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  • Fed’s balance sheet soars to record high with supportive implications for stocks
  • Congress has huge hole in the economy to plug with stimulus 
  • SPX rallies sharply but only gets back to last week’s levels
  • Dollar falls back as Fed starts to quench emergency thirst for dollar liquidity

Fed’s balance sheet soars to record high with supportive implications for stocks
 — The Fed yesterday reported that its balance sheet as of last Wednesday (March 18) soared by $356 billion to a new record high of $4.668 trillion, taking out the previous record posted in January 2015.  When the Fed next week reports its purchases for the week ended today, those purchases will be even larger since the Fed just this past Monday announced its unlimited QE program and has been aggressively buying Treasury and MBS securities this week.

The ECB has also stepped up with big security purchases.  The ECB reported that its balance sheet as of last Friday (March 20) rose by 223 billion euros ($241 billion) to a new record high of 4.927 trillion euros ($5.327 trillion).  The ECB last week announced a program for buying 750 billion euros of securities, which was launched this week.

The BOJ’s recent securities purchases pushed its balance sheet to a new record high of 594.128 trillion yen ($5.340 trillion) as of last Friday.

The ECB’s and the BOJ’s balance sheets are about $660-670 billion larger than the Fed’s balance sheet since the ECB and BOJ already had QE programs in progress before the coronavirus pandemic hit.  However, the Fed’s balance sheet may soon exceed the ECB and BOJ if it keeps up the pace of its recent buying.

The combined total of Fed, ECB and BOJ balance sheets have now risen to a record high of $15.4 trillion, up by more than $1 trillion since late 2019.  The combined Fed-ECB-BOJ balance sheet level is now more than quadruple the $3.5 trillion level seen before the global financial crisis in 2008/09, meaning just those three central banks have injected an enormous $12 trillion of permanent liquidity into the banking system in the past 12 years.

In normal times, an increase in central bank balance sheets is a bullish factor for the stock market since some of that liquidity finds its way into stocks and since low interest rates support higher stock prices.  The recent burst in the Fed-ECB-BOJ balance sheets is clearly a supportive factor for global stocks.  However, the stock market cannot fully get back on its feet until the economic recovery begins and corporate earnings start flowing again at a strong pace.

Congress has huge hole in the economy to plug with stimulus — Congressional leaders as of Tuesday evening said they were on the brink of a bipartisan rescue package totaling about $2 trillion.  The size of that package would amount to about 9.2% of nominal annual U.S. GDP of $21.727 trillion.

In some additional good news, House Majority Leader Steny Hoyer told Democrats on Wednesday to expect two more virus-relief bills.  Congress will likely take a page from the Depression’s history books and launch a huge infrastructure rebuilding program to get people back to work.  President Trump wanted an infrastructure bill early in his term, but was turned down by Republicans who didn’t want to pay for it with deficit spending.  At this point, deficit spending looks a lot less threatening with the U.S. economy facing a big recession and with Treasury yields at record lows.

It is no coincidence that the relief packages coming out of Washington are designed to exceed the size of the GDP hole that the U.S. economy is facing.  Economic forecasts are all over the map and are highly unreliable considering that there is no way to know how long the economy will be partially closed.  However, forecasts for the size of the recession are important for understanding the size of the relief packages.

Goldman Sachs, for example, issued a forecast last week that U.S. GDP could fall by -6% (q/q annualized) in Q1 and -24% in Q2.  Goldman then forecasted a recovery of +12% in Q3 and +10% in Q4, leaving 2020 annual GDP still down -3.8% from 2019.  The Goldman estimate implies a peak-to-trough decline in GDP (i.e., the hole in the economy) in the first half of about -7.5% (i.e., -1.5% q/q in Q1 and -6% q/q in Q2), which would be much worse than the Great Recession’s decline of -4.3%, though much less severe than the -30% decline in the Depression.

SPX rallies sharply but only gets back to last week’s levels — The S&P 500 (SPX) index on Tuesday gapped higher from Monday’s 3-1/4 year low and closed the day sharply higher by +9.38%.  However, Tuesday’s rally succeeded in only getting the index back up to where it was last week.  SPX on Tuesday still closed -28% below the mid-Feb record high.

In an unusual development, the VIX index on Tuesday closed slightly higher by +0.08 at 61.67 even though stocks rallied, the opposite of the usual pattern.  The size of Tuesday’s rally was apparently so large that the VIX index rose anyway, especially since traders needed to account for the outside possibility of a reversal of Tuesday’s rally if the Congressional rescue deal unexpectedly falls apart.

Dollar falls back as Fed starts to quench emergency thirst for dollar liquidity — The dollar index on Tuesday fell back from last Friday’s 3-year high and closed the day moderately lower by -0.44%.  With its expanded dollar swap lines with most key foreign central banks, the Fed appears to have at least temporarily halted the sharp +8.8% rally seen in the dollar index in the past two weeks.

The Fed, through its swap lines, has provided dollar liquidity to Japanese banks via the BOJ totaling $150 billion just since last week.  On Tuesday, European banks took $4.1 billion of dollar loans from the ECB, while UK banks took $3.6 billion from the BOE.

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