Nomi Prins: Repo Injections Are QE by Another Name
Albert Lu: I’m joined today by Nomi Prins, the author of Collusion and former managing director of Goldman Sachs. Nomi thanks for joining me again. How are you?
Nomi Prins: I’m doing great. Thank you so much for having me on.
AL: It’s great to have you on again and, you know, I really enjoyed your recent article "The Soaring Twenties" to start the new year. I think it was a great way to kick off this new year—Ten Economic and Market Trends to Consider for 2020. So, let’s start with just an overview. What do you think the overall backdrop for 2020 is going to be? We had a tremendous 2019. Is it going to be more of that?
NP: I actually think of myself, generally, as a fairly skeptical person, but I also like to look at the data. And what we saw towards the end of last year and, actually, throughout most of last year, was the Fed retreating from its hawkish stance in 2018 and moving very quickly to a more accommodative stance, with three rate cuts. But it wasn’t just the Fed doing rate cuts. The Fed also opened up its balance sheet a little bit more through a little bit more money. Actually, when I say a little bit more, half-a-trillion dollars’ worth more money into the markets through repo operations—meaning short-term loans to the banking community and to the communities they service.
From a corporate standpoint, all of that helps, not just [to] lift the markets, because the extra money was coming in—which we’ve seen in some of the years in the past decade as well—but also because of the confidence that the markets then could have that the Fed would be there. That, if the Fed needed to, it would find ways. They might not be rate cuts; they might not be conventional QE; but they’d be this sort of back and backhanded QE through the repo markets. And not just the Fed, but central banks around the world—and not just the main central banks, but a lot of the emerging market central banks and the sort of medium to smaller form of economies throughout the world—switch to their own accommodative states for their own reasons. And that’s something relatively new.
So, we have almost a three-to-one number of central banks and emerging markets find some form of either rate reduction or other accommodative way to alter their money cost in their own countries throughout the world. All of that culminates into a generally bullish backdrop, I think, going forward into this year.
AL: You know, I couldn’t agree with you more. That reversal was key last year and that, you know, strong double-digit return. Powell talked a tough game but when it came down to it he really gave in.
What do you think, if anything, could make him retreat, yet again, and reverse direction in 2020?
NP: In terms of becoming hawkish again, I think it would take an amount of inflation in real prices that I don’t think we’re going to see. And even if we see it, I think it’s going to be difficult for him to act on it, because there’s a lot of chatter within the Fed, and there has been, actually, [in the] last few years, about whether their inflation targets even make sense and whether or not the 2 percent level is the right level to even start to worry about. So before we would even get to a 2 percent level, which we don’t have, in terms of real price appreciation, but even if we do get there, I think would be more talks within the Fed as to whether that was meaningful.
And so I think that’s going to keep the Fed pretty much in limbo. And also again, we have US elections coming up towards the end of the year. There’s going to be a lot of focus on that, and plus other emerging markets and other types of economies have their central banks also on a neutral-to-accommodative stance. So I think they would have to overcome a lot of data to get back to a particularly hawkish stance, or even to raise rates this year.
AL: I find myself in this strange position not of just agreeing with you—we agree quite often—but also coming around and, sort of, seeing it the way that the consensus is looking at it—that is, all the things are lined up for another good year. I say that reluctantly, because of the underlying problems we have in the economy. But I really think you’re right and they’ve already sort of left the door open, or cracked the door open, to sort of reconsidering that 2 percent threshold by saying they want a symmetric 2 percent, which means they can overshoot. So, you know, I totally agree with you in that. Now, another point you made was about emerging markets, and this also came up in your article. Emerging markets and gold will beat the dollar.
So, you seem to think that our easing is going to beat their easing. Is that a correct way of looking at it?
NP: There’s a couple of different things going on. I think our easing will actually beat their easing, in terms of the fact that we’re not, actually, going to be doing anything. But, we are adding money into the markets. They will potentially be reducing their rates more, but I think [that] net-net that additive inflow into the markets of money from the Fed will be like an ease, right? So, not to get complicated on that, emerging markets have less tools because they have less balance sheet capabilities to take on the sort of debt, or other things, in their own country. So it’ll be two different kinds of easing. So yes, we will be, because we’re opening the Fed’s balance sheet and it’s growing easing by more than emerging markets will. But emerging markets will be easing and that’s going to stimulate their markets and potentially their economies.
Although, I generally don’t believe there’s a real relationship between economic growth and market growth, but it will provide a perception throughout the world of market growth, which will bring in capital in emerging market countries. So it’s sort of like there’s two different reasons but, together, it means the dollar should weaken relative to emerging market currencies. Emerging markets, in general, on a stock basis, should outperform the US, and gold should outperform, potentially, both.
