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Mike van der Westhuizen
Portfolio Manager


I wrote a detailed piece in a previous edition of CITATION in which I laid out the case that central banks would never be able to exit quantitative easing and would, in all likelihood, have to start relying on fiscal stimulus as well. That view was by no means controversial at the time, but I could never have comprehended the scale, timing and cause of where we find ourselves today.

What we witnessed in the markets from late-February 2020 was a liquidity crisis. In light of all the uncertainty swirling around the impact of economic shutdowns in response to COVID-19, investors were running for the door to generate as much cash as possible from selling down almost anything and everything. The sell-off was then exacerbated by, among other factors, investors with geared/levered positions receiving margin calls, risk parity funds de-risking as volatility spiked and, of course, algorithmic traders riding the momentum wave down. Even perceived safe haven assets such as United States (US) treasuries and gold were not spared at one stage. It was all about the frantic dash for cash.

Aside from the equity market, the primary victim was the bond market. Fixed income pricing is opaque at the best of times and during a run for the door, price discovery became problematic. In essence the financial system’s “plumbing” had broken down. This impacted all financial assets since fixed income is often used as collateral to borrow against in order to fund riskier trades, and yields on fixed income assets serve as the discount rate used to value other assets.

Illiquidity and panic selling also resulted in spreads on corporate bonds widening significantly. This meant that these bonds lost capital value, but more importantly it meant that borrowing costs for the companies that issued these instruments increased dramatically. After years of cheap funding and financial imprudence, this put many companies at risk. It was not only companies that were affected. The impact filtered down to borrowing costs for individuals through mortgage or motor vehicle loans, for example. Essentially credit extension and, as a result, borrowing froze up, which is ultimately bad for the economy. Leaving the market to its own devices in this type of scenario would have be catastrophic, and central banks around the world were quick to recognise this.


In light of the above, central bank action has been swift across the globe. However, I’ll focus on the US Federal Reserve (Fed) as it sits at the epicentre of the world’s largest economy and financial markets. Following the initial market panic, the Fed aggressively cut interest rates by 150 basis points, effectively to 0%. This cut aimed to address the economic shock of a shutdown and drag to growth. The cut, however, proved inadequate in allaying any fears since the primary issue was that of a liquidity crunch, meaning liquidity had to be injected into the system. So, first the Fed pulled out the bazooka … and then they threw in the entire kitchen sink.

Over the course of March a number of large stimulus packages were announced to try and bring calm to markets, but none seemed to change the mood. On 23 March the Fed arguably went all in, announcing that it would pledge to purchase assets in the open market without limit on the amount that it would be willing to bring back onto its balance sheet. This would include purchases of US Treasuries (government bonds) and mortgage-backed securities (MBS). In addition, provision was made to allow the Fed, through various special purpose vehicles, to also buy investment grade corporate bonds. This was clearly in response to the spread widening, which I alluded to earlier, that looked set to cause a credit crisis, or even worse a solvency crisis.

For the sake of context, during the global financial crisis of 2008, it took the Fed eight months before they became this aggressive in their actions. Now, all of this has occurred in the space of less than a month, dwarfing prior efforts in magnitude. During the height of the third round of quantitative easing in December 2012, the Fed was purchasing a combination of US$85 billion in US treasuries and MBS in the open market, per month. Following the announcement on 23 March, immediate support in terms of asset purchases totalled US$125 billion (a combination of treasuries and MBS) a day! This has since been reduced to purchases of US treasury securities of $80bn a month.

It is expected that around US$6.5 trillion of monetary support will be provided by global central banks over this easing cycle, with the bulk being made up by Fed measures. At time of writing, global central banks had collectively expanded their balance sheets by around US$5 trillion in response to the market turmoil. It is no coincidence that 23 March marked the recent bottom in the S&P500 and peak in credit spreads before witnessing a staggering rebound. For now, markets are hooked on stimulus.

As a reminder, not even 18 months ago central banks were looking to shrink their balance sheets and normalise interest rates after a decade of stimulus following the global financial crisis. Not only has this reversed, but the hole is now even deeper and the can has been kicked even further down the road. The ultimate moral hazard problem continues to intensify. Companies and investors will continue to take more risk than usual because they know they will be bailed out. The regular “man/woman on the street” meanwhile continues to suffer. We are seeing a classic case of “too big to fail” versus “too small to survive” in action.

