Surveillance: Time for Governments to Try MMT?

Is it enough to deliver a circuit breaker for this very volatile liquid market? Yeah? It uh, well we're waiting. Um, you know, obviously monetary policy it was pretty factive, reasonably effective in creating the money market liquidity. Um, you know, maybe going off with a few bumps, but um, all in all I think is it's pretty steady, and so we did learn a lot at the last crisis. Now, of course, all eyes are on fiscal the fiscal policy, and you know, President Trump's talking about a trillion um.

You know, my back of the envelope estimate that is, if if this is essentially call it six weeks of you know, utter stand still, um, than that equates to about call it a two trillion of g D p um. If you assume that maybe third a third of the economy is actually still operating, then maybe this is about one point three trillion um to fill that gap um. And you know, where does it come from? It's possible this could be that modern monetary theory that's been you know,

bouncing around. Well, there's a question about the school response. In the meantime, monetary policymakers have urgently been trying to prevent a financial crisis from unfolding. As the author of a book, Reading Minds and Markets, Minimizing risks and Maximizing

returns in a volatile global marketplace. It was published in July two thousand nine, very apropos At this moment, which is probably the most volatile time in markets in history, I'm wondering, have we actually managed to stave off a financial crisis or the wild moves we're seeing evidence that we are seeing things absolutely spiral out of control on the market side. Well, I think part of the you know, a good deal, I should say, of the selling that's

going on is forced selling. That the fact is that there are you know, I'm going to say probably call it three to four hundred billion of institutional funds managed UM in a programmatic way. Where volatility goes up, risk has to come down UM. You know, if you know, puts get essentially assigned, then the items have to be sold um, you know, and so there there's UH option writing, there's risk parity UM, and then there's just out an out leverage UM, which has been you know, certainly benefited

these managers for the last several years. And I think that's really exaggerated a lot of the moves. Jack, how far in that leverage unwind are we? Do you have a sense of that? I I really don't, UM, you know, just because of these volatile were we still have these enormously volatile sessions. So it's really hard to gauge you know, how much of this is UM you know, is through I would say from a risk parity point of view, you know, does does the VIX get much higher than eighty?

You know, because it's not necessarily the level, it's the direction. Now because assuming that all risperity traders have you know, essentially adjusted to a VIC saved UM, you know, perhaps if it just stays at that level and comes down, maybe most of that behind us Jack, I believe great cat show. You're joining us on the market in the United States just brings a bauchari jasurists today as general head of US Right Strategy, it's a bout of fantastic

to have you with us on the program. Walk us through what you think is the biggest driver right now. Is it people just selling what they can not necessarily what they want. Is it some big technicalish out technically issue out there, the illiquidity that we're experiencing in some really really big parts of the market, or is this just supply risk? What is it for you at the longer end of the curve. Well, I think it's a

combination of all of the above. UM. I think the last of liquidity, in my opinion, is the number one reason for this erratic moves. That would say in treasuries, because it's it's off twenty basis points one day and then it rallies fifteen basis points the next. Um. If you are a corporate bond investor, for instance, you're not able to sell your corporate bonds, you're going to sell perhaps other liquid assets. You have to be able to

meet your margin requirements or other purposes. Um. There's also a lot of UH you know, demand for dollars broadly speaking from a variety of market participants, and and the first thing that they can sell is the most liquid asset they have. The other fact that, like you pointed out,

is also tangible risk of higher deficits. But I, generally and not I would be emphasize the bond vigilante characterization because in my opinion, over time it's the e c B as well as the FED and all global central banks are doing q E. The trajectory has to be for for yields to gradually move lower. So there's been really no correlation in the last you know, two decades between higher deficits and higher treasure yields. There's a question here.

You talk about the fundamentals, you talk about the lack of liquidity. The lack of liquidity certainly has gotten the attention of the Federal Reserve, and they've tried to step in to try to stave that off by buying additional bonds, particularly on the longer end of the curve. Why has

that not been helping more? That's a very very good questions. So, because the lack of liquidity that I'm talking about is has to do with the post crisis regulatory environment where balance sheets for dealers, who are typically the ones that are disinter mediating this risk has shrunk, so they're very very careful about taking on risk um they have both both on the repost side as well as on the cash side, they're not able to rapidly grow their bound sheet. Also,

there's an issue of price discovery. When there's erratic moves in the markets, it's very hard for market makers to be able to know exactly where whereas things straight so they tend to make the bid offers a lot wider than they normally would. And adding to this problem is the fact that people are working from home. There's not that same levels of information flow that you would see in a trading floor that on any given day that

you've seen right now. Bad for somebody who is hearing these words that that that the treasury market is dysfunctional. This is the seventeen trillion dollar market. It's crucial to the entire global market. Can you give a little perspective about just why that is? Just sort of how crucial it is for the volatility in the treasury space to decline in order for everything else to stabilize. I must say I've been in the bond market for over two decades and I've never seen this kind of volatility and

