EDITOR'S NOTE
Last Thursday, the market briefly started pricing in negative interest rates for the first time.
Specifically, fed funds futures--which are bets on where the Fed's benchmark rate will be in coming months--showed the market implying the central bank will soon cut rates below zero. The same afternoon, economist Ken Rogoff was on "Power Lunch" calling for "deeply negative" interest rates.
"You can't just guarantee every credit in the economy," Rogoff said. "You can't go to a form of socialism, really, that we're tiptoeing towards." He said the fact that negative rates "aren't in the toolkit is a problem," and that "if you were able to do deeply negative interest rates as a part of this that would keep a lot of companies afloat."
The "socialism" that Rogoff is referring to is the Fed's massive bond-buying--of corporate bonds, in particular, this time around. Just like the Fed bought loads of mortgage-backed securities after the housing crash to keep that market from completely imploding, now it's buying corporate debt to keep more companies from going under.
I wonder if it's philosophically consistent, though, to decry the government buying corporate bonds as "socialism" while insisting the government needs to set a blanket deeply negative interest rate that critics warn could severely damage the U.S. economy.
Peter Boockvar rattles off at least eight major problems with the "poison" of negative interest rates: (1) It's a tax on bank capital, (2) It would blow up the money market, (3) It would damage banks' earnings power, (4) It gets passed on to retail customers as a tax or fee, (5) It hurts pension funds and insurance companies, (6) It crushes retirees and savers, (7) It encourages huge sovereign debts, and (8) It "traps" the central bank because it can't unwind without crushing bond prices. Boockvar adds that Sweden has reversed its negative rates and Japan never went to more than -0.1%.
If anything, in contrast to what Rogoff is calling for, the Fed is likely to increase its corporate debt buying while continuing to resist calls for pushing rates negative. It will probably do so in part to offset having to lessen its own Treasury buying (since that's contributing to pushing market rates negative), as analyst Brian Reynolds outlined this morning. And also because the corporate debt markets are not functioning as well as you might think right now.
While companies like Southwest, Boeing, General Motors, and Hertz were able to issue debt last week, Reynolds cautions that "equity investors have read too much into this," since the deals were priced "so expensively that they will likely significantly crimp corporate profits for years to come." Indeed, by the end of the week United Airlines had to pull its own bond offering after investors balked.
While everyone was focused on the jobs report on Friday, the United deal falling through arguably had more significance. In fact, Dave Zervos says the only thing that matters for investors right now is watching the Fed's action on corporate bond purchases. "Their DIRECT support...will continue to be the single most important driving force for capital markets," Zervos wrote last week.
"It's time to accept that the Fed's ACTIONABLE backstop has fully shifted from the [Treasury] rate market to the [corporate] investment-grade market," Zervos wrote. And he, like many others, is now buying investment grade corporate bonds as the Fed's own purchases gear up for launch. (Their actions on junk debt are less of a focus for macro watchers like Zervos.)
To end on the criticism about this all being "crony capitalism," or even "tiptoeing towards socialism," I'll go back to how Reynolds ended his client note this morning. "If the Fed did [start buying more corporate bonds]...next year's projected slow economic recovery would be somewhat less so than is currently implied," he said.
In other words, the Fed buying more corporate debt is the one thing that could help brighten economic prospects for everybody, because it keeps the financial system from further clenching up and companies from piling on such costly debt that it weighs on the recovery for years. Compare that with the Fed going to negative rates, which could be potentially harmful to the public and the financial system.
If the public accepts the Fed playing a bigger role in the economy, it should at least get a better recovery as a result.
See you at 1 p.m!
Kelly
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