Over the last weeks almost everything in the world has been falling apart but the number of new coronavirus cases, deaths, and luckily recoveries - however not to the extent such as infections. The stock markets around the world have fallen into bear markets (more than 20% drop from the peak) - the S&P 500 at the fastest pace ever. The liquidity has been scarce or there has been none. This very important aspect has severely hit the credit markets as the costs of repaying debt as well as the spreads between yields of government and other lower-quality bonds considerably jumped. Furthermore, we are receiving more forecasts about the largest economy in the world, the United States, falling this year into a recession. There is also no much doubt out of the mainstream that we are currently going through a global recession. It has been partially confirmed by the major economic data releases (retail sales, industrial production, fixed investments) from China.
Due to all aforementioned factors, policymakers around the world are trying to calm the markets, prevent the rapid deterioration of the economy (in the areas less affected by the virus) and possible massive bankruptcies as many economic activities have suddenly stopped. Just to mention a few: tourism, airlines, cruise, cargos, oil, restaurants, arts and entertainment.
In my previous take, I highlighted some government measures (fiscal policy) in the United States, Australia, and the Eurozone. This time I will focus only on the Central Banks. In no case, it will be an exaggeration to say that we are witnessing the biggest, the most multidimensional and coordinated monetary policy intervention in the history of mankind. To give you the best perspective, I collected recent actions of the majority of Central Banks around the world which have been conducted across the course of March. See the table below:
As it was not enough, on Friday (March 13) Bank of Japan bought 101.4 billion yen ($940m) of exchange-traded funds and Australian Central Bank injected to the financial system A$8.8 billion ($5.5bn - the most amount in at least 7 years) in its open-market operations, and again A$5.9 billion ($3.6 billion) on Monday.
In Asia, also on Friday, Indonesia’s central bank bought 6 trillion rupiah ($405 million) worth of government bonds to prop up financial markets, adding to 8 trillion rupiah ($532 million) Thursday's purchases whereas the Reserve Bank of India has announced plans to add 250 billion rupees ($3.4 billion) injections through repo market after already conducted a $2 billion injection into the foreign exchange market.
MARKET REACTION
Considering all these activities let's make a quick review of the major trading assets keeping in mind that the Federal Reserve's actions should have the biggest impact.
In terms of the United States bond yields, it is not surprising that they all have been crashing starting from 1-month bill, ending at 30-year treasuries. It is worth noting that for a minute the 1-month bill has fallen below 0. Yes, for the first time the United States has officially visited the negative interest rates territory. Scary.
When you look at this table, does it make any sense to buy such low yielding bonds with very high volatility levels over the last weeks to protect your capital? Probably not.
On the stocks indexes front, it looks dramatic all over the world...
Watch it closely.
When we look at gold, we can see that after the initial 4% spike it has been dramatically sinking together with commodities and the US dollar index.
From the table in the middle of the graph silver is the asset which immediately catches the eye, cratering more than 12%. Lack of liquidity due to margin calls on leveraged positions by investors, hedge funds and other financial institutions or maybe Bullion Banks such as JP Morgan or UBS are shorting (betting on the fall) the paper contracts? It is definitely worth keeping in mind that during the last liquidity crisis Gold has dropped more than 30% before it has started its bull run. This time, however, we don't exactly know how it will play out.
SUMMARY
The Fed's recent Bazooka has left all major central banks around the world with no tools in the interest rates space (see also the first table).
As you can see on the chart, the cost of credit in the United States has been slashed to zero or the so-called zero bound because of the lower limit (0%) in the Fed's current target rate 0.00-0.25%. The only bullets they potentially have are massive money printing in order to buy assets on the market such as government and corporate bonds or exchange-traded funds expanding their balance sheets as well as some facilities which may help some banks to increase lending. However, they are not that effective as asset purchases (if there are still any effective tools), so I will not expand about them.
The above chart shows the Bank of Japan's value of balance sheet as % of GDP (white), Fed (blue), European Central Bank (pink) and Bank of England (orange). When we look at the chart we may conclude that the latter three mentioned central banks have still some space in terms of buying assets even though so many bullets have been already fired. The Federal Reserve Chairman Jerome Powell also said on Sunday night that they still have some ammo. Considering these potential factors, why the markets are again experiencing steep declines? Simply because markets do not believe anymore that any of these tools gonna work. This imposes a very high risk of closing stock exchanges for several weeks. Personally, I have no doubt about that. It can be even said that we came to the point where more central bankers' interventions intended to prevent, actually accelerate the plunge, increase the panic and massive distortions in the financial markets.
To sum it up. The performance of locked down economies can not be lifted using massive asset purchases or drastic rate cuts up until the pandemic will be contained or at least highly limited. Firing the majority of bullets has only caused a complete loss of confidence in the efficiency of the central bankers' toolkit even despite the historic global coordination. Having said that, a very important question arises. Is this the beginning of the end of modern central banking?
Thank you for reading. Take care
Seb
UPDATED CHART OF THE S&P 500 as of March 19 (morning trading)
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