To contain the economic and financial ramifications of the coronavirus pandemic, Central Banks are going all in. Jim Bianco, founder and chief strategist of Bianco Research, warns that this time, monetary policy might be unable to stop financial markets from collapsing.
The Federal Reserve brings out the bazooka: It cuts the federal funds rate down to zero and will buy $700 billion in Treasuries and mortgage-backed securities. Additionally, in a coordinated effort with five other major central banks, including the Swiss National Bank, the Fed opens swap lines to smooth out disruptions in overseas Dollar markets.
Still, financial markets seem unimpressed. Futures contracts on the S&P 500 dropped 5%, reaching a «limit down», while stock markets in Asia and Europe started the week with heavy losses.
For Jim Bianco, these actions are the Fed’s last stand: «This is one of the biggest moments of truth in financial market history. Will last week’s low in risk markets hold? If not, a new era in financial markets may be upon us», says the internationally renowned macro strategist from Chicago.
In an in-depth conversation with The Market/NZZ, he explains why Central Banks are going all in, what happens if risk assets drop further and why closing financial markets may be the only option left.
Mr. Bianco, the Federal Reserve takes massive emergency actions. What does this mean for financial markets?
The Central Banks went all in. They fired all of their ammunition and they’ve got only one goal in mind: They have to stop the decline in financial markets. This started late last week with the Fed’s giant repo operation. You can also throw in the announcements of the ECB and the Bank of Japan. Plus, we have the extraordinary actions taken by European governments to stem the effects of the pandemic. The government of Germany for instance is basically guaranteeing everybody’s job.
However, investors don’t seem convinced. What’s going to happen if markets drop further?
Central Banks need to stop the stock market from falling through last week's low. I believe if markets fall through those levels and keep going down, the so-called Fed Put is dead. It doesn’t work anymore, so quit trying to find new ways to exercise it. Just understand Einstein's definition of insanity: Doing the same thing over and over again, and expecting different results.
What are the ramifications if the Fed Put doesn’t work anymore?
Central Banks will need to move on. So if stocks make new lows we’re at a real risk of financial markets being closed. The Fed and other Central Banks have fired all their ammunition and if markets crash through last week's lows, there’s nothing left. The Fed can’t buy equities outright without a change of the Federal Reserve Act. It would take weeks for Congress to do that. Even if Congress moves with lightning speed it will take them at least a week, and it will be over before that.
What would be the benefit of closing markets?
It took the stock market sixteen trading days to drop by 27% from the all-time highs to Thursday's lows. We have never seen anything close to that in history. The closest we’ve ever been in history was 1929, when it took 42 days to get from the all-time highs to a 20% correction. The speed in this decline is unprecedented.
Why is it so important to stop this crash?
If it continues, you will get margin calls, involuntary liquidation. Markets will lose their ability to price securities, especially things like high yield bonds and emerging markets securities. Funds in those areas will be unavailable for people to redeem because they won’t have any prices. There will be trapped money. Also, you will get broken covenants in the corporate debt area, and that will force changes of control or restructurings. But the biggest damage will be that pensions will become underfunded. Companies will be forced to pony up billions of Dollars to get their pensions back into funding.
And how would it help if markets were closed?
At this point, we’ve shut down everything else to fight this pandemic. There's basically nothing else open right now. So why not close financial markets until we get a better handle at the extent of the damage? And then, we can reopen them and look at the possibility of proper pricing.
In the history of the United States, regulators closed the stock market only four times: 1914 when World War I started, during the bank holiday of 1933, after the Kennedy assassination in 1963 and after 9/11 in 2001.
There is still a possibility that what is happening now might work and we can hold the lows from last week. Then closing markets won’t be necessary. But I think Central Banks are thinking exactly the way I am. Their actions are saying: «We have to stop this now. There is no more time to debate, we are all in with everything now. If it doesn’t work now, we don’t care that we’re out of interest rates cuts, and we don’t care that we’ve already blown up the balance sheet.»
So did the Fed the right thing?
I’m going to give Central Banks an «A+» rating in what they have done so far in this crisis. If I was the Fed Chairman this is what I would do. But it looks like it might not work. So I can’t give Jay Powell an «F» because there’s nothing more he could have done than what he has already done. The Fed did the right thing, but in this environment, doing the right thing does not mean it will work. So that leaves one tool left should risk markets continue to fall through last week’s low: Close financial markets before they collapse.
There were also some issues with the Treasury market last week. What’s going on there?
The Treasury market became very dysfunctional in the second half of last week. It looked like all markets were being liquidated: You had stocks declining, bonds declining, commodities declining, gold declining, and you even had a US Dollar shortage since everybody was running into the Dollar. Everything was being liquidated. So the Fed, recognizing this problem, stepped in on Thursday afternoon with the announcement of $5 trillion of repo operations over the next month. On Friday alone, they offered $1 trillion in repo. To put that into perspective: We are talking about the size of QE1 – that was the first quantitative easing program in 2009 – done in one hour.
Yet markets still tanked on Friday initially.
Only $42 billion of the $1 trillion the Fed offered was taken. That’s because there is a myriad of regulations on banks that don’t allow them to leverage their balance sheets because that was the problem in 2008. So the banks can’t take the money that is offered by the Fed because of regulations. That’s why the Fed is engaging in quantitative easing now.
There are rumors about a large hedge fund or another big entity blowing up.
Yes, there are already storys of gigantic losses in the hedge fund community. BlueCrest, H2O, and Bridgewater have all lost around 20%. With market dislocations like this, no wonder there are rumors that somebody is in trouble. Let me tell you, if markets take out the lows of last week and keep going down, then we can start the rumor of who’s still solvent. That’s why they will have to close the markets.
Investment banks like Goldman Sachs predict that U.S. GDP will shrink 5% in Q2. Is this a realistic assumption?
I fear this might look optimistic in a few weeks. Yes, this pandemic-driven economic collapse will be temporary, one or two quarters, but the risk is very real that long-lasting damage is being done that will hamper the economy for years.
You’re been in the investment business for a long time and have seen quite a few crashes. How do you experience this crisis personally?
This is unlike anything we’ve seen in our lifetime. What’s going on in financial markets today exceeds the financial crisis of 2008, it exceeds 9/11, it exceeds the tech peak, and it exceeds the 1987 crash. Maybe 1929 is still bigger, but few of us were alive then. We’re writing a new chapter for American and world history textbooks. We’re only a few pages into it, and we’re not sure how it will end, but our grandchildren will one day learn school about the great pandemic of 2020 and what it meant for world history.