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This is Starting to Feel More and More Like the Typical Bad Recession

July 13, 2020

Last Week This Morning

  • 10 Year Treasury closed down slightly at 0.645%
    • German bund -0.47%
  • 2 Year Treasury unch at 0.15%
  • LIBOR at 0.175%
  • SOFR is 0.10%
  • ISM Non-Manufacturing climbed back to 57.1, signaling an expansion
  • 31mm Americans lost their jobs last week
  • Trump continues to drain the swamp federal prison system by commuting the sentence of long-time buddy Roger Stone
  • College football is increasingly likely to cancel the upcoming season and I grow increasingly despondent
  • “Cam Newton Scrambling to Get Up to Speed After Patriots Send Him Playbook of Every NFL Team” – The Onion. That’s what a perfect headline looks like.


Fed Balance Sheet – Shrinking?

For the fourth consecutive week, the Fed’s balance sheet actually shrank.  And last week, it shrank by the most in one week in over a decade.  We’re actually below $7T (yay?).

Source: Bloomberg Finance, LP

Much of this decline is not really coming from a drop in QE purchases.  The Fed still bought $18B in Treasurys, over $4B in MBS, and about $750mm in corporate bonds last week.  But all of those numbers are declining, so the Fed’s pace of purchases is tapering (at least until this second wave of covid cases requires more intervention).

Here’s a graph illustrating daily Treasury and MBS purchases since March.  The fact that the Fed hasn’t had to ramp back up to March levels is a good sign.

So why the drop in balance sheet holdings if the Fed is still buying up bonds each week?  The Central Bank Liquidity Swap Lines have contracted substantially.  This is the way our central bank gets dollars (the global reserve currency) into the hands of foreign central banks.  They, in turn, pass along those dollars to their own banks.  During periods of stress, everyone hoards dollars.  So the Fed gives foreign central banks the ability to swap out their currency for dollars, helping to provide liquidity to global markets.  Again, it’s a good sign that the need for these is declining.

Source: Bloomberg Finance, LP

We are experiencing the same here at home.  Remember when SOFR spiked and the Fed had to step in daily with up to $600B in repo intervention?  That market has settled down to the point the Fed no longer publishes daily how much it had to inject.

Source: Bloomberg Finance, LP

After the financial crisis, it took nearly a year before Financial Conditions dropped into “accommodative” territory.  This time around, we got there in about a month.

Source: Bloomberg Finance, LP

What Does All This Mean?

Financial conditions, at least for now, are setting the stage to allow for a recovery.

That doesn’t mean we are out of the woods, not by a long shot.  But we will be able to slowly turn our attention to the underlying economy instead of worrying that financial conditions will seize up and bring everything to a grinding halt.

For me, the biggest issue to watch is labor markets.  Things are so volatile right now it’s impossible to have a firm grasp on where we stand, but permanent job losses are going to continue to climb.

After the financial crisis, the unemployment rate climbed for two years before leveling off and then falling again.  While the pattern will be different this time, the effects will be long-lasting.

Source: Bloomberg Finance, LP

I think this will start behaving more and more like a typical recession as we move forward, and the rebound is years away, not months.


10 Year Treasury

After the financial crisis, it took eight months for the 10 Year Treasury to return to pre-crisis levels.  That would put the T10 back up between 1.50% – 2.00% at year end.

Throw in the uncertainty of an election, and I need to be careful I don’t fall into a complacency trap thinking rates can’t go higher.

Source: Bloomberg Finance, LP


Week Ahead

Inflation data, wage data, retail sales, etc.  Lots of data, but not sure any of them mean much right now.


Click to Open: The Pensford Letter PDF