wide bit offers in the in the treasury market. So I think it's extraordinarily important that the treasury market actually functions properly. As you might know, we've had uh you know, flash rallies in the past, and the Treasury has been very closely monitoring PRISA and in the bond market. But you know, the treasury market is your go to market for for safe haven. So if you're an investor that that wants to get out of risky acids and and purchase a safe haven as that you're going to flock

towards treasury. So it's extraordinarily important that this market functions, uh, you know, very efficiently. And you're seeing that this is not just in the in the cash or TC markets. You're seeing a liquidity in the futures market as well, which is which is also somewhat troubling. So about you just to wrap things up on the regulatory side, you mentioned some of the regulation. I just wonder what you

think should be done. We just had a Bloomberg terminal subscriber right into me, and we've had a lot of people writing with some really really good thoughts on things, and I think this resonates with what you're saying. As volume goes up, volatility goes up, the risk managers will force you to shrink the disposition. So in effect, it forces less liquidity every time there's a crisis. So volo up. Guess what risk managers tap you on the shoulder, pull

back your positions. Look it, he gets worse every time we get into this situation and spatial I just wonder what we can do about that, to cut that break, break that link, get a circuit breaker in there. Well, I think that the FAN has done it's part a little bit by providing the primary dealer facility as well as uh, you know, some of the other report facilities that should provide liquidity to directly the primary dealers and

depository institutions. But beyond that, I would argue that the supplementary lavage ratio requirements and the lavagator requirements that have been imposed in the PROS post crisis period has also vastly limited the dealer's ability to be able to take on very large positions. This is also an issue in corporate bonds, where the vocal rule is very much in play.

So there's there's clearly a lot of good rules that were put in place after the financial crisis, uh to avoid excessive risk taking among dealers, but that's also hurting in an environment like this where you have primary dealers are sort of your conduit for disintermediating risk. It's a bauta great to get your thoughts. Thank you very much for joining US avantea Jappi there stay at General's head

of the US right strategy. I want to bring in Nathan Shakes paging fixed income economists and macro economic research and Nathan fantastic to catch up with you. Let's just get your thoughts on a claims number to eighty one direction to travel not pretty. How bad you expect this to get in the coming weeks. Well, I think your folks have really nailed. A seventy uh increase in a week is enormous, and uh, my expectation is that that

narboro will continue to rise. The question is how high and that this is really our first gauge on just how badly the really economy is going to be hit by this saying. And I think you know to me, it feels like we're we're standing on the edge of it best and we just can't see the bottom. This is this is a very scary juncture, Nathan. This is a very scary juncture, and it's a lot of scary. Uh. There are a lot of people who are very worried

about their own financial well being. They are seeing themselves get laid off in mass and there's a question will the jobs return? Do we have a sense of that? I mean, is there sort of a trajectory here where we could see a rapid increase the number of those unemployed and then it all comes back online. So I'm uncomfortable that the jobs will return some day. But that's the problem is we don't know when that day is, uh, And and how do we get from here to there?

That's really the key question now as I say that, that is also a question that fiscal policy can help answer. This is this is where fiscal policy can be the most powerful. So these ideas that are being floated to significantly in freeze unemployment benefits great idea to help these people, Uh, ideas to buffer those that have lost wages, great ideas. And I think at a time like this it even makes sense as they're considering to just mail people mind.

But fiscal policy is going to be the key to building this bridge from where we are today to that someday when the jobs return. Couldn't agree more, Nathan. And at the moment, there's a line that's going around in fact, over the last couple of weeks, perfection is the enemy of the good. We need this fast. It doesn't need to be perfect, we just need this quickly. Do you anticipate this will get done quickly enough to address some

of the issues that you're worried about right now? Mitch McConnell told his caucus there was some pushback on the bill that they approved yesterday. He said, just gag and vote for it and worry about fixing it later. So I think that I think that the Congress, the political system is very much now in a place where we've got to get something done. It's got to be big, and it's got to be quick. And uh, I would expect that we'll see something on the order of a

trillion dollars of fiscal stimulus. Let's stay over the next week or ten days, could even be faster, Nathan. There's also a question about the psychological impact the staying power that that has on an economy When you have tons of thousands, uh perhaps a million people ultimately according to some estimates, who lose their jobs in short order, What does that do to the economy longer term in terms

of consumer spending and saving raids and household formation. I mean, do you have a sense of how long lasting the psychological impact could be? You know, in in some sense, I would say that we are still dealing with the psychological ramifications of the global financial crisis now, more than a decade later. And I think that this app episode that we're going through now again, depending on how long lived it is, how the virus evolved, is going to

