If you think the Fed's going to fire hundreds of billions or trillions of dollars of "stimulus" rounds at the coronavirus crisis and pierce its grip on mankind, on the market, and on the economy, you're wrong.
This is an existential threat to humans, markets, and economies, which the Fed's ammo can't kill - but it sure can make it worse.
Here's what the Fed's doing, what it's going to do, why it won't work, how you'll know it's not working, and how it's going to make everything worse...[mmpazkzone name="in-story" network="9794" site="307044" id="137008" type="4"]
Bazookas and Moving Targets
Back in July 2008, as the financial crisis was heating up, then Treasury Secretary Hank Paulson asked the Senate Banking Committee for an unlimited amount of credit to rescue Fannie Mae and Freddie Mac, explaining, "If you've got a squirt gun in your pocket, you may have to take it out. If you've got a bazooka, and people know you've got it, you may not have to take it out. By increasing confidence, it will greatly reduce the likelihood it will ever be used."
Paulson got his bazooka but still had to run back to Congress two months later and beg for $700 billion more, this time to bail out Wall Street.
The U.S. Federal Reserve, on the other hand, doesn't have to go to Congress; it's got its own bazooka and an unlimited amount of ammunition.
It can "print" as much money as it wants without asking anyone for anything and fire its funds at will. It's already fired hundreds of billions of dollars at its primary target, the too-big-to-fail banks and financial institutions that feed the Wall Street moneymaking machine, and lately, again, money-losing machine.
On Tuesday, March 3, 2020, with bad news about the novel coronavirus infecting U.S. equity markets faster than its human infection rate, in a surprise move, the Fed cut the fed funds rate, the rate at which banks lend money overnight to each other, by 50 basis points, to a range of 1% to 1.25%.
On Wednesday, March 11, 2020, the Fed said it was increasing the amount of overnight lending it directly favors big banks with from $200 billion to $500 billion.
Then, on Thursday, March 12, 2020, in an official "Statement Regarding Treasury Reserve Management Purchases and Repurchase Operations," the Federal Reserve Bank of New York, the Fed's most important regional bank, where it conducts all of its open market operations (trading), announced it was upping the amount of short-term loan money it would make available to banks to $1.5 trillion.
"Term repo operations in large size have been added to enhance functioning of secured U.S. dollar funding markets," was the core message.
The New York trading desk would immediately offer $500 billion in three-month (term) loans that day, another $500 billion in three-month loans the next day, and another $500 billion in one-month loans to whoever wanted a shorter-term loan. Additionally, the bank's statement declared the term loans would be offered continuously on a weekly basis though month-end.
What the Fed's doing is flushing up its TBTF banks with "liquidity," meaning money they're tight on. Why are they tight? Because the money they should have available, their own liquidity reserves, are parked in accounts at regional Fed banks collecting interest.
Since the Fed's offering really cheap money loans (they just lowered the fed funds rate), term loans as a matter of fact, banks are borrowing from them and not pulling the $1.5 trillion in excess reserves they have parked and are collecting interest on.
If America's banks are in such great shape, which we've been told for years by the banks themselves, who keep making outsized, record profits and buying back their own shares, why do they have to borrow from the Fed like they're facing an existential threat?
They don't have to. But they can.
If they don't need the money, they're borrowing to trade. They're borrowing to buy Treasuries, which they lend overnight to each other as collateral for more loans, which they use to buy more Treasuries, which lowers yields, which makes interest rates a lot lower, which scares the public who think the "flight to safety" is a harbinger of horror to come.
This then prompts the Fed to cut more, which lowers rates, which, most importantly, increases the price of existing Treasuries, giving the banks a profit on their holdings and their Treasury trading.
See how the game works?
Are banks in trouble? Are they just being greedy? We don't know.
If they are in trouble, we're all in trouble - again.
Fed Rate Cut Trouble
After the extraordinary liquidity measures were announced by Brian Sack, who ran the New York Fed's markets desk from 2009 to 2012 and is now the director of economics at hedge fund manager D.E. Shaw group, said, "Financial markets are not functioning well, and the liquidity situation is evolving into something that necessitates a broader and stronger response by the Federal Reserve."
If they're really in trouble, maybe they're making money, courtesy of the Fed, to offset losses on their equity capitalization as their stock prices get hit in the market sell-off.
Either way, the Fed has no place paying big banks interest on their excess reserves. That's crooked. If big banks couldn't earn risk-free interest on their excess reserves, they'd have to lend them out to earn interest on that capital.
That's what banks should be doing with their excess reserves, lending them out in the economy and using them as reserves, not parking them for interest.
But I digress.
The reason the stock market fell on news that the Fed was cutting the fed funds rate 50 basis points is investors took the cut as bad news. Maybe the Fed knew something they didn't, maybe things were about to get worse.
