In January the Department Of Finance will issue the Governor’s Budget for 2022-23. No section will be more important than the Stress Test, which forecasts revenue losses in the event of a stock market decline such as in 2001-3 and 2008-9.
Last January, the Governor’s Budget forecast revenue losses of $100 billion. Just two years earlier, the 2019-20 Governor’s Budget forecast losses of $50 billion. That makes sense because, as DOF explains, “the higher levels and valuations in the stock market increase the risk of a large stock market drop leading to a large decline in capital gains revenues” on which California is extraordinarily dependent.
Schools and other services need predictable annual funding. You should build reserves to the levels predicted by stress tests.
Author(s): David Crane
Publication Date: 5 Dec 2021
Publication Site: Govern for California (Mail Chimp)
However, these numbers are highly influenced by unusual economic times. For starters, states delayed their tax filing deadline by several months when the pandemic began. For most, this pushed their 2020 income tax revenue into the next fiscal year. This artificially deflated 2020’s numbers while inflating 2021 collections.
The federal stimulus has also played a role. Since March 2020, the feds have doled out $867 billion in cash to households via three Economic Impact Payments. While those payments weren’t taxable, they could indirectly increase state tax liability for some. (The New York TimesNYT+1% has a good explainer on that.) Plus, unemployment insurance — which most states do tax — received a massive boost for about 15 months.
The Federal Trade Commission said Monday that it is investigating the causes behind ongoing supply chain disruptions and how they are “causing serious and ongoing hardships for consumers and harming competition in the U.S. economy.”
The FTC said it is ordering Walmart, Amazon, Kroger, other large wholesalers and suppliers including Procter & Gamble Co., Tyson Foods and Kraft Heinz Co. “to turn over information to help study causes of empty shelves and sky-high prices.”
Orders also are being sent to C&S Wholesale Grocers, Inc., Associated Wholesale Grocers, Inc. and McLane Co, Inc.
At the height of the last big wave of Turkey’s ongoing crisis, in August 2018, the European Central Bank issued a warning about the potential impact the plummeting lira could have on Euro Area banks heavily exposed to Turkey’s economy via large amounts in loans — much of them in euros — through banks they acquired in Turkey. The central bank was worried that Turkish borrowers might not be hedged against the lira’s weakness and would begin to default on foreign currency loans, which accounted for 40% of the Turkish banking sector’s assets.
In the end, the contagion risks were largely contained. Many Turkish banks ended up agreeing to restructure the debts of their corporate clients, particularly the large ones. At the same time, the Erdogan government used state-owned lenders to bail out millions of cash-strapped consumers by restructuring their consumer loans, many of them foreign denominated, and credit card debt.
But concerns are once again on the rise about European banks’ exposure to Turkey. On Friday, as those concerns commingled with fears about the potential threat posed by the new omicron variant of Covid-19, Europe’s worst-affected stocks included the four banks most exposed to Turkey: Spain’s BBVA, whose shares fell 7.3% on the day, Italy’s Unicredit (-6.9%), France’s BNP Paribas (-5.9%) and the Dutch ING (-7.3%).
Stock traders today appeared to assume that the omicron variant will hit life insurers harder than health insurers.
The stock prices of Anthem, Centene, Humana and UnitedHealth all dropped from 1.7% to 2.28% — less than the Dow Jones Industrial Average.
The stock prices of Ameriprise, Brighthouse Financial, CNO Financial, Equitable, Globe Life, Lincoln Financial, MetLife, Primerica Principal Financial Group, Prudential Financial and Unum Group all fell 3.5% to 5%.
The stock price of Reinsurance Group of America — a company that insures life insurers against spikes in mortality and longevity risk — fell 9.58%.
Office vacancy rates have risen modestly to 18.3% (see Figure 8). However, actual office usage has declined much more as the work-from-home response to the pandemic became widespread. This decline has had limited financial impact to date because office rentals are usually held in multiyear leases with credit-worthy tenants (see Figure 9). However, there is considerable uncertainty about whether and how demand for office space will change over the long run.
Author(s): Office of Financial Research
Publication Date: 17 Nov 2021
Publication Site: Office of Financial Research, Treasury Department
Today’s graphic from Paul Schmelzing, visiting scholar at the Bank of England (BOE), shows how global real interest rates have experienced an average annual decline of -0.0196% (-1.96 basis points) throughout the past eight centuries.
Starting in 1311, data from the report shows how average real rates moved from 5.1% in the 1300s down to an average of 2% in the 1900s.
The average real rate between 2000-2018 stands at 1.3%.