leave a signature in people's thinking. And I think it's underscoring to them that the world is a risky place. Now. What exactly that means for the economy going forward, I think is an open issue. But on the margin, I think everyone will for some time be a little more cautious and recognize that there are broad classes of risks, some that are evident, in some that like like this

virus that just kind of emerge out of nowhere. Nathan, We're lucky to have you this morning because your economists that sits around some really really great fixed income portfolio managers like Greg Peters, like Mike Collins, like others over a PGIM and I just wonder when you all bang your heads against each other over the last couple of weeks many times, I'm sure how you're thinking about the

key economic question at the moment. Two weeks ago, three weeks ago, the happy talk of a V shaped recovery still dominated a lot of Wall Street. That's gone really really quickly. Now they still talk of eventually coming out of this okay, But I think the downside risk that we keep coming back to them this particular program is will this episode spark a period of defaults and de leveraging that it's going to stick with us for a

long time and long after this health crisis fate. When you will get together Nathan on that issue, what comes out of the other side of that conversation, Well, h for some time we've been quite worried about about debt levels and the risks that they might pose for de leveraging going forward, and our senses at these high levels of debt are an element that's contributing to these historically low interest rates now obviously right now there's a lot

of crisis related factors that have dragged rates down even lower. But those de leveraging incentives flowing from this recognition that the world can be risky. I think they're with us for quite some time. And uh, and you know that that that V shaped recession that you describe is feeling so last week. You know, this week, I think we're hoping for you, and Uh, I worry the next week we may be thinking more in terms of the now, Nathan, I'd love to dig more into the idea of deleveraging.

John is really right to keep bringing it up. There is a question of how it looks. Does it look like companies being more prudent and not doing as many shared by backs and perhaps curbing certain types of executive compensation, or does it look like bankruptcies and defaults? And those are two very different outcomes. Do you have a sense of that? It depends critically on how severe the economic

circumstances are. If if if we go through a period here where CHDP falls sharply and that continues for several quarters, I think we will see some corporate defaults. I think that that's uh, that's unavoidable against fiscal policy can be helpful in providing a safety net for some of those firms and maybe delaying uh that process. But if this is extended, I think we're going to see firms pushed

to the edge and maybe maybe beyond. If it's a shorter term uh development that we're dealing with here, then maybe firms will have a little bit more time and they can do the gentle kinds of leveraging like you described, of maybe reducing share by backs, um being a little bit more cautious in terms of of mergers and acquisitions policy, maybe being a little more cautious on dividends and that kind of thing. But uh, it depends on where the

economy is headed. But you know, it is pretty clear and even before this episode, that's the corporate it's got the message that they had too much leverage and needed to bring it down. Nthan Now that definitely needs a Nthan Shakes page and fixed income economists great to catch over the knighte and my best to the tame over

a page. There's a question going forward of what stock investors are pricing into the market, and I want to read you this quote from Sam Stovall Chief Investment Strategies a CFR, A research in a Bloomberg News story recently, what most investors are worried about is that a recession is a foregone conclusion, and what we don't know is the severity of the recession, whether it will be another great recession or a shallow swoon. Sam joining us now by phone, Sam, can you give us a sense right

now of what stocks are pricing in which of those scenarios? Well, good morning, Lisa and Paul. I guess the question could be what stocks are not pricing in the worst case scenario? UM. A lot of people want to know just how bad could it get? And if you look to valuate, and you look to the fact that even though SMP capital i Q consensus estimates are still pointing to a positive two thousand and twenty UH, it's down from a near

eight percent growth at the beginning of the year. And if you look to recessions since World War Two, basically we have seen on average about a ten percent decline in earnings. So if we were to see a hundred and forty eight dollars on the SMP five hundred, not a hundred and sixty eight dollars and if we went down to a pe of ten times, which is where we went in two thousand and eight, one could make the case that we end up with a fifty six percent bear market, so rivaling that of oh seven through

oh nine. So how much further do we have to go? Well, looking at those kind of numbers, you know we're down right now, so it's almost a doubling of what we've declined. All right, Sam, So what are you thinking about? You've been in the mar It's a long time, Sam, give us. I mean, this is clearly unprecedented times pandemics. This is nothing we learned in business school. This is nothing we've seen in markets before. What is your gut view of kind of what's happening out there? Well, good, good way

of asking that. I think investors should embrace history over hysteria. UM. When I look to what has happened in the past, we went from a all time high to the to climb threshold in twenty two calendar days, which was almost twice as quick as the second most rapid decline UM history would then imply, but not guarantee, that UH swift tends to be shallow that on average, those bear markets that did occur the most quickly ended up being down anywhere from down to the UH just barely a bear

