Scott Minerd ‘Gazes Into Crystal Ball,’ Says Fed May Buy Stocks, Hoard Gold In Severe Crisis

“As I gaze into my crystal ball…”, Guggenheim’s Scott Minerd begins, in a note dated Monday.

To be sure, Scott’s “crystal ball” isn’t always a happy place.

Back on February 27, he “gazed” into it live on national television alongside Joe Weisenthal and Scarlet Fu, who, along with Bloomberg’s audience, were subjected to Minerd’s dark vision for the future of humanity.

Read more: Scott Minerd Woke Up On The Armageddon Side Of The Bed This Morning

“This is possibly the worst thing I’ve ever seen in my career”, Minerd said, of the coronavirus crisis, which hadn’t yet closed down New York City.

He was right. Or his crystal ball was. Soon after that infamous cameo, things fell apart, both for markets and for western economies, which careened into the deepest downturn since the Great Depression.

In early April, Minerd described the situation as “worse than I had expected”, no trivial assessment given that he was expecting the absolute worst.

After that, as risk assets rebounded, he took to complaining about moral hazard and the Fed’s corporate bond-buying program, which hadn’t even launched yet. “The United States will never be able to return to free market capitalism”, he lamented, waxing hysterical in a late April outlook piece.

Eventually, he resigned himself to the fact that the Fed wasn’t prepared to accept a scenario where a pandemic ushers in a credit crisis. Over the past several weeks, Minerd has made what seems like a half-dozen (at least) television appearances, always reporting live from his living room, donning a plaid button-up and mismatched baseball cap.

In his latest, Minerd says that “absent further action by the Fed, the deluge of Treasury securities (to fund virus relief spending) will “likely start pushing interest rates higher, threatening the overall economic expansion”.

As you’ve probably noticed, long-end yields have, in fact, moved higher of late. “The Fed cannot allow this to happen”, Scott says.

He’s right about that. Having set the stage, he proceeds to review what he calls a “progression of policy tools” the Fed will (or could) turn to if the economy “remains mired in a protracted downturn”, a state of affairs he pretty clearly believes is likely.

He starts with forward guidance, which he says will need to mean more than a promise to keep rates low out to five years given the market is already priced for that anyway. He doesn’t say, precisely, what he believes the Fed will commit to, but suggests they’ll need to make it clear that short-end rates won’t rise materially for more than a half-decade.

“The Fed is going to want to establish the shortest minimum time it thinks it can get away with, yet still have the impact of shocking the market”, he writes. “The minimum period of time for keeping rates at the zero bound would be something like five years, but a longer time period may be necessary”.

To be clear, there is no chance that the Fed will commit explicitly to keeping rates at zero until 2030. They may adopt some watered down version of date-dependence, but it will leave room for adjustments and it certainly will not take the form of statement language that mentions a decade other than the one we’re currently in.

That’s not say rates won’t stay at the lower-bound (or close to it) for a decade. It’s just to say that committing explicitly to a date beyond 2025 would be seen as meaningless. Sure, it would catalyze a knee-jerk in STIRs, but there is no sense in which the Fed (or anyone else, for that matter) can predict what conditions will persist in 2025 and beyond with the kind of specificity needed to set interest rates more than a half-decade in advance.

Mercifully, Minerd’s extended color is more nuanced. The Fed would adopt some combination of date- and state-dependent forward guidance, he says:

The Fed will most likely establish a second condition of  an inflation rate target. In this scenario, the Fed could commit to maintaining rates at the zero bound for at least five years, and possibly longer, subject to the average inflation rate needing to exceed 2 percent on average over a five-year period. Only upon meeting the inflation target condition would the Fed begin a lift off in rates. Such an approach would have the benefit of automatically extending the expected period at the zero lower bound if economic conditions worsen or the recovery falters.

There’s nothing novel or controversial about that. Neither is his outlook for QE particularly eyebrow-raising.

As discussed here (again) on Sunday evening, the Fed is currently tapering bond-buying on a weekly basis and markets are looking for guidance about what’s next. Most see the Fed settling on a monthly amount, but there’s a chance they continue to manage things week-to-week. Here’s what Minerd thinks:

Currently the pace of the Fed’s purchases is determined weekly based on market functioning metrics monitored by the Open Market Desk. In the next QE program, the FOMC will outline the composition, size, frequency, and duration of its asset purchases. Given the government’s financing needs, I expect that the next QE program will be larger than any previous rounds of QE in terms of monthly purchases. The current pace of Fed purchases… is insufficient to absorb the $170 billion in net monthly Treasury coupon issuance we forecast for the rest of the year, let alone the hundreds of billions of monthly net T-bill issuance we expect. The duration of the next QE program could also be tied to achieving specific dual mandate outcomes, given the high amount of uncertainty around how long the purchases will be needed. It will likely take at least $2 trillion in asset purchases per year just to fund the Treasury.

