FED FUNDS CUTS ARE FOR TV NEWS AND HEADLINES / THE FINANCIAL TIMES OP EDITORIAL

Fed Funds cuts are for TV news and headlines

The average investor still believes their portfolio can be saved by moderate Democrats, or the FOMC

John Dizard


Jay Powell’s Fed publicity machine does not offer a shelter to investors © Kevin Lamarque/Reuters


The Federal Reserve’s publicity machine is providing investors with a parachute, not a safe landing.

Take the parachute while it is still on offer.

We are still in the phase of the economy and the financial markets where the public is willing to believe “good news”.

That means that when people turn on the sound for TV news and Democratic primary results just after a “50 basis point cut”, they can be persuaded to buy some risky assets.

Since human nature has not changed, it is safe to say that the next long-term bull market will only start after the public no longer cares about any good news when it is announced. This is not that moment. The average investor still believes their portfolio can be saved by moderate Democrats, or the Federal Open Market Committee, or gobs of hand sanitiser.

Start with the thin underlying reality of the Fed’s policy rates. The actual rates at which even most institutions can borrow against Treasuries or government backed securities have not been cut by any 50bp.

On Tuesday, the widely used DTCC GCF Repo index quickly rose from 1.6 per cent at the open to 1.85 per cent, and only came briefly down to 1.5 per cent before creeping up again. The index settled at a 1.72 per cent average for the day.

By that evening, “ease” or no ease, the Fed was turning down some of the record $111bn of bids for repo from within its own select circle of counterparties.

The “Fed Funds cuts” are for television news and headlines. Even the DTCC GCF Repo index is only an approximation of what professional investors have to pay to get liquidity. Thanks to the post-crisis Basel reforms that effectively limit the size of bank and dealer balance sheets, one’s ability to turn even good assets into ready cash is rationed by quantity as well as price.

It depends on your bureaucratic status within the financial world. Do you believe your requests for repo quotes will always be met with a friendly wave on to the banks’ balance sheets? Soon, maybe not.

For fixed-income investors, that probably means letting someone else own your high-yield bonds that are now priced at a premium to par. In part due to the rapid decline of Treasury bond rates, about two-thirds of the bonds in the BofA US High Yield index are trading above par, twice the 30-year average.

That means your junk portfolio still incorporates a lot of bubble-era pricing. Even if the White House is right, and we have years of expansion ahead, then many of your par-plus bonds are likely to be called in for refinancing by their issuer, leaving you with even less yield.

If your job description requires you to hold on to high yield, even now, the reward you get for assuming risk is better if you buy into a sector that has already been slammed by deep discounts. Like, say, low-investment-grade or high-junk-rated bonds issued by natural gas producers.

Yes, you must walk the ESG street of shame. But even wind turbine makers and solar panel manufacturers believe some gas-fired generation will be needed, at least for a few years.

Since it is effectively impossible for most gas-heavy E&P companies to issue new shares or bonds, their spending on new drilling is being cut below the levels needed to maintain production. We are not getting rid of the 40 per cent of the US electric generation provided by natural gas within the next 18 months.

If a junk-financed producer is still solvent, gas prices they receive will have to double or triple from today’s level in order to keep the lights on for the remainder of the bonds’ term. Then sell them and use the profits to buy some more solar panels and batteries for your house.