It’s the most wonderful time of the year. To only slightly paraphrase Andy Williams:
There’ll be parties for hosting
Marshmallows for toasting
And frightening kids don’t you know
There’ll be scary ghost stories
And tales of the gories of
Halloweens long, long ago
It’s the most wonderful time
Yes the most wonderful time
Oh the most wonderful time
Of the year
There’s nothing quite like the combination of that crisp chill of fall in the air, the sight of millions of leaves dying a fiery death (because of the colors, not because they’re in California), and the earthy scent as they start to decay and crunch underfoot for raising the spirits. Figuratively. But also perhaps literally.
We’ve been doing a little reading on the history of Halloween this season, and it’s fascinating to trace the evolution of the perception of the holiday.
In the early days, Halloween reflected an interesting confluence of death and plenty. On the one hand, it was a time of change and loss (of birds, leaves, flowers, light, and warmth) and cold, hard truth; but on the other it was a feast day dating back to the 9th-century Catholic church and the end of the farmer’s year. Flocks were gathered, larders were stocked, the homecoming of seasonal laborers was celebrated, and for the farmers (aka everybody back in that day), there was finally time enough to enjoy the fruits of their labors over the last seven months. It was only really in the last century that Halloween because synonymous with horror.
It feels like there’s more than a bit of that old Samhain feeling in the markets these days, no? The S&P is at all-time highs, yet the specter of recession has been lurking just around the corner. Death and plenty indeed.
And, there’s something strange going on underneath the surface of the markets right now as well.
Specifically, the overnight repo markets. No worries if this is the first time you’ve heard of such a thing - just think bank-to-bank short-term (overnight) lending. Collateralized lending, no less! Remember earlier this year when we were going off on negative interest rates and asking how much you would charge to lend money to the government of Switzerland for 30 years? Similar question: what would you charge JP Morgan to lend them money overnight - just one night - AND they’re giving you US treasuries as collateral against their loan?
Well, on September 17th, that rate blew out to 10%. This was the largest move ever, and brought the rate to levels not seen since back when 3-mo bank CD’s paid 18% (yes, that happened).
In short, this means there was a massive liquidity issue in markets. The Fed stepped in immediately and started offering their own Repo Facility to provide liquidity to the market. It was blamed on end-of-quarter issues and a pending tax deadline (October 15). Here’s a timeline of what has happened since then:
9/17 - Fed announces Repo operations “today and tomorrow”, something that hasn’t happened in over a decade. Repo is oversubscribed.
9/19 - Fed extends Repo operations until 10/10. $75B available in overnight liquidity and $30B available in term liquidity.
10/4 - Fed holds an unscheduled meeting and extends Repo operations until 11/4. Whoops! So much for it being an end-of-the-quarter issue.
10/11 - Fed extends Repo operations until Feb 2020. Also restarts Treasury purchases of $60B per month. Whoops! So much for it being a tax deadline issue.
10/23 - Fed expands overnight Repo to $120B and term Repo to $45B.
So. You’ve got the Fed now giving the markets $270B in liquidity every month. But don’t call it QE! Because Powell said so. Compare this, however, to QE1 ($100B/month), QE2 ($75B/month), or QE3($40B/month increased to $85B/month). What the Fed is doing right now is larger in scope than QE’s 1-3 combined! But if you don’t call the devil by name, he won’t know you’re talking about him, right?
Now, it is a bit of an open question as to whether this will be trick or treat for the markets. We make fun of Powell for saying that QE4 isn’t QE4, but he’s not technically incorrect - if the liquidity provided by the Fed is needed for day-to-day operations, then it shouldn’t have the same effect as the kind of surplus liquidity that sloshed around for the last decade from QE’s 1-3 and drove up asset prices.
Markets seem to have reacted positively in the short-term, in that the S&P has finally broken through the 3000 resistance level to new all-time highs. However, it’s still against a backdrop of falling earnings expectations and really disappointing (though still positive) manufacturing numbers. Over in Europe, you have what can only be described as irrational behavior in the markets.
Companies that beat their earnings guidance this quarter are up, on average, 3% on the news, which is the highest on record. Companies that miss their earnings guidance this quarter are also up, on average 0.6%, which is also the highest on record, and absurd. That tells us that either the market had priced in a much more negative outcome, or people are just buying anything they can get their hands on ahead of further anticipated central bank-induced market levitation.
We have long maintained that markets are propped up in large part by faith in the Fed, and that a loss of that faith will be much more problematic for asset prices than any potential recession down the road. Keep in mind that the Fed was actually cutting interest rates through the last two bear markets, so there’s no real good rationale for the currently held Pavlovian investor responses to Fed action.
What happens, we wonder, when people realize that the spells of the Fed might not actually work? When “QE” becomes the equivalent of “Croatoan” in AHS: Murder House? Well, that’s when “treat” becomes “trick...and nobody wants to be the last one out of a haunted house.
About the Blog:
Here lives our collection of newsletters, articles, and some occasional guest posts by outside authors (where indicated) who have quoted us. If you're interested, feel free to browse through the archives here.