AL: That’s interesting. So, I was going to ask you about that. Gold, I mean. The dollar has been strong for quite some time now. It’s reasonable to expect that that would turn around.
But you think gold relative to other currencies would be a good bet this year?
NP: Yes, because of that implicit, and explicit, easing that will be happening with respect to all these other currencies. The Fed opened the door for these other emerging markets to ease their monetary policies. And as such, relative to those currencies, gold will also be able to outperform as they outperform the dollar.
So the relationships, I think, into this year are going to be really interesting from that perspective. It’s not a hundred percent intuitive, but that’s what I see.
AL: Okay, another point you make here: corporate bond markets will expand. You think that the environment is going to be ripe for continued issuance?
NP: These lower rates, I think that’s going to be a pretty much global type of thing. That’s going to happen. It’s going to be more corporate debt issuance in the US, in the major economies as well as in the emerging market economies, because, again, they’re reducing the cost of their money. So their corporate issuance is going to basically increase. The corporate issuance in general has been in an upward trend in the US and other major economies. That’s going to continue because rates themselves are not going to be moving up.
So, in general, the overhang of debt that we have globally, which will ultimately be a problem, this is still ultimately a crisis that’s being pushed off—all this debt—but I believe this year we’re going to hit more record debt on an absolute global basis. And then, also, in all the individual economies relative to their GDP, relative to their growth.
AL: You highlight a very, I guess, critical problem, and that is the amount of corporate issuance we’ve had. You started the article with a quote from F. Scott Fitzgerald’s wife pertaining to the 1920s, “We couldn’t go on indefinitely being swept off our feet.” And that’s what’s been happening now. We’ve been swept off our feet for many years in a row, and it’s been a great environment to issue debt. But more and more this is becoming a problem. We can’t have levering up forever, corporate buybacks forever.
And, what I’m wondering is, how is this going to play out? Because, on the one hand, we can’t keep doing this and there’s going to be some type of crisis in that market. On the other hand, the government sort of needs negative real interest rates forever so that they can keep borrowing. So how is this going to play out?
Are these spreads going to just blow out spectacularly, or what’s going to happen?
NP: Ultimately, that’s what will happen. So the question is: when will that happen? And what will be the cause of that happening? You and I have talked for years about the fact that there’s too much debt in the world as it continues to increase. And what we saw last year is that the ability for debt to increase [with] what is now a more accommodative interest rate pattern globally than it was in 2018 or 2017 just has made it increase by more. And because there’s no real impetus to raise rates at this point, this is going to be again a year of increasing of debt.
But at what point does the fact that companies, and countries, are not growing as fast as their debt is growing come to a head? I think that will happen through more extraneous circumstances, like when we saw the assassination of the Iranian general by the US and then the world was waiting [to see] whether Iran would retaliate—how would they retaliate? And then, Iran, yes, sent a bunch of missiles to attack some Iraqi bases with US personnel there. Nobody was hurt, but all of those kinds of unforeseeable, yet actually potential if you think about it, phenomenon [sic] could be the things that actually come in and make countries a little more tense in terms of their debt versus their growth scenarios, and investors more tense and money retreat and, therefore, spread blowout. But I think it’s very periodic. The market really digested that whole event really, really quickly.
Another market, a year ago or a year and a bit ago, when the Fed was still in raising-rates mode, would have had a 500–600-point drop on the Dow, just with that activity. And it had a few hundred points, but most of them popped right back up. And so there’s a resilience there. At some point, though, those activities with that much debt will cause the crisis and, I think, it’s going to be when we finally get to leaving this current accommodative period into more tension.
Will there be raising rates? I don’t think, again, [that] it’ll be this year, but let’s say it’s next year, the year after. And then you have those factors. And then, let’s say the trade agreement that was just signed, the “phase one” of the agreement between the US and China which was just signed, is digested. And then, concern, say, grows for “phase two.”
When will that happen? Will that happen?
Will that happen before the election? If it does happen, will it mean anything?
Will China then do something to really annoy the United States?
Will Trump get reelected and react accordingly?
Then all of that stuff can be a part of a debt crisis.
AL: I guess this is a good thing, but I think I was surprised with, I guess, how confident the market was that nothing really bad was going to come of that. Like you mentioned, the Dow did dip but not nearly as much as you’d think. If you look at oil and gold, which are, sort of, war futures—they didn’t really react very much. So the market took it really well. In fact, the market is more concerned about things like China tariffs and other things, like, you know, the way Jerome Powell is leaning much more so than the prospect of war. How do you interpret that? Is that a good thing?