market registration. Also, when I look to a rolling fifteen day percent change change in the intra day high and low of the market, we are second highest only to October late October of two thousand and eight. So we surpassed the U. S. Treasury debt being downgraded in two thousand and eleven. We surpassed the capitulation that took place UH in the end of the O two bear market UM. And basically, I think we're at an extreme in terms of volatility, which could imply that we are probably close

to this crescendo bottom. Yeah, essentially you mentioned the volatility. I'm just looking at the VIX on my Bloomberg terminal screen here eighty one point six seven. Just extraordinary levels on the VIX. So Sam, to the extent that you know, let's look towards the the other side of this virus pandemic crisis. Where where do you think investors when we do get there, where should they be looking? Initially? Well, the first question is what makes think that we could

actually be getting close to a bottom? UH. Well, first off is from an economic perspective, we're still only calling for one quarter of GDP decline. Of course, it's going to be a steep one. We think that when the numbers finally come out, will be up one percent in the first quarter, mainly because of a lot of hoarding

that is being taking place. Second quarter, however, we're going to take it on the chin with a five percent decline, but then see a dramatic bounce up six point four percent in Q three and four point four percent in Q four. UM looking to a simple screening of those companies where we have BY or strong BY recommendations PE ratios below that of the market, yet have high SMP earnings and dividend quality rankings meaning consistency of raising earnings

and dividends. You've got a lot of names that are fairly comfortable with investors. Comcast, Disney, General Mills, Tyson, Amera, Prise, CBS, Health Cor, etcetera. Uh So these are companies like if you're an investor who wants to wear both a belt and suspenders. Uh these could be goodbyes going forward. If, however, you say no, I want to go for those that have fallen the most, because history says those that were

worst end up becoming first. Uh. That is true that when the bottom does occur, usually those priced to go out of business but did not are the ones that tend to recover the most. We're speaking with Sam Stove, all c f R, A chief investment strategists, and here we were basically flat, certainly on the NASDAC when we opened, but seven minutes into the trading day here in New York,

and we see the gravitational force is lower. The SMP now down one point ninety two points is the level there, the nastack down eight tens of a percent at sixty two, And we're looking at at this sort of uncertainty Sam, that you're talking thing about about the depth of the potential recession, about just how long lasting it will be, as well as which areas are going to get hit hardest. And I'm wondering on the other side of this, and I do want to focus on that, just because markets

do try to price in some sort of future. Um, do you have a sense of which companies, which sectors are likely to emerge first? Well? Uh? In their market environments. Uh. It's traditionally your defensive that hold up the best. So UH, consumer staples healthcare. UM. You know, when the going gets tough, the tough go eating, smoking and drinking and if they

overdo what they have to go to the doctor. On the flip side, however, it's usually the cyclicals that tend to be the outperformers industrials, financials, technology that tend to be those that lead on the re emergence of optimism. So you know, I would tend to say, look to those quality companies UH in each one of those more cyclical sectors, and they're the ones that are likely to lead us out. What about big tech because that was the main driver ahead of this downturn UH for for

equity valuations. Do you think they'll continue to lead? Um, Yes, I do. I think when you look to technology right now, SMP capital i Q is pointing to only a one point three percent gain and earnings in two thousand and twenty. Yet tech is still expected to be up about seven and a half percent, the best by far of any

of the other sectors within the five hundreds. So looking at relatively low PE ratios for the sector, UH technology now trading at seventeen four versus fourteen four based on two thousand and twenty estimates, tech is one of those four sectors that is trading at a double digit discount to its relative pe over the last twenty years. Sam, what do you make of the fiscal us we're starting

to hear about coming out of Washington. Do you think is that kind of in line with where it needs to be or do you think we need even more Well? I think that we need to be putting a lot of money back into the system as quickly as possible. Certainly, you know many are complaining that it's not being done quickly enough, but I tend to think that, based on how slowly Congress usually works, that this is pretty much

light speed for them. Um. I think that the fiscal stimulus won't stop any near term margin call induce selling, but it would definitely offer a subsequent springboard to a recovery. Sam, So, I guess I just want to just clarify if you are you kind of in that V shaped economic scenario where we're gonna have one down quarter and then pick it right back up. Yes, that's where we're leaning now,

but it's obviously a very fluid situation. Our belief was that back in just before the first US case of COVID nineteen was reported expectations were for about a two point four percent game in the second quarter g d P. Then it went down to one and a half two and now it's five UM. But still it is a one quarter decline with a very sharp recovery in two three. But obviously those numbers are subject to revision. Sam Stobal, thank you so much for being with us c f R,

a chief investment strategist. Thanks for listening to the Bloomberg Surveillance podcast. Subscribe and listen to interviews on Apple Podcasts, SoundCloud, or whichever podcast platform you prefer. I'm on Twitter at Tom Keane before the podcast. You can always catch us worldwide. I'm Bloomberg Radio.