For the better part of 2019, analysts, economists and market participants more generally came around (in some cases begrudgingly) to the notion that fiscal-monetary “partnerships” are the future of policymaking.
Towards the end of the year, some suggested that future would be upon us more quickly than many imagined just a few months previous.
It’s important not to lose track of the fact that 2019 saw the largest net easing impulse (measured simply as the net number of rate cuts across economies) in years, as central banks responded to the trade war, the slowest pace of growth since the financial crisis and the first full-year contraction in trade volumes in more than a decade.
The abrupt pivot back into accommodative policy was initially a response to the deep selloff in risk assets that unfolded in the fourth quarter of 2018, which itself served as a reminder of just how difficult it is for central banks to disown the power they claimed for themselves post-crisis. Throughout last year, trade frictions kept policymakers wary, leading to still more rate cuts and accommodation.
With the proverbial “ammunition” depleted, many speculated that it was just a matter of time before fiscal policy kicked into high gear, with politicians finally shaking off deficit concerns and seizing the opportunity afforded by record-low rates to fund aggressive stimulus. I discussed this at length last October in “‘QE Infinity’, MMT And ‘Public-Private Policy Partnerships’ For A Brave New World“.
“The reality is that central banks can’t step away from supporting the market”, BofA’s Barnaby Martin wrote last fall. “They will need to be present for a long time, in our view, laying the groundwork for potentially higher debt levels in the future à la Japan”.
“In fact, low rates and QE will become essentials in helping governments create ‘fiscal space’ and manage the transition to higher debt levels and, at the extreme, participate in ideas such as Modern Monetary Theory, in our view”, BofA went on to say.
Fast forward six months and the coronavirus crisis has made this a reality. In effect, it brought forward the future of economics and finance. It sped up evolution.
This was perhaps most colorfully expressed by SocGen’s Albert Edwards, who on February 6, predicted that in response to the next crisis, the world would resort to helicopter money, which will be “successful” in taking a blow torch to the permafrost of his long-held “Ice Age” thesis.
Much to the chagrin of Edwards’s critics, that thesis ended up playing out almost precisely on multiple levels, albeit at a “glacial” pace befitting of its name. In a note out last week, he reiterated that the coming policy prescriptions aimed at combatting the economic fallout from various virus containment measures will eventually “unfreeze” the world. From Edwards:
Amid the global health crisis, financial market practitioners are attempting to navigate their way through the turmoil the markets now find themselves in. For myself, I think I know where we are headed. The good news is that we are in the final phase of my Ice Age. Extreme policy actions will confront the forces of Secular Stagnation, which will ultimately give way to a new secular phase in financial markets – ‘The Great Melt’.
The key to this is obviously coordination between fiscal and monetary policy. And that’s why this crisis is unique.
“The content of policy response, despite some superficial similarity with the past, is very different from anything previously seen including the 2008 financial crisis”, Deutsche Bank’s Aleksandar Kocic writes, in a note dated Monday. Here’s the difference, as quickly explained by Kocic:
Following the events of 2008, monetary policy was engineered around intentions to restore liquidity, repair credit and catalyze return of the risk appetite. While there was some fiscal stimulus in the initial stage, monetary policy was the main tool and the two were not coordinated. In fact, as the market recovered, fiscal and monetary polices functioned in the push-pull mode: When fiscal policy tightened in 2011, that was offset by further monetary easing and when expectations of fiscal easing returned after 2016, monetary policy began to tighten.
That “push-pull” dynamic has been lamented by any number of economists writing since the crisis. It’s akin to driving an automatic with one foot on the brake and one on the accelerator. And for what? To preserve the illusion of fiscal discipline, which is just that: An illusion, which appears and disappears depending on political expediency.
“In contrast, in 2020, fiscal policy is the center of action and monetary policy is reactive to it”, Kocic goes on to write. “However, the two are highly coordinated – they function in a parallel mode”.
The Fed on Friday said it would again slow the pace of its daily buying under the unlimited QE regime. This week, the Fed will buy at a $50 billion/day clip, down from $60 billion over the past two days and $75 billion prior to that. The balance sheet hit $5.8 trillion through Wednesday.
The evolution of this buying needs to be set against projected supply (to fund stimulus, for example) in order to understand the “intensity” (if you will) of the fiscal-monetary coordination.
Here’s Deutsche Bank’s Steven Zeng with a rundown of the numbers and some projections for what’s ahead:
By the end of the week, the Fed will have purchased $1.2 trillion in coupon Treasuries since March 13. The amount of ongoing support in the form of Treasury purchases is obviously hard to predict as it is subject to the evolving situation of Covid-19 and how the financial market reacts. We think the Fed will commit to providing liquidity at least through the end of May, and withdraw only in a gradual and measured fashion. For our projection, we assume $10 billion reduction in daily operations in weekly increments after this week through the end of April, then $20 billion daily operations for May, $10 billion daily operations for June, and $5 billion daily operations for July. At that point, the Fed will return to a similar operation as beginning of the year, purchasing Treasuries using only proceeds from monthly MBS principal payments up to $20 billion per month. Under this assumption, Treasury’s net coupons issuance will remain negative through July but flips in the second half. Additionally, with the anticipated addition of a 20-year bond in May, the duration of net issuance will be higher.
When it comes to financing spending, Steve Mnuchin’s Treasury will likely oblige the clamoring for T-bills, despite his dream of ultra-long issuance.
Cumulatively, government money market funds have seen more than $900 billion of inflows over the past several weeks amid a rush to cash and a flight away from prime funds, which were hit by concerns about a seizing up of the commercial paper market.
“In an echo of Hank Paulson’s crisis-era playbook, the Treasury has since mid-March already issued $270 billion of cash management bills [and] according to Goldman, net bill sales will top $1.2 trillion in April and May alone, the biggest jump on record”, Bloomberg writes, in a piece documenting the funding options available to Treasury and how they interact with offsetting Fed purchases. “Demand [for bills] is at fever pitch”, the piece goes on exclaim, adding that Fidelity has closed three of its money-market funds to new investors, while voracious buying drove rates on 4-week bills to -0.256% last week.
Fed buying was, of course, confined to bills prior to the restart of “real” QE. Now, though, the Fed is not just buying across the curve, but also throwing its support behind a hodgepodge of other markets, via an alphabet soup of liquidity facilities. When it comes to government securities, JPMorgan sees the Fed absorbing more than $340 billion in bills and in excess of $1.1 trillion in notes and bonds by the end of June. Now that’s a monetary-fiscal “partnership”.
Of course, the Fed may need to accommodate still more issuance depending on the evolution of the virus and the fallout for the US economy.
“[An] unknown is the uncertainty regarding the depth of the crisis and intensity of future issuance”, Deutsche’s Kocic says. “In the light of the early labor market outliers of the last week, the current fiscal package looks more like a disaster relief than stimulus”, he went on to write, adding that “it is not unreasonable to expect a need for additional fiscal injection and substantial issuance volume in the not so distant future”.
I’ll simply leave you with one of my favorite quotes, as delivered during a July 2019 Bloomberg interview with Stephanie Kelton:
Greater coordination between fiscal and monetary authorities is almost certainly the wave of the future. [Central banks] won’t openly say that they’ve lost their independence [but] you’re going to see central banks responding in more accommodative, coordinating ways. The language will be that somehow everything that they do is their choice, and justified by their read of economic conditions. But at the end of the day, they’re going to be accommodating fiscal.