NP: Talking about the, sort of, bullish tone we’re in right now does not mean that this is like a natural period of time. We have a tremendous amount of support for the markets coming from central banks. That’s just weird, historically. But it is the case, and that’s why markets care more about money, and the cost of money, that’s coming into them. And if you have enough money, markets feel that they can overcome things like, you know, missile strikes. And obviously, if there is an outbreak of a real wartime situation, the markets would digest that.
But what they’re doing is thinking—all right, well that was a thing. We were worried for a minute. But you know what? It didn’t really get too awful. At that moment, oil prices spiked; they came back down. Everything’s sort of okay and the money is flowing. I think [it] will be more of an issue if Jerome Powell were to turn around [and] be like, “You know what? We’re done with repo operations.” I think that would make the markets upset, as opposed to missile attacks in Iraq, which is a little scary, actually, for the world, because what it means is that the markets kind of don’t care as much as maybe markets should if they were really reflective of opinion and reflective of economies and geopolitics. But they’re more reflective of monetary policy and they’re getting that gift right now.
And so it’s kind of like, you know, sort of placebo in terms of any types of nerves that will come in—just sort of take this, be calm, handle it, and don’t worry too much. That’s how they’re feeling at the moment.
AL: You mentioned Jerome Powell and his repo operations—hundreds of billions of dollars. They’ve made a point of saying that, explicitly, this is not the same as QE. And, you know, maybe technically they’re correct. The markets, certainly, if you look at their enthusiasm, are not buying that. And at the end of the day, dollars and credit are to a great extent fungible. And so, that credit is going somewhere, to purchase something. It certainly does look like QE in terms of the end result.
What do you think is coming in the next quarter? Are we going to get a standing repo facility? If we don’t get something like that, is the market going to have a tantrum? What do you see coming?
NP: Those things, I think. But I think the markets would have a tantrum if it didn’t continue. And I think it’s going to continue, because right now, I think, Jerome Powell has positioned, and the Fed has positioned itself, to give a certain amount of money to the markets on a monthly basis. That’s what the markets are expecting. The Fed knows the markets are expecting that. And I think it’s going to continue, which is one of the reasons why, throughout the latter part of last year, actually, they were increasing their repo operations above, effectively, the $60 billion per month that they had said they would be injecting into the markets.
And so, net–net, when you look at what’s completely been injected on their balance sheet, it’s gone from $3.7 trillion in the end of August, beginning of September, before they started the Fed the repo operations, and now it’s up at $4.1 trillion. And they’ve also completely stopped talking about any type of quantitative tightening on the longer end of the curve. So the only thing that’s happened, whatever you call it, I call it quantitative easing at the lower end of the curve, because that’s what’s happening, money is coming into the markets in return for short-term securities. That is quantitative easing at the low end of the curve.
And, the reason why the market, and banks, and so forth understand it that way is because they’re just getting the money. And whether that money gets used to back longer-term debt or longer-term issuance or an IPO (initial public offering), or some part of another transaction, an M&A (merger and acquisition), or anything else, that short-term money is still there to provide the funding.
So I don’t see the Fed changing that, certainly [not] in the first quarter, because there’s no real point and they’re not seeing any inflationary data that would warrant them to do that. I think the market and the banks would get very upset.
I think it’s hard in these markets to project too far ahead. If we have sort of extraneous circumstances, but if we do I think they would be more negative than positive—like [a] potential increase in tension in the Middle East or a screw up with “phase two” of the US-China trade negotiations, or something like that—which would actually cause the Fed to not discontinue repo operations. So I just see them continuing.
If I had to put a number [on it] I would say at least through the first half of the year. And what’s to say [it] can’t go on longer than that?
AL: I mean, these guys never cease to amaze me.
NP: The only thing that could make it not go on more than that, or at least not have the experiments or to stop at that time, is that if you look at the trajectory of how much money has been going into the markets through these repo operations since September—they would be back above their highest height of a balance sheet since the financial crisis if they actually continued more than, sort of, July-August. So we’ll see what happens. But I think there might be a natural, psychological Fed boundary of: “There is no actual crisis now. So if our balance sheet actually looks like it’s bigger than an actual crisis, that’s kind of an odd thing.”
So I think there might be that natural stop, but I think they can go to that point. I just think someone in there would be like, “Hey, wait a minute, we’re getting to that point. Should we just stop?” So that time horizon kind of matches that value.
