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David Rosenberg: Don’t fight the Fed? Why investors should be wary of market manipulation


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David Rosenberg: Don’t fight the Fed? Why investors should be wary of market manipulation

All I hear over and over again is, “Don’t fight the Fed!” It has become the most overused refrain in the business. Yes, yes, the legendary Marty Zweig is said to have come up with that glib remark, but it was in the context of buying into an undervalued and oversold market when the U.S.…

David Rosenberg: Don’t fight the Fed? Why investors should be wary of market manipulation

All I hear over and over again is, “Don’t fight the Fed!” It has become the most overused refrain in the business. Yes, yes, the legendary Marty Zweig is said to have come up with that glib remark, but it was in the context of buying into an undervalued and oversold market when the U.S. Federal Reserve was pumping the system with liquidity in the latter stages of a recession.

What we have now is nothing short of market manipulation. Reducing the cost of overnight funds is one thing. Extending the intervention to Treasuries or high-quality securities is something we became accustomed to in the aftermath of the last Great Recession. That’s when the Fed became a duration bond manager.

But the central bank is now becoming a hedge fund. Adding low-quality corporate credits to its balance sheet is a whole different game: keeping zombie companies alive, rendering fundamental analysis and price discovery obsolete, and leading to a complete misallocation of resources.

Capitalism has taken a semi-permanent vacation. AWOL. And what it means for the future of society, to be running such reckless and feckless fiscal and monetary policies, is troublesome to say the least.

That is, if you believe in the famous Larry Kudlow thematic of “private sector capitalism.” Actions built on such collective guilt at the government level have created moral hazard beyond belief, blowing a massive hole in the fiscal purse and jeopardizing the sanctity of the central bank balance sheet. There is zero chance this ends well. Societies that run their policies on such guilt truly are doomed, and that is what historians will be writing about in the future.

To have put fiscal policy in a position where people who weren’t even unemployed get a taxpayer-funded benefit is nicht gut. And has American exceptionalism now come to include a policy proposal being bandied about that would have the government actually give people an incentive payment to go back to work? Isn’t that the role of the actual paycheque? Taxpayers be damned. Or will the Fed continue to circumvent the 1913 Federal Reserve Act and operate on exigent (force majeure) escape hatches and head towards outright debt monetization?

We have people who are unemployed but making more money not working than when they had a job. The incentive system has been destroyed, not by the pandemic, but by the pathetic government response, every step of the way (which will likely cost Donald Trump his job this November — don’t shoot this messenger, just look at the polls — all of them).

Having blown the entire situation by being ill-prepared (seriously, calling this a “flu” early on?), and then dragging its heels in understanding how severe the situation was, the public sector then went nuclear and shuttered 80 per cent of the economy that was deemed “not essential.” That such a huge part of GDP is “not essential” is another matter to discuss at some point too — how did that ever happen? — though it explains the past decade having the weakest productivity growth on record.

And what sort of society has more than half the household sector, at a time of full employment, without sufficient cash on hand to withstand two or three months of a lockdown?

In any event, all anyone needs to do is read Jay Powell’s pathetic response to Bloomberg’s Mike McKee last week (the very last question), which was what the Fed chairman thought about its role in recreating a bubble-like investment climate. The answer sounded more like it came from a social worker than a central bank chief. For sure, Jay, creating bubbles is a great way to fight a recession that was induced by a spreading virus and a government-enforced lockdown.

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Here’s the Powell green light for investors: “The concept that we would hold back because we think asset prices were too high … what would happen to the people we’re supposed to be serving?”

Godfather, what can I do? What can I do?

The real bubble is in the corporate credit market, but, of course, all these segments of the capital structure are all correlated with each other. How is it that car rental giant Avis Budget Group Inc., with a junk-rated balance sheet, could have its US$500-billion five-year issued at the beginning of May now trading at 113 cents on the dollar? Viking Cruises Ltd. has its US$675-million bond trading at 14 per cent above par. Would you really buy that? Somebody is. Don’t fight the Fed, right.

How about Ford Motor Co., cut to junk in March, floating a 10-year note in April with the Fed’s backstop, and the bond is selling now at 122 cents. Come again? Intel Corp. is as solid as it comes, to be sure, but its 40-year long bond was trading at 110 cents and a five-per-cent yield at the time of issue just prior to when the Fed’s sweeping measures were announced three months ago, and has been bid to 114 cents on the dollar — the yield is down to three per cent. For an A+ rating? For super-duper maturity in a deep cyclical sector?

Same thing for Morgan Stanley: its US$2-billion 30-year issue, launched on March 19, is now trading at an eye-popping 48 per cent above par; the yield has collapsed to 3.1 per cent from 5.6 per cent — 3.1 per cent for a BBB+ rated 30-year bond. Has the default risk on such a long-term piece of corporate paper really been cut nearly in half in the span of three months?

This market is rigged, pure and simple. So why shouldn’t equities command the richest multiples since the dotcom bubble of two decades ago? But just remember that the bubble came crashing down, and there was nothing the Fed could do about it. Fighting the Fed from late 2000 to the fall of 2002 was probably the wisest thing anyone could have done back then.

David Rosenberg is founder of independent research firm Rosenberg Research & Associates Inc. You can sign up for a free, one-month trial on his website.

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