Fed Says Might Be in Recession Already, 20% 2Q GDP Drop

Vito J. Racanelli

At least for the very short term, as in one week, it seems the Federal Reserve bazooka worked to help calm financial markets, which continue to be in turmoil over the spread of coronavirus. For those who need a reminder, the Fed lowered the benchmark funds rate effectively to zero and made itself ready to lend as needed, through the purchase of nearly $1 trillion in Treasury and mortgage securities. (For more on the opening of Fed coffers, pls see page 6 of the previous issue, March 21.)

Of course, part of the credit for last week’s bounce in U.S. equities must be given (or should it be blamed?) on the U.S. Federal government, which like the Fed the week before, has also opened the spigots of government largesse with a $2 trillion rescue plan. I say blame not in gest. U.S. debt is ballooning to levels few thought possible just a few months ago. How this debt will be paid is hard to imagine, though you can be sure the politicians enacting it now won’t be paying for it. It will be the next generation.

On NBC’s Today show Thursday, Federal Reserve Chairman Jerome Powell said the U.S. economy “may well be in a recession.” He immediately followed that up with a notion the central bank is taking unprecedented action to help ensure economic activity can resume as soon as the coronavirus pandemic is under control.

“When it comes to this lending, we’re not going to run out of ammunition. That doesn’t happen,” Mr. Powell said. He said it was possible that for every dollar in support for lending that the Fed receives from the Treasury, it could extend up to $10 in new loans. Am I the only one scared by such a comment?

Federal Reserve Bank of Dallas President Robert Kaplan warned Friday in an interview on Bloomberg TV, that the U.S. gross domestic product could shrink by around 20% in the second quarter, on an annualized basis. “The unemployment rate could peak in the low-to-mid teens, but we would expect that would quickly decline, we would hope to 7% or 8% by the end of the year,” he said.

In any event, last week yields on short term Treasury bills fell into negative territory for a few days, meaning investors are paying the Feds to hold their cash. This is a strong sign of investor fear. Negative yields have become commonplace in Europe and Japan. Nevertheless, one good sign is that the U.S. Treasury 3-mos.-10-yr. yield curve remains near its widest since November 2018. A steepening curve could portend an economy that will recover for the 1Q-2Q expected decline.

Finally, the Fed asked BlackRock (BLK) to manage the tens of billions of dollars in bond purchases that the Fed will do, including, agency commercial mortgage-backed securities secured by multifamily-home mortgages on behalf of the New York Federal Reserve. The Fed will determine which securities guaranteed by Fannie Mae, FNMA 4.40% Freddie Mac FMCC 3.31% and Ginnie Mae are suitable for purchase. BlackRock will execute the trades. Do you see a potentially controversial conflict, given its status as the biggest ETF provider and institutional investor in the universe? I do.

The yield on the benchmark 10-year U.S. Treasury note was 0.68%, vs 0.85% one week previous.

Upcoming FOMC meeting on April 28-29. Seems like a long way away.

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Vito J. Racanelli
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