Are you, like me, still appalled at how low the 10-year U.S. Treasury yield has plunged? Well, we shouldn't be. Because the Federal Reserve could soon be buying no matter the price.
It makes perfect sense in the wake of the historic inter-meeting rate cut last week. The Fed could have fought the market, said no, the plunge in rates can be fixed with a Coronavirus Marshall Plan, don't look to us for that. Instead, they slashed rates by half a point--in a growing economy and booming labor market! They left the fed-funds rate at 1% (okay, 1.1% technically) and now the market wants that cut to 0.5% next week and there's no sign of central bank resistance.
So it doesn't take a genius to realize what's coming next. The Fed has only a half-point rate cut left after the March meeting if they do what the market's demanding. Which means we are just a couple of Fed meetings and/or a slowdown away from what comes after that--namely, QE (quantitative easing). Yes, we'll be right back to massive Fed bond-buying.
Unless the Fed skips that step this time around and starts buying equities instead!
Boston Fed President Eric Rosengren talked openly about this in a speech he gave on Friday. Musing on what the Fed's next steps could be after hitting zero on rates, he rejected going to negative rates which, he warned, would destroy the banks and "poorly position an economy to recover from a downturn."
As for QE in the classic form of buying Treasuries, Rosengren noted that since the 10-year yield is already lower than the overnight fed-funds rate, it's not clear what the point of buying more of them would be. (Take note, those buying the 10-year here assuming the Fed will come in as the buyer of last resort.)
Which leaves the Fed with what options, exactly, to fight a recession? Rosengren: "In such a case...we should allow the central bank to purchase a broader range of securities or assets." Boom. It's almost enough to make you want to own stocks, right? And sure enough, the Dow closed down "only" 250 points on Friday, after earlier being down almost 900.
What would happen in a world where the Fed started buying the S&P 500? What would price discovery look like when the Fed and index funds together owned more than half of any given company? What about liquidity, which we've already seen shrivel in government bond markets thanks to central bank buying?
I'm not saying the Fed's next step is definitely buying stocks, because they may come up with some "solution" in the Treasury or bond market first, or go the cheap loan route like Europe with its (ineffective) Targeted Longer Term Refinancing Operations. And yes, Congress would need to give approval. I'm just saying it's a real possibility, and a closer one now than I'd ever thought it would be barring another deep recession.
The Fed has painted itself into a corner with last week's emergency rate cut. And its only way out is to further enmesh itself into the U.S. economy at best, and to undermine our economic efficiency at worst.
In fairness, Rosengren hinted at this by saying "the obvious alternative to monetary policy in a downturn" is fiscal policy. Yes! And there were hints over the weekend that the White House may be considering "suspending late fees, instituting low-interest loans for some businesses, and pushing loan modifications," per Politico.
Let's hope something big like that is coming. (And not some generalized "shovel-ready infrastructure plan" that would do nothing to solve this particular crisis.) Better late than never! Especially with so much at stake.
See you at 1 p.m!
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