Hong Kong/ Sydney: After the virus, financial markets will never be quite the same again.
Public officials have raced to put a floor under the stricken world economy in an intervention so far-reaching it’ll transform the very core of capitalism itself for years to come.
A long list of measures that would have looked extraordinary just a few weeks ago has been deployed as central bankers offered loans to an unprecedented range of borrowers and finance ministers said they would shoulder the cost of business payrolls.
Airlines, oil-drillers and other troubled industries are in line for bailouts, while banks are being browbeaten to stop paying out dividends. There’s even open talk of the two arms of economic policy uniting to monetize public debt.
The purpose of the multi-trillion dollar, wartime-scale mobilization is to stop a recession turning into depression. But it’s also likely to change the dynamic of industries and markets as prices that were once steered by open trade are now more influenced by the visible hand of policy makers. And history suggests that it will be a long road before such measures are unwound -– if they ever are.
“There is a good chance that the governments and central banks do not scale back their dominant presence in markets once the crisis passes,” said Jerome Jean Haegeli, chief economist at the Swiss Re Institute in Zurich, and previously of the Swiss National Bank and International Monetary Fund.
Deutsche Bank has already gone so far as to say that there’s no such thing as a free market in fixed income anymore. Volatility is likely to disappear, the bank’s analysts warn, as monetary authorities across the developed world adopt a policy of controlling the yield curve.
Japan has been running that experiment for a few years now. One effect has been to squeeze the dynamism out of some financial markets. It’s relatively common, for example, for hours to pass without any trades in Japan’s benchmark 10-year government debt — a security whose level is essentially determined by official policy, not the hustle and bustle of price discovery.
Under one post-virus scenario, all kinds of financial assets are at risk of waking up one day to find they’ve metamorphosed into something resembling Japanese government bonds. In the U.S., the giant wave of Federal Reserve buying has sent a measure of implied volatility in Treasuries to a one-year low — even as actual price swings hold near a record high.
The Bank of Japan, after more than two decades of buying public debt, now has a balance sheet larger than the economy it’s been trying to prop up. The holdings of the Fed and European Central Bank remain much smaller, roughly 30% and 40% of GDP respectively, but in the coronavirus crisis they’re catching up.
There’s a risk that “the world after corona is even more Japanificated,” said Kazuo Momma, who used to be in charge of monetary policy at the BoJ. “How to get rid of bloated balance sheets and extremely low or even negative interest rates will continue to be daunting challenges for a larger number of central banks for many years to come.”
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The New Whales
The big-three central banks are now asset-owners on an unprecedented scale. Their combined holdings are worth more than one-quarter of the world’s stock-market capitalization –- about four times the pre-2008 level.
But the bailouts extend far beyond central-bank purchasing of sovereign bonds.
All kinds of industries are getting financial support in the form of grants and loans as the market for their products dries up. Germany’s government, for example, has been negotiating to help both the national carrier Lufthansa and the sportswear firm Adidas AG.
U.S. airlines are aid recipients too, while the Fed is wading into markets it has historically shunned. Its decision to purchase corporate bonds reopened credit markets for struggling companies such as Boeing Co. And the expansion last week of one of its crisis facilities, known as the Main Street Lending Program, was widely seen as a helping hand for a U.S. energy industry battered by the oil-price slump.
Business are already facing constraints in return for all this unprecedented support, with some countries curbing share buybacks or dividend payments. Further moves can’t be ruled out. For now though, it’s left stock markets looking unusually detached from the dire state of the economy — and from the prospective earnings of companies.
Even still, warnings of moral hazard have been mostly subdued so far despite the gigantic scale of interventions.
“Desperate times require desperate measures,” said Ethan Harris, head of global economic research for Bank of America Corp. “We have a crisis that has nothing to do with bad behavior of the people getting bailed out. So you’re not encouraging inappropriate behavior in the future, you’re just preventing a depression in the economy.”
Households and workers are receiving financial help too, with governments everywhere expanding safety-net programs such as unemployment insurance. In some cases the measures are billed as temporary, but history suggests they won’t always be easy to reverse.
One result may be a public sector that takes up a bigger chunk of economies, leaving less room for markets. There are limits to the encroachment though. Alicia Garcia Herrero, chief Asia Pacific economist with Natixis SA, points out that the pandemic response has mostly taken place through market channels, instead of more direct routes.
The U.S., for example, is poised to run the biggest budget deficits since World War II. But only in a couple of cases –- like President Donald Trump’s orders for General Motors to make ventilators or meat plants to stay open -– have officials moved in the direction of wartime-style controls over the production lines of private business.
“Central banks are propping up financial capitalism,” said Garcia Herrero, who used to work at the ECB and International Monetary Fund. “They should make sure they fulfill their plans of exiting, no matter the political or market pressure not to do so.”-Bloomberg
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