In order to somewhat address this problem, governments have also announced fiscal support packages, with the US passing a bill approving US$2 trillion in direct payments covering assistance for various distressed industries, small businesses, unemployment, healthcare and education totalling just over 9% of US GDP. This is effectively putting cash directly in the hands of citizens.

Total monetary and fiscal stimulus globally now equates to around 20% of the world’s GDP. As the lines between monetary policy and fiscal policy become more and more blurred, we are potentially entering a new market regime with new rules. Bigger budget deficits, more debt and central banks as the investor of last resort!


In order to fund the additional fiscal spending in the US, Treasury has had to issue staggering amounts of debt. Ordinarily this would cause yields to rise dramatically, but thanks to the Fed buying almost all of the issuance, as well as “talking yields down”, this has not yet become an issue. The act of a central bank funding a budget deficit by buying debt issued by the government constitutes outright debt monetisation. Essentially printing money out of thin air. The quantitative easing following the 2008 global financial crisis was originally not touted at debt monetisation because the goal was to shrink the Fed’s balance sheet, which we now know couldn’t happen.



All of this money printing has resulted in a rapid rise in money supply. Past bouts of quantitative easing didn’t find their way into the real economy, but rather into financial assets, which is why inflation has not been an issue over the past decade. With this tidal wave of US dollars flooding the market, will we now see inflation and a rapid depreciation of the greenback? The answer isn’t that straight-forward.


Aside from many structural shifts in the global economy, including demographics and technology (among others), which are by nature deflationary, high levels of debt are also a deflationary force. In essence, borrowing today is stealing from future economic growth as more money needs to go towards servicing debt and away from productive uses.

On the other hand, printing large amounts of money is inflationary if it finds its way into the real economy through bank lending, or – courtesy of direct payments - into the hands of the population, a situation we are currently witnessing. Of course, the fiscal relief package in the US is intended to be a temporary bridge to plug the loss of earnings due to record unemployment, but get the balance wrong and inflation is a given. Bear in mind, however, that moderate levels of inflation are good, in fact they are highly desirable if a government wants to inflate debt away.

The number to watch in both instances is the velocity of money, in other words for every US dollar of money supply growth, how much filters through to economic growth and ignites the willingness of people and business to spend? A falling velocity, as we are currently witnessing, is an indication that deflationary forces are at play.

The velocity of US dollars also falls into the debate around US dollar strength versus US dollar weakness. Surely all of this money printing is negative for the greenback?

With coordinated stimulus going on around the world the playing field is somewhat evened out, for now. The pace of money printing by the US is far greater than the rest of the world and perhaps that is the argument for a weaker US dollar going forward. The stable/strong US dollar camp argues that US dollar demand is a function of both onshore (US-based) and offshore (non US-based) demand. The US dollar is also a countercyclical currency, meaning that when global growth slows, the US dollar typically strengthens. As the world’s reserve currency, the greenback remains the major currency for trade. It is also the main currency used for foreign borrowing (where a country or company in an emerging market might borrow in US dollars rather than their local currency).

The rapid slowdown in trade due to economies shutting down or slowing (not to mention the impact of trade wars) has reduced the global velocity of US dollars and the currency has strengthened significantly this year (versus a broad basket of currencies, especially emerging market currencies). The stronger US dollar, along with liquidity issues, has forced an increase in demand for greenbacks by borrowers who need to service US dollar debt. In fact, the Fed has had to loan US dollars to the rest of the world through central bank swap lines in order to meet this demand. This vicious circle has kept the value of the US dollar relatively stable as of late, and any blip in the fortunes of the global economic recovery could very well cause the currency to strengthen further. This in turn can increase financial stress, which in turn could require more stimulus.




Markets have, to date, reacted positively to the “kitchen sink” scenario, but ultimately only fundamentals really matter. Only time will tell whether this round of stimulus garners a V, W, L, U or any other letter-shaped recovery to the economy as opposed to only pumping up markets. As always, stimulus of this nature does very well to cover the cracks, but until it is removed it is extremely difficult to assess the true fragility in the system. Perhaps combined government and central bank support becomes a part of everyday life in the future? Perhaps we are witnessing a true regime shift in markets?

At Citadel Asset Management, one of our key investment tenets is that the future is uncertain. Perhaps now, more than ever before, this holds true as we experience tremendous uncertainty playing out. Fortunately, our investment process remains steadfast through all the short-term noise. It is also during times such as these that sticking to your personal long-term investment objectives is particularly important.