by Ivan Martchev
June 16, 2020
We have so far added over $3 trillion to the Federal Reserve balance sheet since the corona-recession began in February – as recently confirmed by NBER. According to Chairman Jay Powell (speaking on 60 Minutes), there is a lot more the central bank can do when it comes to buying assets, which means that its balance sheet can go a lot higher. The Fed’s balance sheet at last count stands at $7.169 trillion.
The Fed already lends money directly via guaranteed loans through the banks it regulates (as the banks themselves are unlikely to make what they view as risky loans). Asked by the 60 Minutes interviewer if he has flooded the system with money, Chairman Powell agreed but clarified, “We print it digitally.”
Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.
A rising Fed balance sheet means more electronic dollars in circulation in the U.S. and global financial system. It’s as simple as an electronic credit in the account a financial intermediary has at the Fed. After the Fed purchased “assets” (mostly bonds), those electronic dollars had to go somewhere. Some of them went into other various types of bonds, but I have no doubt some of them ended up in the stock market.
A three trillion-dollar leap in assets would make a dead cat jump in the air and perform 360-degree flips. If the corona-recession is over soon, this will not likely be a “dead-cat bounce” in the stock market. This is why the success of the reopening is hinging on how much COVID-19 cases spike (or don’t spike).
Right now, it appears that we have some regional spikes, which are part of the first wave of COVID-19 and not a new second wave. Some states didn’t close for long or never faced widespread cases. Others, like New York and New Jersey, faced more cases and were very aggressive in shutting businesses down.
I am not advocating further closures. I’m simply saying that spiking COVID-19 cases will likely show up in the prices of risk assets unless the Fed unleashes full monetary madness and buys everything that’s for sale with unlimited QE, which I doubt they will do. For the first time in anyone’s memory, medical data on a progressing pandemic is a real-time economic indicator in moving prices of financial assets.
The Fed has unleashed QE faster and more aggressively than the ECB and other world central banks. This is partly because the U.S. dollar is the world’s reserve currency and there was a dollar short squeeze going on, causing the Broad-Trade Weighted Dollar Index to hit a fresh all-time high in March 2020 and the JP Morgan Emerging Markets Currency Index to hit a fresh all-time low more recently in 2020.
One aspect of why the Fed has been more aggressive than the ECB is to understand that the dollar short squeeze driven by the record world financial system total dollar borrowing of $12.1 trillion at the end of 2019 grew 6% in the preceding year, according to the Bank of International Settlements.
I thought Quantitative Tightening (QT) in 2018 was going to cause a dollar short squeeze as the Fed was draining electronic dollars from the system – and it did, in terms of the Turkish lira, Argentine peso, and other EM currencies – but this time it is the disappearance of cash flows to service those dollar debts, not rising U.S. interest rates, that caused the dollar short squeeze.
Until this pandemic is over – and I don’t think it is over yet – I would view the current dollar weakness as temporary. After the pandemic is over, the dollar will likely decline, given the amount of new electronic dollars in the system, but not before the pandemic is over.
The Brazilian Real is a Real-Time COVID Indicator
It does not look like Brazil has a good handle on the pandemic spreading there. With less money to handle deficit spending, and a less advanced healthcare system, the damage to the Brazilian economy could be very serious. This dynamic is the same for any emerging market with an out-of-control COVID problem.
It was not encouraging for the Brazilian real to go from four ($0.25) to six ($0.17) to the dollar as the epidemic started. We had a very nice snap back from six ($0.17) to five ($0.20) in the past month as the developed world was getting ready to reopen. I would view the Brazilian real as a good “reopening indicator” as it is a high-beta emerging markets currency that encapsulates the appetite for risk tolerance of the institutional investor as well as reflecting the improving (or deteriorating) of global trade flows.
Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.
The actual all-time COVID-era low on the USDBRL exchange rate is 5.99 ($0.167). If the real moves past six against the dollar, I would view it as a confirmation that the global reopening is not going well and the pandemic in Brazil and other emerging markets is not under control.
Also In This Issue
A Look Ahead by Louis Navellier
The Fed Launches an Epic Battle Against Deflation
Income Mail by Bryan Perry
Risk Assets Are Proving Resilient
Growth Mail by Gary Alexander
Both Gold and Stocks Belong in a Balanced Portfolio
Ivan Martchev is an investment strategist with Navellier. Previously, Ivan served as editorial director at InvestorPlace Media. Ivan was editor of Louis Rukeyser’s Mutual Funds and associate editor of Personal Finance. Ivan is also co-author of The Silk Road to Riches (Financial Times Press). The book provided analysis of geopolitical issues and investment strategy in natural resources and emerging markets with an emphasis on Asia. The book also correctly predicted the collapse in the U.S. real estate market, the rise of precious metals, and the resulting increased investor interest in emerging markets. Ivan’s commentaries have been published by MSNBC, The Motley Fool, MarketWatch, and others. All content of “Global Mail” represents the opinion of Ivan Martchev
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