AL: Finally, you talk about inequality, wealth inequality. And we’re in an election year. I expect this will be talked about frequently. So what do you think the issue there is in terms of markets and how the markets are going to react or be impacted by this?
NP: From a market standpoint, as long as the money is coming in, they’ll continue to inhale it. Banks will inhale it. It’ll transfer itself into debt, but what happens on the ground? I mean, why inequality continues to grow is that, on a percentage basis, there are fewer participants in the market than the value of the market is increasing.
So, most citizens in most countries have zero positive outcome from the market going up, and they know this. As debt increases, and as public debt increases—as Treasury debt and Japanese government debt, the European Union, debt in emerging markets increases—it means there’s less money left to go into infrastructure growth and into cultural programs, into education, and to health and to things that governments would otherwise potentially fund, which means that for people living on the margin, their ability to get things without having to pay more for them, when they’re not making more on the margin, is that much harder.
And so that tends to result in some of the things that we’re seeing, in civil unrest around the world because of that economic inequality, because of austerity programs, because of just money being used for financial assets and not for citizen assets. And that’s one of the reasons that led to what is going on in Hong Kong, Venezuela, the Middle East, potentially in the US into the election—probably in a more subdued manner because we tend to be more subdued—and in some of the demonstrations that have the United States on a relative global basis. But I think that inequality growth does manifest in the civil unrest and in how people vote as well.
We saw that, in general, with the UK voting very strongly for Boris Johnson’s party, the Conservative Party, because they did not believe that the Labour Party was offering them a way out of inequality. So why not just—I’m oversimplifying; it’s a major, larger conversation, but—stick with what we have, you know, decrease uncertainty going into Brexit and let’s just move on. But that’s not necessarily good for them economically. So I just think there’s going to be more instability throughout people at the middle and lower echelons of money and society as the markets go up.
AL: So we’ve heard some of that in the early phases of the Democratic primary. How much traction do you think they’ll get on that in the election? And then I guess I’ll ask you to predict now where you think the election is going.
NP: So, I think that, from the standpoint of inequality, the Trump administration is going to obviously downplay that, because there is a certain number that looked good on the surface, like the level of stock market being high, like unemployment, right? Average wage is going up even though that doesn’t mean people aren’t working multiple jobs and don’t have higher costs in their own households.
So I think from the perspective of how that story plays out, the Republican Party and the Trump administration will do everything they can to underscore that the positive elements of a general economic health, whereas, the Democrats are going to continue to highlight what their constituents are saying and what the rest of the numbers bear out—that even if on average certain things look good, like the market or unemployment, the struggle is still there and the, sort of, inequality just deepens that struggle. And how do we understand that that’s what citizens are, actually, sort of thinking about on a regular basis. And then the extent to which they can talk to people and give them real solutions and real platforms, that will be something else. I do think it resonates with a lot of voters, not just Democrats, but I think even on middle Republicans who have problems making their bills or meeting their bills on a monthly basis, that things are more expensive than the overall markets and the overall economic health rhetoric might indicate.
So, I mean, we’re going to find out in the next month or so. I think what’s going to happen on the Democratic side, I think if Biden continues to be the front-runner and becomes the ultimate candidate, he will talk about inequality. I think he’ll more talk about the sort of problems of what has been happening in the last couple of years with respect to trade, with respect to war, etc. I think if Bernie Sanders becomes the candidate, he’s going to continue to talk about who’s getting the money, you know? That it is Wall Street relative to main street, and resonate with people who are feeling that in their own lives in that manner.
In terms of who wins in November, it’s hard to say. I mean, there’s a strong tendency to vote for an incumbent president or for an incumbent president to win in the second term unless there’s a major economic downfall going on. For example, George Bush did not win a second term, because there was a major recession going on as he was working towards being reelected.
So given that on the outside the economy still has a lot of positive numbers that are played repeatedly, that could move the line over to reelecting President Trump. But I think we have yet to see the story of how people in the swing states resonate with the candidate when there’s only one candidate on the Democratic side and, you know, six or seven that are still running. I think it will become a lot clearer as to what people are going to support.
Will they support [a] healthcare for all type of thing—where they can actually have that comfort on the healthcare side and that comfort on [the] student loan side? I mean, there are debt problems, there are cost problems that do need to be resolved, whoever is going to run the country come next year. I do think voters on both sides of the equation want to know what those solutions really are.
AL: Nomi, thank you very much for joining me on the show. I really appreciate all of your insights and I’m really looking forward to speaking with you again. Please visit Nomi on Twitter @NomiPrins.
This article originally appeared on Sprottmedia.com.