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2020-

2020-05-17 b
Things fall apart; the centre cannot hold;
Mere anarchy is loosed upon the world,

"the endgame for the current monetary regime"

Goldman Spots A Huge Problem For The Fed

Update: In implicit confirmation of everything said below, in his 60 Minutes appearance, Jerome Powell said that "There’s a lot more we can do. We’ve done what we can as we go. But I will say that we’re not out of ammunition by a long shot,” he said. Powell noted the Fed can increase its emergency lending programs and make monetary policy more supportive through forward guidance and by adjusting the Fed’s asset-purchase strategy. Which, as explained extensively below, is precisely what the Fed will have to do: by as much as $3 trillion in additional QE just to offset the flood of new debt coming to the market in the next 6 months.

And just to remove confusion, there was this exchange which the "pajama traders" appear to have focused on:

Scott Pelley: Fair to say you simply flooded the system with money?

Jerome Powell: Yes. We did. That's another way to think about it. We did.

Scott Pelley: Where does it come from? Do you just print it?

Jerome Powell: We print it digitally. So we-- you know, we-- as a central bank, we have the ability to create money digitally and we do that by buying Treasury Bills or bonds or other government guaranteed securities. And that actually increases the money supply. We also print actual currency and we distribute that through the Federal Reserve banks.

To give Powell the credit, at least he was being somewhat honest: unlike Bernanke who claimed the Fed does not "print" digital bills, Powell no longer felt compelled to make the obvious lie. And judging by the ongoing surge in gold and silver overnight, the market seems to appreciate Powell's honesty.
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In short, even with central banks unleashing $7.9 trillion in QE so far in 2020 (according to Bank of America calculations) of which the Fed accounts for over $2.8 trillion in debt purchases alone, this won't be enough to monetize the tsunami of debt that is coming to fund the biggest global rescue operation in history, and if investors find that suddenly the bond market has to clear without the only true backstop - the central bank - willing and able to mop up all the supply, a critical precondition for the continuation of "helicopter money", the outcome could be disastrous.

Incidentally, we first warned about the urgent need for the Fed to aggressively step up and boost its QE (instead of continuing to taper it by $1 billion week after week as it did again today) on Wednesday when we quoted Curvature Securities' rates strategist and repo expert Scott Skyrm, who calculated that "there are $689 billion net new Treasurys settling during the month of May and $992 billion net new Treasurys settling between now and June 15. Yes, almost one trillion new Treasury securities hitting the market within the next month!"
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Conveniently, Goldman's argument allows us to recycle our conclusion from two days ago, in which we said that here is the layman's version of what was just said: "the Fed has flooded the system with liquidity... and it is not enough, because the way helicopter money works, is that liquidity supply (the Fed), and liquidity demand (Treasury via debt issuance) go hand in hand, and periods of too much supply, as was the cash with the Fed's massive QE in late March and early April, are promptly followed by periods of dramatic liquidity demand, such as the next month when $1 trillion in liquidity will be drained to fund the US government "money helicopter."

Goldman's own calculations suggest that the shortfall net of the Fed's ongoing QE tapering could be as much as $1.6 trillion.

As a result, Powell faces a two-fold problem: since the Fed chair has taken negative rates off the table, Powell has no choice but too boost QE again, and unleash another firehose of debt monetizing liquidity in the financial system. However, any such reversal to the Fed's current posture of shrinking QE will be met with howls of rage, especially among what's left of the conservative political establishment. Which means that, just like in March when the Fed used the first pandemic-induced market crash to unleash unlimited QE, the Fed will soon have to go for round 2 and spark a new market crash, one which it then uses as an alibi for the next massive liquidity injection. Failing to do that, watch as the dollar takes off as markets sniff out that another major dollar squeeze is imminent. And since this will accelerate the liquidity crunch, one way or another, the coming $1.6 trillion in Treasury issuance - which has already been generously greenlighted by Congress - will serve as a trigger for the next market shock, one which the Fed will quickly reverse by expanding the already unlimited QE by trillions on very short notice.

The only question we have is whether this will be the market crash that the Fed uses to unveil it will also buy equity ETfs next, or if Powell will save this final bullet in its ammo for whatever comes next.

Finally, it's not just us reaching this conclusion: yesterday - one day after our dire assessment - Bloomberg reached the same conclusion, and in "An $8 Trillion Spree Sets Clock Ticking for Bonds’ Judgment Day" in which it wrote that "investors are mopping up the sales as long as central banks engage in so-called quantitative easing, buying an unlimited amount of debt to counter the ravages of the pandemic. But at the first whiff of a recovery, or a pullback from policy makers, all bets may be off. Throw in the threat of inflation amid a global fiscal splurge exceeding $8 trillion, and bond investors look set for a toxic cocktail of risks in the not-too-distant future."
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Ironically, this also means that an end to the coronavirus crisis is the worst possible thing that could happen to a world that is now habituated to helicopter money and virtually unlimited handouts, which however need a state of perpetual crisis.

"Once there is an end to the crisis in sight, they will be less and less willing to provide support and it will fall more on the street to absorb paper," said Mediolanum money manager Charles Diebel, who’s adding bond steepeners in anticipation of a coming inflationary supernova.

That, incidentally, would be the endgame for the current monetary regime, which is why anyone hoping that officials, policymakers and the establishment in general, will allow the coronavirus crisis to simply fade away, is in for the shock of a lifetime.

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