Mar 10, 2020

Axios Markets

By Dion Rabouin
Dion Rabouin

Are we headed for a recession? Let me know what you think - Dion@Axios.com (or just reply to this email) or hit me on Twitter or Instagram.

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🎙“No duty is more imperative on that government, than the duty it owes the people, of furnishing them a sound and uniform currency.” - See who said it and why it matters at the bottom.

1 big thing: The dominoes are set for a recession

Illustration: Sarah Grillo/Axios

The coronavirus is already the most serious threat to the U.S. economy since the financial crisis, and the dominoes are aligned for a severe recession that could erase much of the 11-year recovery, Axios' Dan Primack and I write.

What's happening: While the outbreak itself is unlikely to drive an economic collapse, the U.S. has been something of a ticking time bomb for some time.

  • Growth has declined over the last two years despite higher government spending and a $23.4 trillion national debt.
  • While the labor market has boomed, many of the jobs added have been hourly service-industry positions that offer limited scope for savings or health insurance.
  • 44% of all U.S. workers earn barely enough to live on, a Brookings Institution study found in January.

Where it stands: While President Trump said late Monday that he would work with Senate Republicans on a "very substantial" payroll tax cut and relief for hourly workers, such measures — if they can be enacted — could still be insufficient to fend off a recession.

At the same time, corporate America is more heavily indebted than ever before, due to years of record-low interest rates and increased borrowing.

  • The Federal Reserve has repeatedly warned that this spike in leveraged lending — combined with loosening covenants — has created risks not only to bond issuers, but also to the wide network of hedge funds and mutual funds (yes, mutual funds) that actually hold the debt.
  • In short, it's an economic haystack awaiting a match.

One big difference between 2020 and 2008 is breadth. The financial crisis began with financial services companies and insurers, which meant bailouts and structural fixes could be aimed at Wall Street. But this crisis is hitting the entire economy with a single blow — harming not just the Fortune 500, but also mom-and-pop businesses.

Bonus: The cavalry may not come to the rescue this time

The Fed, which helped rescue the economy after the 2008 crisis, looks effectively out of ammunition.

Between the lines: Starting in 2007, the Fed cut interest rates by 500 basis points, bought an unprecedented amount of U.S. debt and unleashed a flurry of stimulus programs that propped up the economy.

  • Rather than winding them down, the Fed has had to extend the programs throughout the recovery.
  • As a result, after last week's emergency rate cut — and possibly another that's expected at next week's policy meeting — the central bank has limited ability to take action.

Threat level: Government also increasingly looks broken. The dysfunction in Washington is dimming hopes for major fiscal stimulus that economists say will be needed to offset the outbreak's negative impact.

  • The $8 billion allotted to the coronavirus so far "is an insult," Claudia Sahm, former top economist for the Fed's Board of Governors, tells Axios. "It has to be hundreds of billions of dollars, and it has to be now."
  • "I want to see it — and maybe I will," Sahm, now director of macroeconomic policy at the Washington Center for Equitable Growth, says. "But without that piece, we are in a recession before the end of the year."
2. Catch up quick

Italian Prime Minister Giuseppe Conte announced the entire country would be placed under quarantine from Tuesday morning until at least April 3, as Italy's COVID-19 outbreak has infected more than 9,000 and killed over 400. (WSJ)

Apple sold 494,000 iPhones in China last month, less than half of what it sold in the country in February 2019, as smartphone sales overall fell by 54.7% year over year. (Reuters)

Oil prices yesterday saw biggest one-day decline since the 1991 Gulf war. (Bloomberg)

3. Recession, Fed cuts and QE are already being priced in

Data: U.S. Treasury; Chart: Axios Visuals

The U.S. fixed income and Fed fund futures markets are not only pricing in a U.S. recession and the Fed cutting interest rates to zero, they are now pricing in quantitative easing and asset purchases, analysts tell Axios.

What's happening: After U.S. 10-year yields fell to 0.32%, their lowest level on record, and yields on the 30-year bond dropped to 0.72%, investors began pricing in a bond-buying program from the Fed that would target longer-dated Treasuries.

  • "The market is starting to look towards other measures ... and is very gradually trying to price in a Japanization of the U.S. curve," Subadra Rajappa, rates strategist at Société Générale, tells Axios.

What it means: Japan's central bank has instituted the world's most aggressive monetary stimulus campaign, buying not just government bonds, but also corporate bonds and even ETFs in an effort to help stimulate growth and inflation in the country.

  • The stimulus has had limited effect and the country looks almost certain to fall into recession by the end of the first quarter.
4. There Is No Alternative to Treasuries
Expand chart

Data: FactSet; Chart: Axios Visuals

The acronym TINA (There Is No Alternative) had long been used to explain why investors piled into U.S. equities, but it may now apply to U.S. Treasuries.

State of play: After Monday's sell-off, the S&P 500 has erased all of its gains dating back a year, and the dollar, emerging market equities and oil are all negative during that period.

  • Treasuries have become the de-facto defensive asset for the market and "investors have to make sure that they have enough cash on the sidelines to meet whatever their cash needs are for at least the next year," Richard Steinberg, chief market strategist at The Colony Group, tells Axios.

On the other side: Benchmark 10-year Treasury yields (which move inversely to prices) have fallen by almost 150 basis points since the start of the year, meaning holders of U.S. government bonds have seen significant price appreciation.

  • Traditional safe havens gold and the Japanese yen have both gained a little more than 5% for investors year to date, but that is quaint in comparison to the staggering move in Treasury yields from their Jan. 1 levels.
Dion Rabouin

Quote: No duty is more imperative on that government, than the duty it owes the people, of furnishing them a sound and uniform currency.”

Why it matters: The quote is from President Abraham Lincoln, who issued the first U.S. paper money, known as the greenback, on March 10, 1862.