May 1, 2020

Axios Markets

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🎙 "I've been stacking my karma, Nefertiti, no drama. Make a feminist planet, women haters get banished. Covered up or not, don't ever take us for granted." See who said it and why it matters at the bottom.

1 big thing: Central banks load up for a long war

Illustration: AĂŻda Amer/Axios

The world's most powerful central banks made clear this week that they expect the economic damage from the COVID-19 pandemic to be deep and long-lasting and they are arming themselves for war.

Driving the news: After announcing Wednesday that it would do whatever it takes and then some to buoy the U.S. economy, the Fed unveiled a beefed-up new version of its $600 billion Main Street Lending Program that will effectively shred parts of the 1913 Federal Reserve Act (with authorization from the Treasury Department).

  • That followed announcements from the European Central Bank and Bank of Japan in the preceding two days for massive lending and bond-buying programs that would be increased, in ECB president Christine Lagarde's words, “by as much as necessary and for as long as needed."

Why it matters: We are entering an uncharted era of central banking that will see the Fed and its peers lend money directly to businesses, take unprecedented risks and directly support tremendous portions of the global economy.

  • "There are a number of concerns but I think the attitude of central banks right now is 'Damn the torpedoes, full speed ahead,'" Kathy Jones, chief fixed-income strategist at Charles Schwab, tells Axios.

The big picture: Central banks were established to keep inflation in line and to use their lending powers only to purchase assets backed by their governments.

  • However, since the BOJ first began a quantitative easing program to prop up Japan's economy, central banks have been providing more and more support.
  • The world's central banks currently hold around $25 trillion of financing on their balance sheets and have committed to do everything from invest in companies with junk credit ratings to buy stocks.

The bottom line: This is not what central banks were designed to do, but in the face of this historic economic shock and in the absence of clear alternatives, it is what they are doing.

  • No one is quite sure what happens next.
2. The Fed is looking to help fill the hole PPP missed

Reproduced from Deutsche Bank Global Research via TSA; Chart: Axios Visuals

While business owners have largely praised the federal government's fast response and the good intent of the CARES Act, it has left much to be desired.

  • It is believed that one of the reasons for the Fed's expanded lending under the Main Street facility is the struggles of the Paycheck Protection Program.

What it means: With the Small Business Administration overwhelmed by demand and many small business owners unable to access funding, PPP has been plagued by bad news since even before it launched.

Where it stands: "PPP was the right idea but it was intended to be a short-term measure and really needs structural changes that can, in addition to a major infusion of resources, give travel businesses and their workers a real chance to survive," Tori Barnes, executive VP of public affairs and policy at the U.S. Travel Association, said during a media briefing Thursday.

  • "There are many businesses with no customers, with no revenues that are left out altogether of PPP and the CARES Act."

Between the lines: By reducing the size of the loans it offers (which unlike PPP loans cannot be forgiven), the Fed's Main Street program allows medium-sized businesses direct access to its seemingly bottomless supply of cheap capital through financial institutions that take on, at most, 15% of the risk while the central bank shoulders the rest.

  • "By lowering the minimum loan size you’re going to be able to reach a lot of companies that would’ve been in that PPP range," Amanda Fischer, policy director for the Washington Center for Equitable Growth, tells Axios.
  • "$500,000 is still bigger than the average PPP loan recipient, but this isn’t Wall Street levels of money."

Of note: The Fed also is buying PPP loans to clear them from bank balance sheets and allow more lending.

3. The unemployment insurance conundrum

Data: Treasury Department via the Peter G. Peterson Foundation; Chart: Axios Visuals

The PPP initially made headlines for leaving out many small businesses who were muscled out by large corporations and savvier peers with long banking histories, but now even those who secured the funding say the program needs to be overhauled.

Driving the news: "It’s difficult to successfully use the Paycheck Protection Program loan," Jackie Victor, founder and owner of Detroit's Avalon Breads, writes in an op-ed for the New York Times.

  • She points out that requirements for the money be spent within 60 days, that the business retains all of its employees and that it uses 75% of the money for payroll makes practical use of the loan almost impossible.
  • Other business owners point out that for companies with workers who make less than they would through the government's expanded unemployment benefits, putting them back on payroll when they are not allowed to work is cruel and will actually hurt the relationship between employer and employee.

Details: The CARES Act increased eligibility for unemployment benefits, provided an additional $600 per week and extended insurance payments beyond the typical 26 weeks.

  • Since enactment of those provisions in late March, federal spending on unemployment insurance has risen noticeably, the Peterson Foundation notes in a recent blog.

4. Catch up quick

The White House threatened to add more tariffs on U.S. companies that import Chinese products as a means of retaliation for the COVID-19 outbreak. (Reuters)

The American intelligence community believes the COVID-19 virus that originated in China was not manmade or genetically modified. (Reuters)

The number of Americans filing initial unemployment claims hit 3.84 million last week, bringing the rolling six-week total to 30.3 million. (CNBC)

Amazon saw its profits shrink last quarter and CEO Jeff Bezos warned the company was seeing “the hardest time we’ve ever faced.” (Bloomberg)

5. "Downgrades, defaults and bankruptcies," oh my!
Data: Chart: Axios Visuals

The Fed has not yet begun buying corporate bonds through its announced special facilities, but just by announcing plans to take action has sparked rallies in bonds across the spectrum and improved market functioning.

Yes, but: "The Fed’s aggressive actions have benefited the markets in the short term. Longer term, however, we think there will be downgrades, defaults, and bankruptcies, particularly among companies that came into the downturn with high leverage," warns Ruta Ziverte, head of fixed income for William Blair.

  • With corporate debt markets again functioning smoothly, she expects to see a significant increase in bond issuance "as companies see their earnings decrease and sell more debt to raise funds," she says in a blog post.
  • "We expect this to result in more downgrades ... across the full ratings spectrum."

What's happening: More than $120 billion of investment grade bonds have been downgraded to junk status this year, and approximately $300 billion of the lowest rated investment grade bonds are on watch for downgrades or have negative outlooks, Ziverte notes.

  • "We estimate that as much as $200 billion of debt (about 3.7% of the investment grade market) could be downgraded over the next 12 to 18 months."
6. Investors preferred cash as stocks had the best month since 1987
Data: FactSet; Chart: Axios Visuals

The Fed's programs also helped spark a rally in equity prices, and the S&P 500 had its best month since 1987 in April.

  • While retail traders have jumped into the stock market with both feet, institutional investors have preferred to play it safe and go to cash, data show.

By the numbers: Investors sold $7 billion worth of equity mutual funds for the week ending April 29, according to data from Lipper, and $1.5 billion worth of equity ETFs. An ETF that tracks the S&P 500 saw the largest outflows of the week, with $4.8 billion of redemptions.

  • That contrasted with $83 billion of inflows to money market funds, which are essentially cash, during the week, according to Lipper's data.

The big picture: April was a historic month for money market funds, data from the Investment Company Institute show.

  • Total assets parked in money market funds increased to $4.73 trillion as of April 30.
  • That's the highest amount ever and nearly $1 trillion more than the level of assets held in money markets at their pre-2020 peak during the global financial crisis.
  • It's an increase of more than $500 billion from levels recorded during the last week of March.

Quote: "I've been stacking my karma, Nefertiti, no drama. Make a feminist planet, women haters get banished. Covered up or not, don't ever take us for granted."

Why it matters: The line is from rapper Mona Haydar's 2017 certified banger "Hijabi (Wrap my Hijab)."