Deficits, Debt, and Deflation

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This week I cover the April employment report, the potential for negative policy rates at the Fed, an insightful interview with Dr Lacy Hunt on Deficits, Debt, and Deflation....plus Mark Cuban's Blog Maverick post on how the reopening is going in Dallas.

Top 2 Stories of the Week

The April employment report was tragically weak, yet not unexpected.

Non-farm payrolls collapsed by 20.5 million in April, now an infamous record we hope to never experience again. Notice in the chart to the right how the monthly job losses dwarfed even the deepest of recessions going back as far as 1940. The "tiny" blip on the far left of the chart was Sept. 1945 when nearly 2.0 million jobs were lost at the end of WWII. Last month, the job losses by sector were just as alarming. Leisure and Hospitality lost 7.6m, Retail shed -2.1m, health and education services cut -2.5m jobs, manufacturing cut 1.3m, and construction lost nearly 1.0m jobs.

The unemployment rate soared to 14.7% for the highest jobless rate since the Great Depression. The under-employment rate (a group that includes those unemployed and those working part-time for economic reasons but are available for full-time work) surged to 22.8%.

According to the Household Survey, those workers who indicated they are "on temporary layoff" numbered 18.063m while those who said they suffered permanent job losses totaled 2.0m. We can only hope that most of the 18m workers temporarily let go will have a job to come back to. The more of them who do, the better the recovery will be (while the opposite also holds true).

On the Doorstep: Negative Rates?

The 2yr Treasury note yield fell to a new record low on Thursday and again today, finally finding a floor at .103% on Friday morning. Prior to this, the previous low was .174%. Once that level was pierced, technical buyers piled in.

There was another dynamic that was occurring at the same time on Thursday. Prices on the the Fed funds futures contracts from Nov'20 out through the mid-'21 stack (not too liquid beyond that) spiked above par (100.00) for the first time ever. As you can see on the chart

to the right, the April'21 contract traded above $100.00 mid-morning on Thursday to $100.035 and it continued up to $100.06 on Friday morning before falling back to end the day slightly above $100.00.

As you may know, 100 minus the contract price is the implied Fed funds rate for that expiration. We were suddenly staring at a market that was pricing in a negative Fed funds rate as early as Nov'20 when all was said and done on Thursday. On Friday morning, the rate implied by the April'21 contract was as low as -6bps.

The catalyst for this move was likely a squeeze on the shorts that were leaning against the $100.00 level. Just because the futures traded to a negative implied yield, doesn't necessarily mean the Federal Reserve's policy rate is going to move negative. In addressing that concern, Chair Powell recently said:

"we do not see negative policy rates as likely to be an appropriate policy response here in the United States."

- Jerome Powell, March 15, 2020

* * *

"I do not think we'd be looking at using negative rates, I just don't think those will be at the top of our list."

-Jerome Powell, September 18, 2019

Powell also said in his presser after the Sept 18, 2019 FOMC meeting "If we were to find ourselves at some future date again at the effective lower bound, again not something we are expecting, then I think we would look at using large scale asset purchases and forward guidance."

Well, here we are. Never say never. Watch what they do, not what they say.

Here I share a couple of articles that put the risks and arguments for and against a negative rate regime into perspective.

First, this from former Fed Chair Ben Bernanke in a Brooking's Blog from March 18, 2016.

Some notable qoutes from Bernanke:

"We can’t rule out the possibility, though, that at some point in the next few years our economy will slow, perhaps significantly." Bernanke never contemplated a time when the economy would come to a full stop!

"The Fed could resume quantitative easing (QE), that is, purchases of assets ....for the Fed’s portfolio, financed by the creation of reserves in the banking system." "It’s also possible that a new round might be less helpful than before." (Consistent with the Lacy Hunt interview - linked below). "For these reasons, before undertaking new QE, the Fed might want to consider other options. Negative interest rates are one possibility."

"Of greater concern is the basic legal issue: Does the Fed have the authority to impose a negative interest rate on the reserves banks hold with it?" and "the law says that the Fed can pay banks interest on their reserves, but it is not immediately clear whether that authority extends to “paying” negative interest."

This from former Fed Chair Janet Yellen on CNBC February 10, 2016 and referenced by Bernanke:

“We were concerned about the impact it would have on money markets, we were worried it wouldn’t work in our institutional environment.”

Back to Bernanke:

"There has been much discussion recently about negative rates’ effects on bank profitability, but the 2010 Fed memo was more concerned about money market funds (MMFs), which play a larger role in the U.S. than in Europe or Japan. Like banks, U.S. MMFs have traditionally promised their investors the ability to withdraw at least the full amount that they’ve invested. Not making good on this promise is known as “breaking the buck.”

"With floating net asset values, MMFs will no longer effectively be promising to pay investors back dollar for dollar, that is, “breaking the buck” is no longer an issue. However, as mentioned, not all funds must adopt the new approach; those that do not could still be potentially rendered unstable by consistently negative returns on the assets they hold." "In that scenario, a policy of modestly negative interest rates might be a reasonable compromise between no action and rolling out the big QE gun."

The second article is from Forbes.com where contributor Vineer Bhansali argues that the Fed will move to a negative policy rate, and why that's good.

Deficits, Debt, and Deflation

This week, Treasury said $3tln in marketable debt will be issued in the May-July quarter to finance the coronavirus rescue. Next week's May quarterly refunding will be a record $96bln total package. Treasury surprised the bond market by shifting the funding mix out on the curve.

With the debt and deficit exploding, I bring you this terrific podcast interview with Dr Lacy Hunt, Chief Economist - Hoisington Investment Mgmt Co. If you have 50 minutes to spare, it is well worth a listen, even if you may not agree with his arguments. The interview starts about 20 mins in and runs to 70 mins.

I've always been a fan of Lacy Hunt's work. These are my key takeaways from the interview:

??U.S. will close 2020 with a massive output gap, stagger out of recession, and take 6-7yrs to recover to pre-crisis levels

??U.S. rates will not go negative unless Fed takes overnight rate below zero. Not clear if Fed has that authority.

??He is expecting mild deflation based the current level of Fed/fiscal support. Risk premium in spread product will move higher. UST to outperform.

??At 90% Debt/GDP, economy loses ~ a third of growth rate vs trend. Hunt - we're headed toward 125% debt/gdp.

?????? ??????????: "???????? ???? ?????? ????????, ???? ???? ????????" -- in speaking of the decline in the marginal use of every new $1 of debt. Economic activity will become progressively weaker as the support programs grow by the trillions.

One last thing....

This from Mark Cuban's Blog Maverick weblog on how the reopening is going in Dallas:

This article is part of my LinkedIn Newsletter Series: Indicators and Insights – Perspectives on the Top Financial Market Movers with a View of What's to Come.

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