The Chaos Report

The only reason the U.S. central bank would be taking this action is things have gotten unexpectedly bad, unexpectedly fast

And it needs to do it to—hopefully—hold the banking system and the economy together. So it’s kind of the exact opposite of a happy situation.

We want to keep this as brief and simple as we can, so at the risk of oversimplifying, the Fed is trying to accomplish a couple of things:

1. It’s trying to force people to spend money by making it worthless for them not to. Consumers right now are hoarding cash, just like everything else. By creating a situation where there’s no benefit beyond safety to keeping money in the bank, it’ll hopefully spur spending. Mortgage rates, for instance, should drop to or near their lowest levels ever. Making it a great time to buy real estate. But are people really going to be out looking at that kind of investment right now? And even if they are, will banks give them a loan?
2. It’s trying to force banks to lend money to people and businesses even though they have no clue whether they’ll be able to pay it back. Even if they’ve been good customers. We’ve talked extensively about the lack of visibility right now, and that’s completely why this is the biggest battle the Fed is now fighting. The Coronavirus and response/lack of response has upended so many industries and created uncertainty for so many employers and employees. And trillions of dollars of wealth has disappeared from the economy mostly via plunging stock prices. So the Fed is reducing the risk of supplying funds to people and small businesses by offering a giant pile of cash that costs zero for banks to tap into.

The Fed also plans to buy hundreds of billions of dollars in Treasury securities to shore up the market. And let banks hang on to funds they take from the Fed for a while. That’s intended to supply longer-term support for the economy and financial system.

But remember, the Fed just cut rates by a lot a little over a week ago. And just a few days ago, opened a $1.5-trillion window for short-term loans to banks. So the surprise cut Sunday almost surely means there’s a dire emergency at least somewhere in the system that wasn’t even close to being fixed by that previous cut, and now has to be addressed ASAP with dramatic follow-up action. The Fed could go even further: to negative interest rates, something Trump’s also long advocated. That would mean it’d cost people money not to spend their money. But negative interest rates are almost never a sign of a healthy economy, almost by definition: if you have to in effect fine people for hanging on to their cash, what does that say about their belief in the economy? And so negative rates are often accompanied by long periods of economic malaise.

The President’s declaration that the Fed’s move “makes me very happy”, represents no deeper thinking than glee because he’s finally getting his way. Beyond that small personal victory, it’s far from something to be elated about.

And it’s important to remember, Trump wanted the Fed to drop interest rates to 0% long before the Coronavirus outbreak. Where would we be now if they had?

And a lot of the problems we’re facing now are or will be exacerbated by the fact that the President and Republicans embarked on an unbridled experiment to stimulate the economy at a time the economy was already booming, in the form of $1.5-trillion in tax cuts mostly to corporations. Making the hole we might be in now much harder to climb out of. Because any economic stimulus plan will necessarily involve the federal government taking on huge amounts of additional debt. Which is fine in an emergency, but added to the unprecedented debt that’s already out there that was handed out when everything was great…?

Let’s set that aside for a second, and ask one final question today: will the Fed’s latest move work? Especially since its cut last week seems definitively to have not. The Fed emphasizes in the release it put out announcing the latest cuts that the “U.S. economy came into this challenging period on a strong footing“. Still, that’s hardly reassuring because it underscores what we identified earlier as the biggest problem of all right now: no visibility of where we are now, and what’s going to happen.

Just as we don’t know yet how many people are sick, except that it seems bad, we don’t know what’s happening to the economy, except that it seems bad.

Even if all this we’re seeing is people and banks suddenly not acting rationally, it’s still the reality of what’s actually happening right now in the face of the pandemic.

One thing to watch out for that’s crucially important is whether any money market fund “breaks the buck”. That means the value of the uninsured but usually considered very safe investment, which is designed to always stay at $1, cannot. That happens either because so many investors in the fund are trying to get to their money all at once, or because the fund invested in something it thought was very stable and suddenly went bad. Or both. It only happened once before, in the wake of Lehman Brothers’ collapse in 2008. Kind of a modern-day equivalent of a run on banks. (Bank deposits, unlike money market funds, are currently insured by the government.)

There’s been no indication of that kind of peril yet. And it’d be pretty extreme even under these circumstances. (But frankly, we don’t really even know what “these circumstances” are.) Things are moving so fast now and changing so quickly, it’s worth keeping an eye on.

More so than how the stock market reacts. As we said at the time of the first Fed cuts last week, stabilizing the stock market would be a nice side-effect, but it’s not the point. The point is nothing less than keeping the American economy in business.