El-Erian: Fed Is Doing Quasi-Fiscal Operations by Buying ETFs

Submitted by Taps Coogan on the 18th of May 2020 to The Sounding Line.

Enjoy The Sounding Line? Click here to subscribe for free.

Enjoy The Sounding Line? Click here to subscribe.

It’s a somewhat nuanced point, but in an interview with Bloomberg, Allianz chief economic advisor Mohamed El-Erian recently highlighted the slippery slope that the Fed is now racing down. According to its founding 1913 Federal Reserve Act, the Fed is not permitted to purchase assets with credit risk. Doing so would blur the line between monetary policy aimed exclusively at broad monetary conditions like interest rates or inflation (the Fed’s domain) and fiscal policy that includes the power to spend, take losses, and do bailouts (the federal government’s domain). Nonetheless, through its Special Purpose Vehicles, the Fed is now buying ETFs that have significant default risk. While the Treasury has agreed to assume the credit risk for the Fed, the line between the two is becoming increasingly hard to find.

Some excerpts from Mohamed El-Erian:

“(The Fed) is already half-pregnant. They are already underwriting significant default risk. It’s one thing buying fallen-angles, investment grade names that have been downgraded to high-yield. It’s a completely different issue when you start buying the index and I think that that makes them ‘half pregnant.’ They cannot clearly separate between what is a fiscal operation and what they are doing now, which is quasi-fiscal operations.”

“…There has been a lot of narrative right from the beginning that (airlines) are the exception, that we should treat them differently (with more bailouts). Why are they the exception? Because they’ve seen such simultaneous destruction in both… demand side and how many people they have employed etc… But today’s numbers tell you it is a much wider phenomenon. They are not the exception, they are a leading indicator and the longer the dislocations continue, the more we will have other sectors that are hit… What do you do with restaurants? …OpenTable just estimated that a quarter of the restaurants aren’t coming back. That looks like airlines by the way. So one has to be really careful about treating the airlines as exceptions…”

“Too many people have dismissed this earnings seasons as a look-through, as not containing much economic information. I think that is wrong. Balance sheet, balance sheet, balance sheet. Which means: what does access to capital look like? What is the cash burn look like? What are cash balances and how much debt is there? We’ve been talking about it in terms of companies, but it is also a sovereign issue around the world…”

To Mr. El-Erian’s point about ‘balance sheets’ consider the following chart.