GOP, Democrats fight, but the Fed acts.

For those of us living in export countries, a stronger home currency (to the US dollar) translates into lower returns. In our case, with iron ore and gold at lofty price levels a slightly stronger AUD is not as bad as it could be. And, it’s slightly better for importers despite the low consumption environment.

But there’s a lot of whipsawing going on. Some of the currency de-stabilising factors include: trade/currency/tech wars, upcoming U.S. elections, populism, disappointing earnings for Industry 3.0 companies, negative real rates and plentiful USD swap lines provided by the Fed to other central banks.

But what’s becoming more and more baked into ‘sentiment’ is that the U.S. is COVID-19 ground zero. Infection rates are worsening in the home of the free, and the expected long-term effects of the virus are starting to rattle a lot of cages.

Yesterday, the Senate majority proposed the HEALS Act, i.e., the next fiscal welfare to follow the CARES Act, and valued at $1 trillion. It includes $400 per week less in unemployment insurance than under the CARES Act. That roughly equates to 30,000,000 people missing out on $400 per week, i.e., $12 billion per week that the Republicans believe represents a disincentive to return to work. Democrats disagree.

No doubt this will be debated for some time given there is daylight between the $1 trillion proposed and the Democrats’ position which is hovering in the vicinity of $3 trillion. But they will need to act fast with paychecks already running out, pretty much now.

In the end, there will most likely be a compromise and ongoing relief.

In the meantime, death star admiral Jerome Powell announced an extension of the Fed’s lending facilities (delivered in the first COVID-19 blast) that were scheduled to expire on or around September 30. These have now been extended until 31 December 2020, unless the Fed and the Treasury decide otherwise.

Nicely done, Chair Powell.

While the Fed Chair does not see Fiscal as his job, he’s been pretty diligent and fast in greasing the wheels of credit to ensure it is abundant, with ample liquidity in markets. He now needs business sentiment and growth to catch up.

Notably, this Fed created side-car to Fiscal stimulus more than covers the period including the U.S. elections and the Christmas period.

The Fed said:

“The three-month extension will facilitate planning by potential facility participants and provide certainty that the facilities will continue to be available to help the economy recover from the COVID-19 pandemic.
The Board's lending facilities have provided a critical backstop, stabilizing and substantially improving market functioning and enhancing the flow of credit to households, businesses, and state and local governments. Each facility was created under section 13(3) of the Federal Reserve Act with the approval of the Treasury Secretary.
The extensions apply to the Primary Dealer Credit Facility, the Money Market Mutual Fund Liquidity Facility, the Primary Market Corporate Credit Facility, the Secondary Market Corporate Credit Facility, the Term Asset-Backed Securities Loan Facility, the Paycheck Protection Program Liquidity Facility, and the Main Street Lending Program. The Municipal Liquidity Facility is already set to expire on December 31, with the Commercial Paper Funding Facility set to expire on March 17, 2021.”

This is a pretty positive move, even though the $2.3 trillion plus in estimated lending from the first blast in April has only produced around $110 billion of loans so far. Bottlenecks, policy, eligibility, unattractive terms (which were recently improved) - probably a bit of all of those.

On top of this, the Fed continues to extend USD swap lines to other central banks, making USD plentiful. It has also been managing down interest rates, with a side effect being that there is little support for the USD in its own right. Bond buying has slowed markedly, but the Fed’s balance sheet is still around the $6.9 trillion level.

On balance, the above has created a weaker trend for the USD. In Australia we may see some further weakening in export dollar returns as a result, but this might be partially offset if China’s demand for iron ore and world demand for gold continue, and at least those two commodity prices stay high as a result.

Nonetheless, our Reserve Bank and Treasury officials will need to work harder for their pay in the weeks and months ahead to ensure the correct balance of welfare safety net and economic stimulus. Over the past two decades, Governments in Australia have not had to deal with this, so we can expect a few bumps along the road to reflation - given we just experienced our first full year of negative inflation.

Stay tuned and stay safe.

Mike.

NextLevelCorporate is a leading independent strategic corporate advisory firm with a multi-decade track record of delivering transformative corporate finance solutions, in and out of Australia.