Moneycontrol Pro Weekender | The greatest monetary policy experiment in history

Dear Reader,

It’s been a great week. The Sensex is now up over 20 percent from its March lows. The S&P 500 is only about 21 percent lower than its all-time high. Both the CBOE Vix and the India Vix continue to fall, an indication that confidence is returning to equity markets.

Foreign portfolio investors have turned net buyers of Indian equities. Even better, the domestic retail investor saw the market sell-off as a buying opportunity -- net equity inflows into equity mutual funds were very strong in March, with SIP flows setting a record. We had pointed to research that argued the underperformance of Indian equity markets was due for a reversal.

There are good reasons for the rebound. Earlier in the week, there was much jubilation over lower deaths in Italy, Spain and New York, but they still have some way to go before they definitely turn the corner. Instead, what markets are cheering is the massive support given by the developed world to their economies, the latest being a Euro 500 billion rescue package put together by EU finance ministers.

The Bank of England will now directly finance the UK government deficit, bypassing the bond markets. And the US Fed unveiled a $2.3-trillion lending package on April 9 that will allow it to purchase even high yield bonds. We had speculated whether the Fed would buy oil to limit the damage to the US economy - the move to buy junk bonds will bail out many oil companies.

In his webcast, Fed chairman Jerome Powell explained what the Fed was trying to do. He said, ‘We are using our tools to help build a bridge from the solid economic foundation on which we entered this crisis to a position of regained economic strength on the other side.’

And further, ‘As a result of the economic dislocations caused by the virus, some essential financial markets had begun to sink into dysfunction, and many channels that households, businesses, and state and local governments rely on for credit had simply stopped working. We acted forcefully to get our markets working again, and, as a result, market conditions have generally improved.’

Simply put, the support measures are a means of ensuring that businesses and people survive the lockdown and that the economic disruption does not lead to a vicious cycle.

In the Q&A session that followed, Powell said that in addition to buying municipal bonds, investment grade bonds and now high yield bonds, he wouldn’t hesitate to move into new areas if needed. He also said that there were essentially no limits to the amounts the Fed could purchase. It’s the greatest monetary policy experiment in history.

The announcement that the Fed would buy junk bonds sent the biggest high-yield bond ETF up 7 percent. And the Fed’s balance sheet topped $6 trillion for the first time as Powell cranked up the printing presses. As we had pointed out, the money helicopters are on their way.

Also in the Q&A session, Powell was asked not once but twice whether the Fed’s bond buying spree would lead to inflation and to runaway asset prices. He said he wasn’t worried about inflation, but didn’t answer the question about asset price inflation. He would hardly be worried about that either, some would even say that’s what he’s aiming at.

With this kind of support, why shouldn’t investor confidence rise? US equities had already run up ahead of the Fed’s announcement and the only reason they came off the day’s highs on April 9 was because of the disappointment about the OPEC plus deal not being done. The jury is still out whether this is just a bear market rally and the damage to the US economy is horrendous, as seen from the unemployment rate shooting up to 14 percent. But the market is ignoring the bad news, which suggests that much of it is already in the price.

Back home, though, the economy was very weak when the virus hit us and RBI’s industrial survey showed that conditions were worse than during the global financial crisis even before the lockdown. After the lockdown, the Institute of International Finance says India’s GDP could shrink by 0.3 percent in 2021-22. That is just a guess, because nobody can predict how long the virus will wreak its havoc. Indeed, the RBI’s Monetary Policy report, which said COVID-19 is haunting India, believes it will be difficult to even collect the data to gauge inflation.

At the time of writing this, we still await a decent fiscal package from the government, the recent move to pay out income tax and GST refunds being a drop in the ocean. There is an urgent need to relax the fiscal rules for the states to allow them to expand their support programmes.

We pointed out the dangers to small NBFCs and to infrastructure and construction companies if a relief package is not forthcoming soon. We warned that even after the lockdown is lifted, the economic recovery will be a long and shallow one. We gave some suggestions about how the lockdown should be lifted. And we pointed out that even the best NBFCs will take time for resuming business as usual.

Our team of independent research analysts spent the week telling investors which sectors and stocks are best avoided here and here and here. They also looked at the lessons to be learnt from past crises such as the Great Depression and Black Monday and the dotcom bubble and the Global Financial Crisis. And we wondered whether it’s time to book profits in pharma stocks.

I leave you with this bit of good news for the Indian markets in these dismal times.

Cheers,

Manas Chakravarty

PS: Friday also saw the first edition of Moneycontrol Pro Masters Virtual, an online summit where current issues and their impact on investments are discussed with leaders and experts. Keep on reading Moneycontrol Pro for invitations to more such events.