The massive emergency easing measures enacted by the Fed over the weekend to inject liquidity into the global financial system are a sign of sheer panic. Both their sheer scale, and radical extent—including cutting rates to zero, $700 billion in new QE, and eliminating reserve requirements for U.S. banks—speak vividly to the gravity of the situation financial markets are now facing.
We are on the brink of total collapse. Monday’s violent negative market reaction—surely the opposite of that which Chair Jerome Powell hoped for—also confirms this.
Yet, like a tsunami visible first on a distant horizon, this economic maelstrom has been looming for quite some time. As we have argued repeatedly, the crisis most likely started on the 16th of September, 2019, within the repo-markets. The Coronavirus was only the trigger, and now a convenient excuse, for emerging—and unfortunately very real—economic calamity.
We have published a report, Prepper’s Bunker: Coronavirus update, where we detail how investors, corporations and households can prepare for the crisis. We have also made our scenario forecasts on the economic impact of the pandemic freely downloadable. We urge everyone to check them.
But how bad is the situation in the financial markets now?
The beginning (and the end)
There have been at least four recent market bailout operations enacted by the central banks during the last two and a half years.
The BoJ and the PBoC calmed the run on junk bond ETFs in November 2017. The ECB cleared the European corporate markets after they become clogged in March 2018. The PBoC and the Fed bailed-out the credit and stock markets at the turn of the New Year in 2018/2019.
On September 17th, 2019, the Fed enacted a bailout of the repo-markets, which is still very much ongoing. Just yesterday, the Fed provided almost $130 billion worth of liquidity to the repo-markets. And now, the FRA-OIS spread has started to shoot up, indicating that stress in the inter-bank markets is building rapidly.
These all contribute to the same conclusion: financial markets are extremely stressed.
The Credit market is THE ISSUE
The main problem is presented in Figure 1. Yields in the credit markets (especially in high yield) are spiking aggressively. As the Federal Reserve cannot—at least not yet—buy corporate bonds or common stock, it does not have a direct way to affect rates there.
This issue is aggravated by the fact that in many countries, as in the U.S., corporate debt is at record highs (see Figure 2), and that capital markets, not banks, are now responsible for a considerably higher share of corporate financing than prior to the 2008 crisis. This, quite simply, means that if and when the credit markets go, we all go with them.
We are in a deep hole
The simple and ominous reality is that no amount of central bank induced artificial liquidity can alleviate the impact of the coronavirus on the real economy.
It also follows that no amount of central bank liquidity can stop the stock and credit markets from falling, when the real economy and corporate earnings sour, as is now happening.
It is completely unfathomable to us and will almost certainly be condemned by future economic historians as to why global central banks, led by the U.S. Federal Reserve, first chose endless monetary stimulation and then to exhaust all their traditional monetary stimulus options to uphold the now-collapsing expansion. They fomented an incomprehensibly-large financial bubble that is now imploding before our eyes.
For three years, we’ve been warning that the world economy is desperately fragile. Few have heeded our warnings. Now the chickens have come home to roost.
God help us all.
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