruptcy. 

If you listen to earnings calls of the past couple of weeks, the common theme has been raising cash, by drawing down credit lines and new debt issuance.  And one after another, the reporting companies seem to be having no problem finding buyers for new debt.