Daily Comment (April 9, 2020)

by Bill O’Grady, Thomas Wash, and Patrick Fearon-Hernandez, CFA

[Posted: 9:30 AM EDT]

It’s Holy Thursday in the time of COVID-19.  With financial markets closed tomorrow for Good Friday, our next report will be published on Monday, April 13.  From all of us at Confluence Investment Management, we wish you a Happy Easter and Passover.  Equity markets are taking a breather today after the recent rally (although the breaking announcement by the Fed to boost lending has reversed the downtrend—see below), while oil is up on hopes of an output reduction agreement.  Our Weekly Energy Update is available.  Claims remain historically elevated.  We update the COVID-19 news.  Here are the details:

COVID-19:  The official number of global cases is 1,496,055 with 89,435 fatalities and 336,780 recoveries.  Here is the FT chart:

Clearly, Spain and Italy are bending the curve.  The U.S. is accelerating at a slower pace.

The virus news:

  • One of the persistent questions we are getting is, “when is this done?” A recent NYT report offers four benchmarks that need to be met for the current measures to be reduced:
    • Hospitals need to be able to safely treat all patients without resorting to crisis standards of care. This wouldn’t mean COVID-19 cases would not continue but that treating them would become routine.
    • The government at all levels must be able to treat everyone with symptoms.
    • The government at all levels must have the ability to monitor confirmed cases and perform contact tracing. This may require some relaxation of privacy rules.
    • A state or region must have a sustained reduction in cases for 14 days.
    • In addition to these four conditions, we will need to see serological testing to see who has immunity.
    • And, it isn’t really under control until there is a vaccine.

Once the four benchmarks are reached, we should see gradual relaxation of social distancing measures.  Still, until herd immunity develops, we will likely see some continued modified social distancing measures, e.g., fewer restaurant tables, masks for those over 60 or with compromised immune systems, temperature testing at airports, etc.

The policy news:

  • BREAKING: The Fed announced it will purchase $2.3 trillion in new debt purchases which includes the government’s small business loans, municipals, mortgages, and, maybe, non-investment grade (yes, junk) bonds. Details are still sketchy, but the initial look is that this is yet another dramatic expansion of funding.  Apparently, the Fed is not planning on buying junk directly but the ETFs; this is a bit of a distinction without a difference.  We will be watching this going forward BUT THIS IS A BIG DEAL.  The Fed is getting deeper into the “weeds” of credit, increasing the odds that the bank will eventually take credit losses.  We have been watching the Fed’s balance sheet expansion with great interest; it is looking increasingly like it is trying to resolve the large private debt overhang (defined as household and non-financial corporate debt) by taking it on the public balance sheet.  The last time we witnessed this sort of public/private debt swap was WWII.  The alternative to dealing with this overhang is debt/deflation, which has become politically impossible.  The last 12 years of very low rates allowed the overhang to persist without triggering a downturn but also led to weak growth.  This debt swap may be the only way out, but there will be strings attached.
  • The Fed minutes held no real surprises, but did clearly show a high level of concern.
  • Europe continues to struggle to develop a response to the economic problems caused by the virus. It appears that the European Stability Mechanism (ESM), a body created during the 2010-11 Eurocrisis, will be the lending arm; Eurobonds look like a dead letter.  Apparently, northern European nations are open to lending out of the ESM but want “memorandums of understanding” that would put restrictions on borrowers.  This demand is toxic for southern Europe, a holdover of what Greece was required to accept during the Eurocrisis.  Thus, not much has been accomplished.
  • Congressional bickering over additional fiscal support is making headlines; the GOP wants a quick add to small business lending, while the Democrats want to add more money and other funding. Although much ink (or electrons) is spilt over this wrangling, this is rather normal.  We expect something to be passed in the next week or so.
  • The firehose of policy stimulus has a couple of caveats. First, using the banking system as a conduit has proven to be rather clunky.  Second, there is a surprising lack of oversight on both fiscal and monetary policy.  The lack of oversight at this stage opens up the potential for retroactive supervision years from now; you could see borrowers being questioned before Congress at some point.
  • A warning: the CFTC is reporting a surge in new scams involving complex derivatives. The common feature is high fees.

The economic news:

The market news:

The foreign policy news:

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