The reason the stock market continued to fall - hard - after the Fed announced it was making $1.5 trillion available to banks, is if banks need that much money immediately, they're in trouble.
We don't know if they're in trouble or just being their usual greedy self-serving selves.
Either way, how's any of that confidence building? Firing the Fed's bazooka at banks has had the opposite effect.
And then there's the economy.
This time around, the Fed lowering rates and providing "stimulus" to the economy in the form of cheap money won't result in a "V-shaped" recovery.
The Fed admits as much itself.
In a November speech, Jerome Powell, chair of the Fed, discussed the risky situation that the Fed has put itself in as a result of lowering interest rates, saying, "This low interest rate environment may limit the ability of central banks to reduce policy interest rates enough to support the economy during a downturn."
The crux of Powell's speech was that interest rates are historically low, but not high enough for them to be lowered to help stimulate the economy out of a downturn.
The position that the Fed finds itself in today, in which it has artificially boosted the market by suppressing rates, means that it faces a risk in terms of its ability to be a lender of last resort and provide the economic stability that it was designed to provide.
So much for the Fed's "wealth effect."
The brings us to the looming recession...
Demand Destruction Leads to Recession
Recessions happen when consumer spending weakens, leaving companies with lower revenue and kicking off a dangerous cycle of job cuts, slowed purchase activity, and economic contraction.
The world's already seeing massive demand destruction from the coronavirus, with the United States only beginning to feel its impact. We're likely headed for a recession, probably a global recession, as consumer spending weakens for obvious reasons.
Goldman Sachs estimates 10% to 15% of U.S. GDP consists of services such as entertainment, restaurants, church services, and public transportation that would suffer if people limit interaction and avoid large gatherings. Goldman also estimates the disease will knock roughly three percentage points off annualized growth in the next quarter, with these demand-side effects accounting for almost half.
On top of demand destruction, the market tanking 25% in record time is killing the so-called "wealth effect," where people seeing equity markets soar feel richer and spend more. That can easily work in reverse.
What makes the coronavirus unique is that it's arriving on both the supply and demand fronts.
So-called "demand destruction" from China's quarantine orders represents a serious near-term threat, Morgan Stanley analysts wrote in a note last Friday, adding that consumer activity would sharply decline in the tourism, entertainment, and physical retail sectors.
Manufacturing activities "will have a much wider impact on the global economy via the spillover effects to global supply chains," said the team led by Chetan Ahya, chief economist at Morgan Stanley.
The Fed can't offset these effects, said Jan Hatzius, Goldman's chief economist. "If you're worried about catching a virus, you're not going to be persuaded to put yourself at risk because of small changes in your wealth or borrowing rates."
Lowering already low rates won't cushion the hit to demand when employees lose their jobs because of supply disruptions or consumers staying home, or when spending and investment retreats due to lower stock prices and uncertainty.
So, no, the Fed's bazooka won't work to stimulate the economy this time.
But it will make things worse.
This time, as goods and services become scarce on account of greatly reduced manufacturing and production, including in mining, agriculture, farming, and livestock production, prices are going to start rising.
This time, the Fed's helicopter money is going to trigger inflation. And when prices start rising for goods and services, when demand returns, as it will eventually, the Fed's not going to be able to control "real" rates.
What's going to happen then to all the companies who are addicted to cheap financing and have been able to roll over their excessive leveraged balance sheets is, they'll collapse.
Their lenders will suffer huge losses. Markets will convulse. And we'll see once and for all, the emperor has no clothes.
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About the Author
Shah Gilani boasts a financial pedigree unlike any other. He ran his first hedge fund in 1982 from his seat on the floor of the Chicago Board of Options Exchange. When options on the Standard & Poor's 100 began trading on March 11, 1983, Shah worked in "the pit" as a market maker.
The work he did laid the foundation for what would later become the VIX - to this day one of the most widely used indicators worldwide. After leaving Chicago to run the futures and options division of the British banking giant Lloyd's TSB, Shah moved up to Roosevelt & Cross Inc., an old-line New York boutique firm. There he originated and ran a packaged fixed-income trading desk, and established that company's "listed" and OTC trading desks.
Shah founded a second hedge fund in 1999, which he ran until 2003.
Shah's vast network of contacts includes the biggest players on Wall Street and in international finance. These contacts give him the real story - when others only get what the investment banks want them to see.
Today, as editor of Hyperdrive Portfolio, Shah presents his legion of subscribers with massive profit opportunities that result from paradigm shifts in the way we work, play, and live.
Shah is a frequent guest on CNBC, Forbes, and MarketWatch, and you can catch him every week on Fox Business's Varney & Co.