Leverage, Capitulation and MMT - March 24, 2020

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May not be Sufficiently Liquid to Meet Demand”

Back in July, we were watching leveraged loans. Specifically, a Bank of England Financial Stability Report warned of potential problems in the sector. In addition to investors “not being compensated for the risk they are taking”, they predicted that “large-scale redemptions from open-ended funds could amplify price falls”. Moreover, “non-bank investors have significant holdings” of leveraged loans. As the New York Fed had explained in an earlier research note, the “migration of leveraged lending” was due in part to regulatory guidance, with the ultimate outcome that the “nonbanks’ volume of leveraged lending… more than doubled”. Fast-forward to today, and the chickens are coming home to roost. As discussed in an article in the Financial Times, even US bonds, “one of the safest, most easily traded financial assets in the world” is facing a liquidity crisis amid a “stampeded for the exits”. The Fed has taken an ever-increasing number of steps to try to head of liquidity problems and has announced a whirlwind of ancronym-worthy programs to “provide powerful support for the flow of credit to American families and businesses”.

“We have not seen Capitulation”

Despite the alphabet soup of vehicles, facilities, and programs the Fed is throwing at credit markets, Scott Minerd of Guggenheim warned in a recent research note that he sees “a number of trouble spots” that still remain. In addition to a potential $1 trillion of investment grade bonds that “are in danger of being downgraded”, the “asset securitization market is essentially not functioning”. And, while premiums on junk-rated credit have hit the highest levels since 2011, as covered in an article from Reuters, “securitization tourists” have yet to capitulate, hanging “on to positions and hope”. Minerd, “an optimist at heart”, believes there will be “announcements of additional programs and changes in operating procedure at the Fed” and ultimately believes the Fed will have to “keep the liquidity spigots open for a long time”.

“Ich bin ein MMTers”

There is one potential downside to all of this money sloshing around. As a CNBC segment tweeted by Warren Mosler discusses, the Fed could “punch a button and create trillions”. But the “infinite balance sheet” is “attenuated by the possibility of inflation on the back end or the difficulty the US government could have in selling debt”.

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