Taps Coogan – June 12th, 2020

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Peter Fisher, Dartmouth Tuck School of Business Senior Fellow, recently spoke with Bloomberg in a must-watch interview and laid out the highly concerning outlook for the US economy once it gets beyond its initial bounce and why the Fed may end up regretting its bailout of the corporate bond markets.

Some excerpts from Peter Fisher:

“The question is where do we find an engine of growth here, once we bounce off of the floor… It’s a little hard to find that.”

“Government spending provided a floor and stabilized the economy, but that’s not going to be the engine of growth for the next two or three years… Global trade has been slowing down for two years (and) that’s looking worse. It’s very hard to see how global trade could be the engine. That leaves us with investment and consumption… With consumption I think we want to focus on the savings rates. For the last ten years it was a sufficient explanation for the slow recovery to see that the savings rate went from 3%, to 6%, to 8%. The Fed couldn’t get it back down by lowering rates… We just never got consumption going as fast as we would like. With Covid… it’s really hard to see how consumption is going to be the driver that leads us higher. That leaves us with corporate investment, but we’ve just taken corporate debt-to-GDP to a historic high and it’s really hard to see how corporate borrowing is going to stimulate investment in the teeth of weak demand… I have a had time (seeing where that growth driver) is.”

“When you take a measure and turn it into a target, it loses its information content and that’s what the Fed has done to the investment grade and high yield credit… and also, they’ve made equities more volatile… Think of the capital structure of the whole country. The Fed saying ‘I’m providing a floor for the credit side of the capital structure,’ that means that the equity side is going to be more volatile…”

“The Fed has done what it can and it may create a problem here. That is, pushing equities prices back up to historic highs and getting corporate debt-to-GDP higher in the teeth of a recession doesn’t really make a lot of sense… (The Fed) has adopted a view that they are going to influence the real economy by stabilizing financial conditions. Now, all the financial conditions indexes that have been built over the last 20 years are all just proxies for volatility. So when volatility goes up, the Fed just steps in and tries to suppress volatility. I don’t think they have a theory of the optimal level of volatility, but they’ve backed themselves into targeting it… The Fed should have a choice: They can either stabilize the real economy, or they can stabilize financial asset prices. You can’t stabilize both…”

Has the developed world finally reached the point were the only path forward is a protracted period of low economic growth, higher savings rates, forced deleveraging, and currency devaluations? It wouldn’t be the first time, nor the last.

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