Equities rose sharply on the back of another big announcement from the Fed. Liquidity-driven markets play into the hand of emotion, rightly or wrongly. But labour market conditions remain in doldrum, giving us a total of 16.7 million Americans out of work in the last three weeks. These numbers only include people who were able to file their claims given the widespread reports of jammed hotlines to confirm their unemployment status. The Fed introduced an additional US$2.3 billion program to support  midsized businesses with less than 10,000 employees and US$2.5 billion in revenues. Included in the program will be financing to institutions lending through the Payroll Protection Program. It would be interesting to watch if monetary policy is effective in solving current recessionary condition or we are walking into liquidity trap in next couple of quarters!

It seems Fed is leading ahead of fiscal stimulus to solve current economic predicament. Fed has the power to lend but I guess I would not be too wrong to say that most of the Fed's liquidity operations, ultimately, are to support the U.S. treasury market. There is no different, just a replay of the entire 2008 crisis playbook with a bigger cheque size. Those in treasury business surely agree with me that it becomes nearly impossible to transact in other markets or effectively hedge interest rate risk without a properly functioning treasury market. To turn around the economy, we need spending. Fiscal equation remains lacking.

Tackling treasury market will result in a weaker US dollar environment in the long run via new money creation. World today has a US dollar problem. Many countries have debts denominated in US dollar. When the 2007/08 financial crisis began, the U.S. net international investment position was equal to about -10% of US GDP. It has worsened significantly since then in just those 12 years and is now about - 50% of US GDP (or about US$22 trillion). As of 2019, global debt surpassed US$250 trillion, which is more than 250% of the world’s GDP. As global trade grinds to a halt and US dollar stops flowing around the world, the risk of defaulting on US dollar debt rises. As global trade dries up and in need of debt servicing, they are forced to sell U.S. assets to get US dollar in exchange of their respective foreign exchange reserve and this needs a stable benchmark curve and support global liquidity.

If we look back at the 2008/09 global crisis, the U.S. stock market double-bottomed at the same time as the US dollar index double-topped. In another word, Fed’s liquidity operation is not a panacea but no more than a symptomatic treat.

As it stands, it alleviates US dollar shortage in time. Those countries with more FX reserves than US dollar-denominated debts including Malaysia, Taiwan, South Korea, China and Thailand, have held up rather well in this challenging time, although they are all under pressure now like everyone else.

Chee Seng, Wong
CIO, Athena Advisors
wong-chee-seng@outlook.com