The Fed is throwing all of its fire power at markets, and yet interest rates continue to rise, a troubling sign when the economy looks set to slow down dramatically.
Markets continue to swing violently with the Dow losing another 6.2% Wednesday; oil plunging 24%, and copper down about 7%. The credit markets continue to function poorly, and the usually steady, safe haven Treasury market has been extremely volatile.
In times of stress, rates in the Treasury market, which move opposite price, usually fall. Rising rates could increase borrowing costs for all kinds of loans for businesses and individuals .The credit and rates markets also are the direct target of the Fed’s stimulus programs.
“Certainly, yields are running counter to the Fed’s wishes. They’re trying to bring rates down to zero along the curve, like the fed funds, but it’s not working,” said Chris Rupkey, chief financial economist at MUFG Union Bank.
As the Fed battles the credit crunch with monetary policy, the White House is pushing for a big fiscal stimulus package to help the economy and individuals that would total about $1.2 trillion, according to Treasury Secretary Steven Mnuchin.
“The market is reflecting fear about the spending for these programs … another $1 trillion. Who is going to finance the other $1 trillion this year?” said Rupkey.
All around the world, governments are increasing spending to battle the economic impact of the virus and that means a lot more debt — and higher interest rates. The U.S. already faces a $1 trillion budget deficit.
Strategists say the Fed has to do more, and new programs may be needed to deal with the illiquidity in the Treasury market. Broadly, the Fed is trying to fix credit markets and get them to perform normally, but just the benchmark 10-year Treasury alone had a wild day, on top of a wild day Tuesday. The 10-year is closely watched since it influences so many lending rates, including home mortgages.
“[Tuesday] was the biggest move in the 10-year since the Volcker era,” said Michael Schumacher, director of rates strategy at Wells Fargo. “It went from 0.72% to a peak of 1.09% to close at 1.08% … It was just as volatile today and was all over the place …The correlation between stocks and bonds in the U.S. is warped.” In late afternoon trading on Wednesday, the 10-year yield was at a high 1.25% and the low was less than 1%. It was at 1.20% in late day trading.
“There really has not been an effective safe haven for a couple days. You can’t go to gold and you can’t go to Treasurys,” said Schumacher. “It’s pretty clear central banks are doing what they have to do all around the world. It’s the [fiscal] stimulus thing that is key.”
The Fed has been aggressively announcing programs, and on Sunday slashed its fed funds target rate range to 0% to 0.25%. It has also repeatedly increased liquidity in the repo market; added a facility for commercial paper and said it would buy $500 billion in Treasurys. It has also opened swap lines with other central banks to make dollars more available.
As the Fed has moved, government and business have taken action to prevent the spread of the virus, and those actions have taken a bigger and bigger toll on the economy.
“We keep marking it down with each new disclosure of business and industry,” said Rupkey. “You could pencil in negative 8% growth in the second quarter. We had one quarter in the early 1980s, with an 8% decline when Jimmy Carter told Americans to put away their credit cards, and for some reason they did. Then we had the Lehman one, 8.4% decline in the fourth quarter of 2008.”
In this slowdown, the decline could be short and swift. The hit to the restaurant sector alone is large and the industry says it could lose 5 million to 7 million jobs alone, he said. President Donald Trump has advised Americans against going to bars and restaurants and some states, like New York, Connecticut and New Jersey, have mandated closures.
Rupkey said he expects Treasury yields to ultimately settle down. “I don’t think they’re going to keep rising. The markets are unsettled to put it mildly … prices are just sloshing around, up and down, you don’t want to hold the market to any one day’s price. Look at it again in a week,” said Rupkey. “I think fair value is around 0.75%” on the 10-year yield.
Another issue driving Treasury rates higher is the rush to raise cash. “People have to raise cash … I would say there’s a liquidity aspect of being able to sell what you can sell to raise cash because cash is king and it is creating an exaggerated move in the Treasury market,” said Jim Caron, fixed income portfolio manager at Morgan Stanley Investment Management.
Institutions and companies globally are looking for dollars to meet their dollar funding requirements and that has triggered more sales of Treasurys. The dollar index has shot up from about 95 on March 9 to 101.23 on Wednesday, Many companies have drawn on credit lines so they are not cash short during the downturn and that has strained markets.
“The Fed is buying a lot of Treasurys at a very rapid pace right now. They’ve said they’re going to be buying $500 billion, but in the last four days they’ve bought $160 billion,” said Mark Cabana, head of U.S. short-rate strategy at Bank of America. “That’s a very rapid pace and the bond is selling off right now and it’s 25 basis points higher. This tells you even though the Fed has done a lot, they have to do more.”
Cabana said the Fed could help markets by buying a broader array of financial assets, including corporate bonds.
Rupkey said the Fed and Treasury perhaps could find a way, with a rule change to allow the Fed to buy some new securities issued by the Treasury to fund the stimulus program, which must be approved by Congress.
“It’s kind of heresy. It’s not the traditional thinking,” said Rupkey. “It has been tried by the Bank of Japan. The question is would it work. … At this stage, we’re just trying to keep the downturn from accelerating as millions are going to get laid off from the corona virus. The shuttering of business, especially restaurants and bars. It would be almost patriotic for the Fed to do that at this point. … I guess you can take all your economic theory and throw it out the window. “