CORONAVIRUS, FEAR & THE FED

President Trump Should Make Nice with Jerome Powell

By John Lekas, Leader Capital

The fear of the economic effects of the coronavirus is spreading far faster than the bug itself. Big headlines blared over the weekend that the virus now had infected more than a hundred thousand people and killed fewer than four thousand of them, so far.

This, on a planet of seven and a half billion people. But what does context matter when we are in the middle of a market meltdown and wild bouts of viral volatility?

The Dow fell 6% in the first 90 minutes trading on Monday, a plunge so sickening that trading curbs kicked. Profit-taking, unalloyed fear, the coronavirus, and plunging oil prices (which usually should be a good thing) are combining in an ugly cocktail.

At first, I was optimistic that coronavirus was overblown as a news story, and its impact would be limited. At my firm, which runs a half-billion-dollar bond fund, we scour the numbers of new cases compared with the mounting number of cures. I have been confident that coronavirus cases would peak in March and subside. Not to worry.

I still believe the virus will peak and fade, in retrospect it will be a lesser event—but it now is clear that the virus’s adverse economic effects are taking hold, anyway. Now that coronavirus is a global meme and menace, the damage to growth, business, supply chains, consumer purchasing and more now is locked in—even though the bug itself is far less lethal than some have feared.

For evidence of this, look past the stock market, which has been so wild and is too emotional and melodramatic at times like these to make any sound, thoughtful forecast on the economy.

Look, instead, at the bond market and the yield on 10-year Treasury notes.

The course of ten-year Treasury rates is a predictor of GDP: if the yields are low, economic growth will be low. To me, the latest plunge in yields means that GDP growth in the U.S. could fall below 1% next year and beyond. That would be only half of the so-so 2% growth that GDP has been logging for a decade.

In terms of stock prices, we now believe the S&P 500, at 2785 on Monday morning, is more likely to fall below the 2600 low that we had forecast as the downside risk at the start of this year. Maybe more. Strap in and hold on to your hats.

Last week, ten-year yields fell to an unprecedented low of 0.6% and change. That is vastly lower than rates went in 2008-09 after the collapse of Lehman Brothers and the ensuing Great Meltdown, which, arguably, was a deeper and scarier crisis.

Yields plunged because frightened money fled stocks, which were are record highs, and retreated into safer government bonds, sending prices up strongly. When the prices that investors are willing to pay go up for 10-year bonds that pay a fixed interest rate, the effective yields the bonds pay go down.

This latest round of whoop-do-woos is a sign of the volatility we can expect for the rest of the decade. It is why we at Leader Capital have dubbed it the Topsy-Turvy Twenties, as Part One of this series declared.

Given the economic challenges that lie ahead, President Trump will need the cooperation, now more than ever, of Federal Reserve Chairman Jerome Powell. In fact, Powell may be the biggest threat to the re-election of President Trump, more so than any Democrat.

The Fed’s role in helping us get out in front of the virus fallout is limited, surely. It cut rates a surprising half a point last week, and the stock market continued to fall anyway. Traders (and computer algorithms) may have been frightened in part by the Fed’s rather dramatic response: maybe things are worse than we were assuming.

Now would be a bad time for Mr. Powell to decide a few more bubbles need popping.

Now would be a bad time for the Fed head to decide to pull back from the overnight-lending “repo markets,” which might spark the next meltdown (see part 2 of this series).

Suddenly, President Trump needs Mr. Powell’s patience, forbearance, and accommodation. Yet the President has Twitter-tortured his own appointment to the Fed, insulting his intelligence and capabilities.

Even after the half-point cut from the Fed last week, Trump continued to pressure for lower rates, complaining that the U.S. is paying investors far higher rates than anywhere else in the world. The President may have a point, and he might want to express it in softer and more constructive way. Sigh.

President Jimmy Carter lost re-election in part because Fed Chairman Paul Volcker raised the fed funds rate to 20% to tame 10% inflation. George H.W. Bush saw Fed chief Alan Greenspan raise rates from 6.5% to 9.75% in his re-election year and lost to Bill Clinton. President Trump has criticized Jerome Powell far more directly and bluntly than any President before him. Bad idea.

Surely Messrs. Volcker and Greenspan meant no harm, nor does Jerome Powell. It’s just that, it doesn’t matter who gives you the poison, whether friend or foe. You end up just as dead.

Part One: Brace Yourself for the Topsy-Turvy Twenties
Part Two: The Next Meltdown?

This commentary is intended to be general in nature, reflects our opinions and is based on our best judgment at the time of writing. No warranties are given or implied regarding future market activity. This commentary is not intended to be, nor should it be used as a substitute for individualized investment advice. No specific decisions should be made based on this commentary. These opinions should not be construed as a solicitation for any service. Past performance does not guarantee future results.