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The U.S. Federal Reserve warned Friday that the financial sector faces “significant” vulnerabilities due to the coronavirus pandemic, as businesses and households grapple with fragile finances for the foreseeable future.
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Friday’s report noted the financial stresses that could build if the crisis persists, and households and businesses continue to be deprived of wages and revenue.
In short, no one from hedge funds to major banks to households would be immune from the risk they might default on debt, be forced to sell off assets, end up in bankruptcy, or see the value of assets dwindle.
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... Fed Governor Lael Brainard ... highlighted a key worry at the central bank: that what might start as a cash crunch could spiral into something worse. Among highly indebted businesses, she said, “we will be monitoring closely for solvency stresses...which could increase the longer the Covid pandemic persists.”
Few if any parts of the economy are safe. ....
“Financial sector vulnerabilities are likely to be significant, in the near term,” the Fed said. “The strains on household and business balance sheets from the economic and financial shocks since March will likely create fragilities that last for some time.”
Kenneth Rogoff said:... As an analogy, the IMF or Chapter 11 bankruptcy is very good at dealing with a couple of countries or a couple of firms at a time. But just as the hospitals can’t handle all the Covid-19 patients showing up in the same week, neither can our bankruptcy system and neither can the international financial institutions.
So there are going to be phenomenal frictions coming out of this wave of bankruptcies, defaults. It’s probably going to be, at best, a U-shaped recovery. And I don’t know how long it’s going to take us to get back to the 2019 per capita GDP. I would say, looking at it now, five years would seem like a good outcome out of this.
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The monthly tally of defaults in the U.S. leveraged loan market has hit a six-year high, data from Fitch Ratings showed, as companies are either missing payments or filing for bankruptcy because of the fallout from the coronavirus pandemic.
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Banks are selling leveraged loans backing acquisitions at the fastest pace in months as they seek to shed risk accumulated prior to the pandemic.
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Analysts are more gloomy on the outlook for loans compared to junk bonds, which have seen spreads tighten about 190 basis points since the Federal Reserve’s historic pledge to buy some speculative-grade debt early last month.
UBS Group AG strategists wrote last week that the global leveraged loan market is vulnerable to a sell-off as earnings weaken and defaults stack up. They expect U.S. leveraged loan spreads to revisit March wides of 825bps from the 672bps level recently seen as default risk increases.
June 03, 2020
Federal Reserve Board announces an expansion in the number and type of entities eligible to directly use its Municipal Liquidity Facility
For release at 1:00 p.m. EDT
The Federal Reserve Board on Wednesday announced an expansion in the number and type of entities eligible to directly use its Municipal Liquidity Facility (MLF). Under the new terms, all U.S. states will be able to have at least two cities or counties eligible to directly issue notes to the MLF regardless of population. Governors of each state will also be able to designate two issuers in their jurisdictions whose revenues are generally derived from operating government activities (such as public transit, airports, toll facilities, and utilities) to be eligible to directly use the facility.
In addition to the expanded terms outlined above, the MLF continues to be directly open to U.S. states, the District of Columbia, U.S. cities with a population of at least 250,000 residents, U.S. counties with a population of at least 500,000 residents, and certain multistate entities.
The MLF was established under Section 13(3) of the Federal Reserve Act, with approval of the Treasury Secretary. It will offer up to $500 billion in lending to states and municipalities to help manage cash flow stresses caused by the coronavirus pandemic.
With highly questionable legality on top of a 100% certain moral hazard, here are the details of the Fed's new Secondary Market Corporate Credit Facility
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- The Facility will leverage the Treasury equity at 10 to 1 when acquiring corporate bonds of issuers that are investment grade at the time of purchase.
- The Facility will leverage its equity at 7 to 1 when acquiring corporate bonds of issuers that are rated below investment grade at the time of purchase and in a range between 3 to 1 and 7 to 1, depending on risk, when acquiring any other type of eligible asset.
I think we need a new name to properly explain what it really is: an asset price support mechanism.
Not only is the facility a legally questionable moral hazard, it is also nothing but an asset prices support system that keeps zombie corporations alive.
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This $74 billion decline in total assets during the week was powered by a plunge in repo balances and foreign central bank liquidity swaps, while some alphabet-soup programs also unwound. And the junk-bond and ETF buying program stalled.
And there is a big shift happening: The Fed has started lending to entities, including states and banks, under programs that channel funds into spending by states, municipalities, and businesses, rather than into the financial markets. These types of programs are propping up consumption – not asset prices. That’s a new thing. I don’t think the hyper-inflated markets, which have soared only because the Fed poured $3 trillion into them, are ready for this shift.
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Federal Reserve Chair Jerome Powell has likely heard it all about negative U.S. real yields: How they’re devastating for pensions and life insurers, causing equity valuations to outpace the economic recovery, encouraging a stampede into gold and out of the dollar and giving the green light for American companies to gorge on cheap debt once again.
The message he and his colleagues are likely to convey at their meeting this week: That’s all fine with us.
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Running Score
- Hard Lockdowns: Two Fed Presidents, Neel Kashkari (Minneapolis) and Charles Evans (Chicago) support hard lockdowns.
- More Free Money: Three Fed Presidents, Neel Kashkari (Minneapolis), Charles Evans (Chicago), and Thomas Barkin (Richmond) support more free money.
It is a certainly that all or nearly all the Fed presidents are in the Free Money group.
Kashkari, Evans, and Barkin have made it official.
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The dethroning of the dollar from its pandemic supremacy is changing the trading game across stocks, emerging markets and commodities.
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The dollar’s decline has also helped thrust gold onto center stage, since the two are considered to typically move in opposing directions. Though the relationship isn’t straightforward, the greenback’s descent as real yields plumb fresh lows is being met with outsize demand for gold.
Going forward, some investors are betting that bullion will prove a better haven than Treasuries as inflation bites ...
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Vaccine rollout and loose monetary policy will weigh on the U.S. dollar next year, with the currency at risk of falling 20%, Citi said in a note this week.
"When viable, widely distributed vaccines hit the market, we believe that this will catalyze the next leg lower in the structural USD downtrend we expect," Citi wrote. "Given this set-up, there is the potential for the dollar's losses to be front-loaded, with the USD potentially falling by as much as 20% in 2021."
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The Fed has now put on ice five of its SPVs (Special Purpose Vehicles) which had been designed back in March to bail out the bond market. It unwound its repo positions last June. Its foreign central bank liquidity swaps are now down to near-nothing except with the Swiss National Bank, which seems to have a need for dollars. The Fed has been adding to its pile of Treasury securities at the rate spelled out in its FOMC statements, thereby monetizing part of the US government debt. And it has been adding to its pile of Mortgage Backed Securities (MBS).
The result is that total assets on its weekly balance sheet through Wednesday, at $7.4 trillion, are roughly flat with the level in mid-December and are up by $200 billion from early June, with an average growth rate over the six-plus months of $30 billion a month.
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In response to a questions posed by Congressman Warren Davidson about whether “M2 [money supply] going up by 25% in one year” is going to “diminish the value of the U.S. dollar,” Powell responded, “there was a time when monetary policy aggregates were important determinants of inflation and that has not been the case for a long time.”
Powell added that “the correlation between different aggregates [like] M2 and inflation is just very, very low, and you see that now where inflation is at 1.4% for this year. Inflation dynamics evolve over time, but they don’t tend to change overnight.”
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