If you want more on the T-bill issue, I strongly encourage you to read “Zoltan Pozsar On Money Market ‘Singularity’ And War Finance“. As far as keeping a lid on yields, Minerd is, of course, correct that the Fed will buy coupons as needed in order to ensure there’s not some disorderly rise in borrowing costs that imperils government finances at a time when deficits “need” funding (and for our purposes here, I’m going to leave aside the fact that there is, in fact, no “natural” law that says spending has to offset by borrowing for an issuer of a reserve currency).

Minerd acknowledges what I’ve implored readers to acknowledge themselves in the absence of a public declaration from “name brand” market mavens – we are buying this debt from ourselves. “The dirty little secret about quantitative easing during the financial crisis is that it was used to finance the US Treasury”, he writes.

It’s not a “dirty little secret” – what it is, is the public’s generalized apathy towards anything that sounds complicated and an unwillingness on the part of voters to make an effort to understand the issues that affect them.

In any event, Scott goes on to note that yield-curve control is likely in the cards, albeit not imminently. He goes over the basics for the uninitiated:

The Fed would announce a rate–say 50 basis points–and state that it stands ready to purchase all Treasury bonds of a certain tenor that trade above this level. It is worth noting that establishing a policy for yield curve control is fundamentally at odds with setting a quantitative target for QE purchases. Once the Fed transitions to yield curve control, the quantitative purchase target becomes somewhat meaningless. This has been the experience of the Bank of Japan which, after implementing yield curve control, continued to have a purchase target of 80 trillion yen per annum. But in reality, it has bought much less, totaling just 18 trillion yen in the past year.  

After that, he ventures into what he calls “the land of more remote possibilities”, which includes negative rates.

He reminds you that “it’s not like the Fed provides a permit in order to allow bonds to trade at negative yields”. Long-end yields for safe-haven European debt (and even some semi-core bonds) have traded well below the ECB’s depo rate. 10-year German yields, for example, have traded below -0.80% at the lows.

The bottom line, Minerd writes, is that “negative market rates can happen in the US, and most likely will happen at some point” with the only question being “whether the Fed endorses a negative interest rate policy”.

Then, Minerd takes up the thorny issue of the Fed buying stocks. Essentially, he argues that if stocks were to fall by, say, 30% again, and credit spreads refused to respond to corporate bond-buying, the Fed might choose to purchase equities rather than take rates negative. The mechanism would be the same. To wit:

If the Fed needs to tame a severe credit crisis, it will have to find a way to prop up stocks and thereby maintain access to capital in a market other than the bond market. The Federal Reserve charter does not allow for the purchase of stocks, but the U.S. Treasury could establish a special purpose vehicle to buy stocks that the Federal Reserve could fund. That artifice would be similar to that which is used for the purchase of corporate bonds and ETFs. If credit spreads should start to widen significantly again, perhaps if we see a second spike in COVID activity as the lockdowns are unwound, the Fed would not rule out a program to prop up equity prices and provide financing to the Treasury to do it.

Lastly, he outlines what he calls a “break the glass” option, which will doubtlessly delight some readers.

Minerd doesn’t spend a ton of time on it, but he suggests that the Fed and other central banks might buy physical gold in the event the market begins to speculate on the demise of the greenback.

He concedes that currently, “there are no signs the world is questioning the value of the US dollar”, but notes it’s losing share at a glacial pace in global reserves.

“With the Fed going all-in on financing the government deficit, the US dollar could be at risk to negative speculation of its status as the dominant global reserve currency”, he says, before musing that “the accumulation of gold as a reserve asset historically has been seen as a responsible policy response in periods of crisis [and] this may very well become the policy option of choice in the future”.

Two things on that (from me):

1. The dollar’s status as the world’s premier reserve currency is threatened more by US foreign policy than it is by any deficit, no matter how large. For instance, the constant weaponization of the USD and the US financial system through draconian sanctions aimed at punishing perceived “foes” (sometimes for not very good reasons) along with the 2018 experience (when the rest of the world was again reminded that financial stability outside the US depends almost entirely on the Fed not erring by overtightening during a hiking cycle), are likely to be the key drivers of continued de-dollarization. Not deficits and not “money printing”
2. It’s not entirely clear that markets would be comforted in a crisis by a central bank that takes a page out of the conspiracy theorist playbook and begins hoarding physical gold. Indeed, it’s possible to argue that would be the single-worst decision policymakers could make in a modern crisis, because if the people who print the money suddenly start buying gold and silver with it, it wouldn’t say much for their confidence in the paper-based “store of value” that they print, now would it?

Minerd doesn’t go into the logical next step after gold hoarding, which I suppose would be a QE program involving massive purchases of Green Giant vegetables, farmland and Vienna sausages.

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