Larry Berman takes a look at yield curve control
The global cost of recovery from COVID-19 will likely be in the tens of trillions when the dust settles. There is no limit to the amount of support we will provide to combat COVID-19, a sentiment that has been echoed by just about every government worldwide. Global debt was already at a staggering 370 per cent of GDP combining personal, corporate, and government. The vast majority of this new support and subsequent promises and stimulus, will need to be monetized by central bank printing presses. They will likely do it in a similar way to what they did during WWII.
The New York Federal Reserve Bank released this paper to remind investors what happened.
"Fixing the level of Treasury yields endogenized the size of the System Open Market Account: the Fed had to buy whatever private investors did not want to hold at the fixed rates. As a result, the size of the Account increased from $2.25 billion at the end of 1941 to $24.26 billion at the end of 1945."
The size of the Federal Reserve balance sheet has exploded and it will never normalize again. They tried in 2018 and quickly had to reverse it. I’ve been discussing this concern for years in my BNN Bloomberg roadshows and on air. The world is awash in debt and the solution, for now, is yet more debt.
The financial world is fragile. These are not reasons to be bullish on growth. These are structural changes investors need to understand longer term implications. I will talk more about this on future episodes. I’ve said for years, I’ve been concerned about risk assets. Last year I noted that I was never more concerned in my near 35 years of observing markets.
Yield curve control will see the Federal Reserve peg interest rates. Now, they have been doing this since day one, but they have always only been able to control the overnight funding rates. Quantitative easing has been in play since the financial crisis of 2008-2009 where the Fed increased the size of its balance sheet to help market liquidity. The Fed bought longer-term government debt and mortgages. As of April 9, the Fed announced it is buying junk bonds: The worst quality of company debt we have.
If that’s a reason for any investor to be bullish on stocks, we have very different world views. That’s a reason to think the system we know is broken. It does not matter what the catalyst is or was (in this case, COVID-19), the message is that the leverage in the world is toxic. Low rates are toxic. But these themes are measured in years and decades, not days, weeks and months. I fear our leaders don’t get it.
EUROZONE and US YIELD CURVES
This current crisis raises many questions and has few answers. But the “safe” bond yield that makes up 30 to 70 per cent of most pension plans is, perhaps, permanently impaired. At least for a decade more, but I fear it cannot be resolved in our current system.
The checklist of what we are now faced with includes: The greatest pandemic the world has seen since the 1918 Spanish Flu, one of the greatest declines in oil demand ever seen, more intervention from central banks and governments, among many other pressures.
Investors need to understand what this means for their financial futures. I’m not trying it be an alarmist. I have solicited, and continue to solicit, counter-arguments as to why I’m wrong about the outlook. I’ve not heard any good ones. The next economic phase after this dramatic deflationary shock is a political shift to more extreme measures. We will have to pay for decades of largess at some point. We have a decade or more of stagflation ahead.
But there is good news, too, it’s not dire at all. The smart people of the world are developing technologies to improve our lives every day. Gene therapy, cloud computing that allows us to work from home and so on… There are themes to invest in. But I’m afraid that the next decade is going to be very difficult for pension funds and capital markets. There’s even talk the Fed will buy stocks soon. Tell me why that’s a good thing over a beer or something stronger. We need to have an adult conversation and come up with real solutions.
Be safe. Listen to the science. Good health to all.