Demographics impact interest rates on a number of levels. The aging population—paired with declining fertility levels—result in higher savings rates, longer life expectancies, and lower labor force participation rates.
In the U.S., baby boomers are retiring at a pace of 10,000 people per day, and other advanced economies are also seeing comparable growth in retirees. Theory suggests that this creates downward pressure on real interest rates, as the number of people in the workforce declines.
Workers resigned from a record 4.4 million jobs in September, according to Labor Department data, and new surveys show that low-wage workers, employees of color and women outside the management ranks are those most likely to change roles. The findings signal that turnover isn’t evenly spread across the U.S. workforce even as employers across industries struggle to fill a variety of roles.
The overall percentage of people considering leaving their jobs — about three in 10, according to research by consulting firm Mercer LLC — is fairly consistent with historical trends. But sentiment varies across demographics and occupations. While front-line and low-wage positions typically see high rates of turnover, for example, employees in those roles are especially likely to leave now, Mercer found in a survey of 2,000 U.S. workers conducted in August.
Nearly half of low-wage and front-line workers surveyed said their pay and benefits were insufficient while 41% said they felt burned out from demanding workloads. Some 35% of Black employees and 40% of Asian employees said they were considering leaving, compared with 26% of white employees.
Our view of the current level of vulnerabilities is as follows:
Asset valuations. Prices of risky assets generally increased since the previous report, and, in some markets, prices are high compared with expected cash flows. House prices have increased rapidly since May, continuing to outstrip increases in rent. Nevertheless, despite rising housing valuations, little evidence exists of deteriorating credit standards or highly leveraged investment activity in the housing market. Asset prices remain vulnerable to significant declines should investor risk sentiment deteriorate, progress on containing the virus disappoint, or the economic recovery stall.
Borrowing by businesses and households. Key measures of vulnerability from business debt, including debt-to-GDP, gross leverage, and interest coverage ratios, have largely returned to pre-pandemic levels. Business balance sheets have benefited from continued earnings growth, low interest rates, and government support. However, the rise of the Delta variant appears to have slowed improvements in the outlook for small businesses. Key measures of household vulnerability have also largely returned to pre-pandemic levels. Household balance sheets have benefited from, among other factors, extensions in borrower relief programs, federal stimulus, and high aggregate personal savings rates. Nonetheless, the expiration of government support programs and uncertainty over the course of the pandemic may still pose significant risks to households.
Leverage in the financial sector. Bank profits have been strong this year, and capital ratios remained well in excess of regulatory requirements. Some challenging conditions remain due to compressed net interest margins and loans in the sectors most affected by the COVID-19 pandemic. Leverage at broker-dealers was low. Leverage continued to be high by historical standards at life insurance companies, and hedge fund leverage remained somewhat above its historical average. Issuance of collateralized loan obligations (CLOs) and asset-backed securities (ABS) has been robust.
Funding risk. Domestic banks relied only modestly on short-term wholesale funding and continued to maintain sizable holdings of high-quality liquid assets (HQLA). By contrast, structural vulnerabilities persist in some types of MMFs and other cash-management vehicles as well as in bond and bank loan mutual funds. There are also funding-risk vulnerabilities in the growing stablecoin sector.
Last week, real yields, which take into account the corrosive effects of inflation, hit some of their lowest levels on record. One measure of real yields, 10-year Treasury inflation-protected securities, fell to minus 1.2%, according to Tradeweb. That is the lowest on record, according to data going back to February 2003.
In essence, with real yields negative, the purchasing power of money invested will decline over the lifetime of those bonds.
Real yields have fallen because of colliding factors. These include the highest inflation rate in over three decades combined with nominal bond yields that have risen only modestly as central banks hold back from raising rates.
The prospect of negative returns on super safe inflation-protected bonds has pushed investors to buy riskier assets.
Historical Fact: Some readers may have a pressing question: What happens to debt, including mortgages, under hyperinflation? In finance, there is a popular quote, “there is no free lunch.” By 1924, Weimar Germany will redenominate and reinstate debt into the brand new Rentenmark after bailing out Deutsche Bank and Commerzbank. It’s a messy process and beyond the scope of this publication you’re reading.
In this essay, we consider an additional application. Using the utility framework described by Warren (2019), we examine the impact of using one of BB’s fitted jump-diffusion models on a pension plan sponsor’s long-term asset allocation decision. We want to compare asset allocation results to those using the standard finance workhorse model of a geometric Brownian motion (i.e., lognormal return generating process or LN hereafter).