‘Difficult Tradeoffs’

Markets were displeased for most of Monday, as US lawmakers struggled to come to an agreement on $2 trillion in stimulus for a US economy that, by almost all accounts, is about to drive straight through a “closed road” sign and crash into a depression, Clark Griswold style.

Democrats rejected Mitch McConnell’s plan for a second time in a vote Chuck Schumer called “irrelevant” as he negotiates “continuously” with Steve Mnuchin. The two men were close to an agreement as of Monday afternoon.

There was no deal before the second vote, and McConnell apparently knew it, but he went ahead anyway, seizing an opportunity to make it appear as though Democrats were needlessly obstructing an honest GOP effort to move forward with badly-needed virus relief.  The New York Times describes the scene:

The normally staid Senate dissolved into shouting and partisan bickering before the vote, as senators sparred over the huge government rescue package.

At the heart of the impasse in the Senate is a $425 billion fund created by the bill that the Federal Reserve could leverage for loans to assist broad groups of distressed companies, and an additional $75 billion it would provide for industry-specific loans. Democrats have raised concerns that the funds do not have rules for transparency or enough guardrails to make sure companies do not use the funds to enrich themselves or take government money and lay off workers. They also argue the measure would give Mr. Mnuchin too much discretion to decide which companies receive the funds, calling the proposal a “slush fund” for the administration.

Among other contentious issues was a lack of disclosure requirements related to loans and what Democrats suggest are loopholes that, in theory anyway, could allow Trump’s real estate businesses to benefit from federal COVID-19 funds.

Complicating matters further is a different version of the rescue plan floated in the House by Nancy Pelosi. “The Senate Republicans’ bill, as presented, put corporations first, not workers and families”, she said, in statement, insisting that her bill “takes responsibility for the health, wages and well-being of America’s workers”.

“The House measure would fund hospitals’ virus response and would call for the president to use the Defense Production Act to shore up critical supplies”, Bloomberg notes. “It would also increase funds for schools, food assistance and to help states expand early and absentee voting”.

Obviously, the bills would have to be reconciled before they could be sent to Trump’s desk.

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And speaking of reconciliation, investors understandably struggled to reconcile this latest bout of intractable partisan bickering (which clearly suggests that, even in the face of a veritable viral apocalypse which has literally infected members of Congress, US lawmakers still cannot muster any semblance of bipartisanship in the name of expediency) with the overtly bullish message emanating from the Fed.

Jerome Powell on Monday essentially offered to backstop everything from the broken Treasury market to illiquid corporate credit to IG ETFs to student loan ABS. Long story short, if it’s on your books and it can be even loosely described as investment grade, the Fed will either loan you cheap money against it, or buy it from you outright.

Read more: The Fed’s ‘Shock And Awe’ Part II- Open-Ended QE, Corporate Bond Buying, Credit ETF Purchases And More

The Fed’s corporate bond buying program (and specifically the inclusion of ETFs) was enough to send LQD to its best day since the last crisis. The vehicle was up more than 7%.

And not a moment too soon. Last week, LQD plunged and the discount to NAV was becoming wholly untenable.

If you’re wondering what ultimately caused the $2 billion+ AlphaCentric Income Opportunities fund to drop ~27% in two days on Thursday and Friday (I wrote about that on Sunday here), we now have the answer. Here, for those who missed it, is the chart:

“A cluster of funds that own mortgage bonds sought to sell billions in assets to meet investor redemptions, sparking pleas for government intervention”, Bloomberg reported, adding that “the sales included at least $1.25 billion of securities being listed by the AlphaCentric Income Opportunities Fund [which] sought buyers for a swath of bonds backed primarily by private-label mortgages as it sought to raise cash”.

That speaks to just how acute things are, and why the Fed felt compelled to step in again with its most aggressive raft of measures yet.

Treasurys bull-flattened Monday, as a long-end selloff sparked by Steve Mnuchin’s comments about selling “a lot” of debt to fund stimulus was muted both by the delay on Capitol Hill and the Fed’s promise to buy unlimited amounts of debt.

Stocks ended lower, extending losses from last week, during which the S&P suffered its largest one-week decline since 2008.

Systematic selling is largely behind us, and it’s worth noting that what was a massive asset manager long has been sharply pared amid the rout.

“After the standard ‘first-mover’ equities deleveraging out of the systematic community over the past two months, the concern then turned to the traditional asset manager base as the most-likely source of funds for further capitulatory selling, especially after building what was a 100th %ile notional long in US equities futures just 1.5 months ago”, Nomura’s Charlie McElligott said Monday.

(Nomura)

“Unfortunately, our concerns were realized, as asset managers have been a one-way capitulatory/redemption flow out of US equities ever since, selling $165 billion of futures across SPX/NDX/RTY in the past month alone”, Charlie went on to say.

Again, it’s possible to adopt a more constructive outlook on stocks going forward, assuming Congress can pass legislation and containment measures can, at the least, prevent a viral nightmare scenario where the US morphs into a giant version of Italy. A huge rebalancing flow into stocks “should” be in the offing, and, again, systematic funds are more likely to be buyers going forward after an epic de-leveraging/purge into the worst VaR shock since Lehman.

And yet, Larry Kudlow seemed to hint on Monday that the administration is, in fact, leaning in the direction of trying to ramp the economy back up, the advice of medical professionals be damned. “We can’t shut the economy”, he told Fox. “The president is right”, Kudlow added, referencing an all-caps tweet from Trump. “The cure can’t be worse than the disease and we’re gonna have to make some difficult tradeoffs”.

To be clear, when Larry says “tradeoffs” he is referring to people’s lives versus the economy.

“President Trump is weighing calls from some Republican lawmakers and White House advisers to scale back steps to contain the coronavirus despite the advice of federal health officials as a growing number of conservatives argue the impact on the economy has become too severe, according to several people with knowledge of the internal deliberations”, the Washington Post said Monday afternoon, effectively echoing Bloomberg’s reporting.

“Loosening restrictions on social distancing would override the internal warnings of senior US health officials, including Anthony Fauci, who have said the worst of the pandemic has yet to be felt in the United States”, the Post goes on to say, adding that “the push to reopen parts of the economy has gained traction among Republican lawmakers”.

Read more: Fed Does ‘Exactly What Market Needed’. Trump Considers Flouting ‘Advice Of Health Professionals’ To Save Economy