Monetary policy April 2020

A flood of liquidity means financial markets have detached themselves from the real economy. How long can this continue?

Market impact of terrible economic data is being more than offset by extreme monetary stimulus

While nearly 16 million Americans (approximately 15% of the US workforce) have lost their jobs, several stock indices have posted record returns. Indeed, during the five days to March 27 the Dow Jones Index had its best week since 1938.


Everyone gets a bailout

Zombie companies, zombie countries, over-indebted companies, companies with economically unsustainable business models – the Fed is trying to save them all with huge bailout packages. Governments are also launching ever larger fiscal rescue packages. To what extent these rescue efforts will ultimately succeed is unclear. The same “exercises” take place in Europe, Japan and most other countries. Among central banks, the Fed is by far the most aggressive.


The Fed surprises even those who have come to expect the extreme

On Thursday, April 9 the Fed announced an additional $ 2,300 billion in “credit support measures”, which include purchasing mortgage-backed securities and high-yield bonds. Thus, the Fed is moving towards becoming a general supplier of corporate credit, taking on the role of the banks and distributing billions of dollars at zero interest. In the US Federal rescue, the Fed and the Treasury appear to be merging into a gigantic planning authority. With the state now taking over large parts of the economy, market mechanisms are increasingly eliminated. Markets aren’t free when risks (including losses) and gains are “forcibly separated”.


“Whatever it takes” …

…. the Fed and the Treasury are doing all they can to stop stocks and bonds from falling, with even additional measures being threatened to prevent a negative wealth effect. This fits with the political message of the Trump Administration: “No one else is so good for the stock market. Vote for me and stocks will continue to rise”.

The Fed has announced that it will buy assets (including very risky ones) to an unlimited extent. It also suggests it would prefer to remove shares and bonds from private ownership rather than preside over falling asset prices. As a result, the financial markets are no longer markets in the strict sense as they can no longer exercise their signaling function. Economic misconduct goes unpunished and the owners of capital receive strong protection. All the while, protection for the unemployed is much less pronounced.


Our “moral hazard” overlord might express himself like Yoda from Star Wars as follows:

“Preventing Schumpeter’s creative destruction and saving zombies is a natural concern of the “dark side”…errm, the central banks.” Meanwhile, George Saravelos, head of Deutsche Bank’s FX Research, writes: “In a matter of weeks, policymakers have become the backstop for private-sector credit markets. At the extreme, central banks could become permanent command economy agents administering equity and credit prices, aggressively subduing financial shocks. It would be a bi-polar world of financial repression with high real economy volatility but very low financial volatility”. In other words, a ”zombie market”.


The positive: the fight against bankruptcy could be (partially) successful ….

…. if isolation measures can be eased in coming weeks and months. The data are still not wholly clear, but infection growth rates have declined in most regions and countries thanks to the measures undertaken thus far. Meanwhile, the number of those needing intensive care is falling in many countries. It seems plausible to us that the global economy can be “fired up” in the next few months, especially if sufficient protective masks are available and healthcare system capacities (in terms of medications, intensive care units etc.) become adequate. Indeed, there are encouraging signs on these issues and many countries now plan to phase out their isolation measures.

Also, today’s central bank “puts”, whereby investors are shielded from losses, could also be viewed as a positive for markets, at least in the short term.


The negative:

“Moral hazard accidents”, the elimination of market prices as indicators of scarcity, the takeover of large parts of the economy by “state planning authorities” will all lead to a more inefficient economy and thus to dramatically lower growth trends.

Rescue measures, enabling the preservation of massive wealth for the few, will have to be financed by society as a whole, something which will greatly increase inequality.

Many voters will think as follows: “Work doesn’t pay but investment surely does. While jobs aren’t being saved, investors get to keep all the profits they have made from their past investment decisions”.

Today’s obviously unfair situation risks sending voters to the political extremes, both on the left and the right. Many voters will blame their poor circumstances on the market economy and will seek to punish investors and the financial markets. In truth, it is the overriding of the market economy by government “asset pricing institutions” that has fueled inequality. But we don’t expect most voters to accept this.


Oil prices aren’t stabilizing despite the recent oil producers’ agreement

OPEC and other oil producing countries have agreed to cut production by 10% (twice as much as was agreed during the 2007/8 financial crisis). So far, the oil price has so far hardly benefited, tending to move sideways. Higher oil prices are needed to save large parts of the oil industry and we expect further measures to support this.


Might shares also be about to fall sharply?

Investors’ fear of missing out on this government-driven rally rises with each day that stocks go up. On the other hand, as they have no insider access to the decision-makers, investors are also afraid of what the Fed might unilaterally decide to do next. Which companies and sectors will enjoy the grace of being saved and which not? Which institutions enjoy the Fed’s favor? Hedge funds with fewer than 500 employees?

It is unclear whether the Fed will be able to prevent sharp falls in the prices of stocks, bonds, real estate and “other” assets in the long, or even the medium, term. For one thing, the decline in global GDP in the first six months of 2020 is set to eclipse all records since World War II. This fall in economic activity implies a very sharp drop in corporate earnings. Second, it is also completely unclear whether the prices of risky assets (stocks, junk bonds, etc.) are currently above, below or near the “minimum price targets” known only to central bank insiders. Moreover, the Fed, the ECB, the BoJ and others will not want to fire all their ammunition at once. A further risk, now that the state is already subsidizing capital, is that a subsidy for labor financed by higher (corporate) taxes could follow, which would weigh on profits. Finally, there is little information as to the extent to which companies will be affected in terms of their profits outlook. Our conclusion given all this is: Yes, stocks can certainly fall!


We therefore stick to our strategy of tactically underweighting stocks and overweighting gold. As a “safe haven”, gold could benefit from the prospective sharp rise in indebtedness, possible instabilities in the financial system which may result from this, as well as the risks of “currency debasement”. Elsewhere, we believe convertible bonds offer an attractive ratio of risk to reward.



Contact: Thomas Härter, CIO, Investment Office
Telephone: +41 58 680 60 44

Disclaimer: The information and opinions in this document come from sources that are considered to be reliable. Nevertheless, we cannot guarantee the reliability, completeness or accuracy of these sources. The information and opinions in this document do not constitute and shall not be construed as a solicitation, offer or recommendation to purchase or sell any investment or to engage in any other transaction. We urgently recommend that interested investors consult their personal investment advisor before making any decisions based on the document so that personal investment objectives, financial situation, individu-al needs, risk profile and other relevant information can be duly taken into account in conjunction.