Top 10 Macro Charts of the Week

As we have learned over the last few weeks, it is much easier to make a call on the state of the economy than it is to call the direction of the equity market. You don't have to be a genius, or even an economist, to know that global GDP is taking a massive hit. Almost every article describing an economic data release begins with a sentence like: "Worst drop in _____ since the financial crisis."

The bond market gets the joke. Short-dated interest rate futures are priced to reflect a Fed that will keep interest rates pinned near zero for the foreseeable future. The high-yield bond market is anticipating a nasty turn in the default cycle. But the stock market? It appears to be pricing in a scenario where the economic activity (and consumer behavior) quickly reverts back to normal and the massive stimulus measures in place will more than offset any permanent demand destruction. Possible? Yes. Probable? No.

This week's commentary includes a mix of observations on everything from recent global growth data, an update on the utilization of the Fed lending programs, and more.

No Surprise: US GDP Heads Lower

At the end of last month, the NY Fed began publishing its Weekly Economic Index (WEI) to measure real economic activity at a weekly frequency. It tracks ten daily and weekly economic indicators, including same-store retail sales, an index of consumer sentiment, initial unemployment insurance claims, an index of temporary and contract employment, a measure of steel production, a measure of fuel sales, and a measure of electricity consumption. Currently, the index suggests a “real-time” decline in economic activity of 10.9% vs. the full Q1 official GDP of negative 4.8%. The index is released twice per week, on Tuesdays and Thursdays on the NY Fed website.

Record European GDP Decline

Official Eurozone GDP figures were also released last week, and as grim as the data looks, it is likely to get revised down even lower. Eurozone GDP fell 3.8% in Q1, the biggest quarterly drop since the financial crisis. The ECB is also making another attempt to boost lending by lowering the interest rate on its targeted longer-term refinancing operations by another 25 basis points to 50 bps below the deposit rate. With 30-year swap rates below zero, it is hard to believe the economy needs lower long-term rates for economic stimulus.

Global Fiscal Thrust

With monetary policy seemingly reaching the limit of its effectiveness, the onus is on governments to step up with fiscal stimulus, a challenge they are embracing wholeheartedly. The fiscal impulse (change in primary budget balance excluding interest payments) in the US, Euro area, Japan and China far exceeds that provided during the last recession. More spending means larger deficits. The IMF expects the world’s gross fiscal debt will grow to 96.4% of GDP this year from 83.3% in 2019. In advanced economies, it is projected to grow even more, climbing to 122.4% from 105.2%. 

Fed’s Lending Facilities Still Mostly Idle

Only a small part of the Federal Reserve’s emergency lending facilities has been drawn so far. Unsurprisingly, initial demand for aid was focused on the Paycheck Protection Program where loans could be forgiven if certain terms were met. According to Oxford Economics, only $89 billion of the lending facilities have been utilized. On Thursday, the Fed announced a relaxation of some of the criteria for the Main Street Lending Program to make more businesses eligible. Some programs, such as the Commercial Paper Funding facility, are unlikely to expand much further in the current environment given market spreads are now considerably lower than the spread offered via the Fed.

CP Market Spreads Normalize

The Commercial Paper Funding Facility purchased its first CP on April 14, roughly three weeks after the term sheet was released to the public. As of April 23, the total amount bought by the Fed was just $249 million. For top-rated CP, the Fed will pay 3-month OIS + 110 bps, and for lower-rated paper, the Fed will pay OIS + 200 bps. Secondary spreads have since tightened, with CP now trading at a spread of just 26 bps over T-Bills. The flood of cash pouring into money market funds is helping compress short-dated paper. Money market funds have taken in nearly $1 trillion in the last two months.

Bigger Balance Sheet, More Profits at the Fed

Regardless of exactly how much of the various credit facilities are utilized, it is clear the Fed’s balance sheet is going to expand. Estimates are for the central bank’s balance sheet to balloon to around $10 trillion, or roughly 45% of GDP. The combination of more assets and a lower IOER rate will translate into higher profits at the Fed, which ultimately will get remitted back to the US Treasury. Assuming a balance sheet of $9.2 trillion in 2021 and an IOER rate of 0.1%, we project the Fed will net approximately $140 billion in profits in 2021 from the various lending programs and asset purchases. To put things in perspective, the entire US banking system had net profits of $233 billion in 2019.

I wrote a more detailed article on Forbes that goes into more detail on how and why the Fed can generate such massive profits. You can read the article here:

Profits From Fed Balance Sheet Expansion Could Top $140 Billion

Options Traders See More Downside Risk in Copper

Copper, which is used in everything from electronics to electric vehicles, has gained more than 4% this month on signs that the health crisis is beginning to ease. Factory activity in China is increasing as more businesses resumed work. Options traders, however, are pricing a higher chance that copper prices will fall over the next three months than continue to rise. Implied volatility for 3-month call options is trading at a 3.2% discount to put options, the largest discount of the year, despite the recent change in risk sentiment.

100-Year Bonds: Some Good, Some Bad

A hundred years is a long time, especially when you are lending money. As we have seen over the last few months, anything can happen, making such long-term credit assessments very difficult. That has not stopped countries from taking advantage of investor appetite for yield and duration. Investors that bought Austria’s 100-year bonds that mature in 2117 are sitting on substantial capital gains; the current bond price is trading at a $92 premium over par. Investors in a similar maturity bond issued by Argentina are not so happy; it is trading at a dollar price of less than $25, and Argentina is expected to default on its debt in the next few months – just four years after the bonds were issued.

Fixed Income ETF Returns

Equities are not the only asset class to rebound in April; most fixed-income markets also performed well. HY emerging market debt posted the highest one-month return of 7.7%, followed by long-dated investment-grade corporate bonds at 6.86%. IG and HY municipal bonds, however, posted losses as investors grow concerned over the health of state and local governments.

Used Car Prices Plummet

In a sign of further distress in the auto sector, Hertz said on Wednesday it was in talks with its creditors to avoid defaulting on debt related to its rental vehicle fleet, after skipping a payment that was due on April 27. Hertz, like other car rental companies, is suffering from a drop in revenue due to travel restrictions. It is also getting hurt from a plunge in used car prices. The Manheim used car price index fell 11% over the last month, the largest drop since the index was started. The prior decline record was 5.5% in November 2008. While the decline in wholesale used vehicle prices so far in April is historic, retail prices appear to be holding steady.