The US Federal Reserve’s move to calm turbulent financial markets will not stop prices from falling further, warned institutional investment researcher, Jim Bianco.
The president of Chicago-based Bianco Research said the Fed and the treasury should be preparing for “lower” lows and tougher markets because the central bank “put” was no longer effective.
His comments follow the Fed’s most recent bailout package which includes buying $600 billion worth of bonds a week as part of an unlimited quantitative easing program. At that rate, Bianco said the central bank would own two-thirds of the US Treasury market in a year.
“The Fed’s bond-buying program will only work if the market is close to perceived fair-value,” he said in an interview with Investment Magazine. “They can stop the repricing for a while, but ultimately the Fed policy will only work if you assume that markets have gone too far down.”
Bianco added that the world has permanently changed since the outbreak of the coronavirus and if risk markets were still expecting lower prices in a post-virus reality, then assets would continue to re-price.
“If the Fed is trying to stop the market from reflecting this, it will fail,” he said. “We are headed to a new reality and markets understand this which is why they are rapidly re-pricing to a post-virus world.”
The investment specialist said he was afraid that investors would see another ‘leg down’ because the Fed could not stop the market from “fundamentally being in the wrong place.”
A temporary bottom
“I don’t think we are at the new level,” he said. “I think we may have found a temporary bottom.”
As for the lack of liquidity in fixed income, the researcher said it would only be solved only when bond markets started to see broad market support because there were “way too many sellers in this market.”
“We know the coronavirus case count will subside at some point and we know the economy will restart but there will be a big change in attitude,” he said. “Companies will be less aggressive about globalisation which will result in higher costs and more inflation. We are either going to have inflation for the first time in 25 years or we can delete the word from our dictionary because if this doesn’t get it going, nothing will.”
He noted that the Fed’s announcement on unlimited QE had little impact on the 10-year Treasury yield. In fact, yields have risen slightly to 0.72 per cent. Bianco said in a normal market, the yield on 10-year bonds would have moved to zero, yet fears that the massive stimulus will lead to inflation is nixing any prospect of a bond rally.
Bianco also said that Wall Street had taken the view that a virus-driven economic collapse would be temporary over one or two quarters. “These details don’t matter,” he continued.
In his view, companies will worry less about efficiency and more about resiliency; they will hold higher cash levels and less debt. For their part, investors will also become more risk-averse.
“If that’s the way we are going then we will come up short and the markets won’t make it back to previous highs,” he said. “We are transitioning from a pre-virus economy to a post-virus economy and we should not think of it as mean reversion.”