All about risk
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Two things on the Fed’s mind are the core rate of inflation (all items excluding food and energy) and rent. Both have proven stubborn.
Despite constant talk of falling rent prices please note that Rent of primary residence has gone up at least 0.4 percent, every month for 23 straight months!
The falling rent meme has been wrong for at least a full year.
Author(s): Mike Shedlock
Publication Date: 12 July 2023
Publication Site: Mish Talk
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The Fed’s Summary of Economic projections is far more interesting. I highlighted the median economic forecast in pink. Each dot represents the position of someone at the meeting.
Looking ahead to 2025, the Fed is clueless.
Actually, that’s not a bad thing. Someone on the committee is likely to be correct.
Moreover, the results look like one of my favorite sayings: I don’t know and no one else does either, especially the Fed.
Author(s): Mike Shedlock
Publication Date: 14 Jun 2023
Publication Site: Mish Talk
Link: https://www.wsj.com/articles/the-banking-sector-turmoil-in-charts-52bb6095?mod=e2twg
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It has been a wild ride for banks. Silicon Valley Bank, which catered to venture capitalists and startups, collapsed March 10 after a run on deposits that was preceded by a plunging share price and a money-losing bond sale as the bank tried to raise capital. Two days later, Signature Bank SBNY -22.87%decrease; red down pointing triangle was closed by federal regulators following a run. Then, First Republic Bank FRC 29.47%increase; green up pointing triangle, at risk of a run as its share price plummeted, was flooded with cash in an extraordinary action by some of the largest U.S. banks—but its shares resumed their plunge a day later.
Here is how some banks ended up in the market’s crosshairs.
Author(s): Nate Rattner, Alana Pipe
Publication Date: 18 Mar 2023
Publication Site: WSJ
Link: https://www.brookings.edu/research/capital-regulation-and-the-treasury-market/
Excerpt:
The dramatic, though short-lived, disruption of the market for U.S. Treasury debt in September 2019 and the more profound market dislocations at the onset of the COVID crisis in March 2020 have raised the issue of whether the treatment of central bank reserves and sovereign debt in bank capital requirements exacerbated the problems. Changes have been proposed to the Enhanced Supplementary Leverage Ratio (eSLR) and G-SIB (Global Systemically Important Bank) capital surcharge, both of which apply only to the eight U.S. banks designated as globally significant. Because these banks are some of the most important dealers in U.S. Treasuries, regulatory disincentives to hold and trade Treasuries can adversely affect the liquidity of the world’s most important debt market.
Disagreement over whether to adjust the eSLR, the surcharge or both is often just a version of the continuing debate over the right level of required capital. Some banking interests seize on episodes of Treasury market dysfunction to argue for reductions in the eSLR and surcharge. Some regulators, elected representatives, and commentators see any adjustments as weakening post-Global Financial Crisis (GFC) capital standards. Yet it is possible to reduce the current regulatory disincentive of banks, especially at the margin, to hold and trade Treasuries without diminishing the overall capital resiliency of large banks.
The concern with eSLR is that when it is effectively the binding regulatory capital constraint on a bank, that institution will limit its holding and trading of Treasuries. The eSLR can be modified to accommodate considerably more intermediation of Treasuries without significantly undercutting its regulatory rationale. As for the G-SIB surcharge, there are some unproblematic changes that could help. But the chief complaints from banks about the G-SIB surcharge will be harder to satisfy without undermining the rationale of imposing higher capital requirements on systemically important banks.
Even with a change in the eSLR, banks’ holdings of Treasuries would continue to be subject to capital requirements for market risk. Moreover, as the failure of Silicon Valley Bank has demonstrated, the exclusion of unrealized gains and losses on banks’ available-for-sale portfolio of debt securities, including Treasuries, can give a misleading picture of a bank’s capital position. Following the Federal Reserve’s 2019 regulatory changes, only banks with more than $700 billion in assets or more than $75 billion in cross-jurisdictional activity are required to reflect unrecognized gains and losses in their capital calculations. The banking agencies should consider a significant reduction in these thresholds.
Far-reaching deregulatory changes would not remedy all that is worrisome in Treasury markets today. As the studies cited in the full paper emphasize, a multi-pronged program is needed. In any case, it would be misguided to seek greater bank capacity for Treasury intermediation at the cost of undermining the increased resiliency of the most important U.S. banking organizations or international bank regulatory arrangements. At the same time, it would be ill-advised not to recognize the changes in Treasury markets, beginning with their increased size because of fiscal policy. The modifications of capital regulation, especially the eSLR, outlined in the paper should ease (though not eliminate) constraints on banks holding and trading Treasuries without endangering the foundations of the post-GFC reforms.
Author(s): Daniel K. Tarullo
Publication Date: 17 Mar 2023
Publication Site: Brookings
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On day one of Fixed Income School, you learn that bond prices mean-revert. While a stock or a house’s price can continue to increase as the company or land becomes more valuable, yields can only go so low. Nobody will pay to lend someone else money, or at least, they won’t pay much to do that. Bond prices can only climb so high before they fall. While some evidence shows that yields trended downward slightly as the world became less risky, they still tended to revert to a mean greater than zero.
It’s easy to blame Silicon Valley Bank for being blissfully ignorant of such details. They purchased long-term bonds and mortgage-backed securities when the Fed was doing QE on steroids! Did they expect that to last forever? Well, maybe that was a reasonable assumption, based on the last 15 years, but I digress.
Many of these smaller banks, particularly Silicon Valley, are in trouble because they were particularly exposed to rate risk since their depositors’ profit model relied on low rates. So, when rates increased, they needed their money—precisely when their asset values would also plummet. It’s terrible risk management. But, to be fair, even the Fed (the FED!) did not anticipate a significant rate rise. Stress tests didn’t even consider such a scenario, even as rates were already climbing. Why would we expect bankers in California to be smarter than all-knowing bank regulators?
According to the New York Times, Central Bankers still expect rates to fall back to 2.5%. Why? Because of inequality and an aging population. But how does that work, and what’s the mechanism behind it? No good answer, or not one that squares with data before 1985, but we can hope. Sometimes we just want something to be true and for it to be true for politically convenient reasons.
Author(s): Allison Schrager
Publication Date: 20 Mar 2023
Publication Site: Known Unknowns at Substack
Link: https://www.politico.com/news/2023/03/13/barney-frank-signature-bank-collapse-warren-trump-00086765
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From his front-row seat, [Barney Frank] blames Signature’s failure on a panic that began with last year’s cryptocurrency collapse — his bank was one of few that served the industry — compounded by a run triggered by the failure of tech-focused Silicon Valley Bank late last week. Frank disputes that a bipartisan regulatory rollback signed into law by former President Donald Trump in 2018 had anything to do with it, even if it was driven by a desire to ease regulation of mid-size and regional banks like his own.
“I don’t think that had any impact,” Frank said in an interview. “They hadn’t stopped examining banks.”
But Warren, a fellow Massachusetts Democrat who designed landmark consumer safeguards that ended up in Frank’s 2010 banking law, is placing the blame firmly on the Trump-era changes that relaxed oversight of some banks and says Signature is a prime example of the fallout. Warren argues that, had Congress and the Federal Reserve not rolled back stricter oversight, Silicon Valley Bank and Signature would have been better able to withstand financial shocks.
Author(s): ZACHARY WARMBRODT
Publication Date: 13 Mar 2023
Publication Site: Politico
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The Treasury and Federal Reserve stepped in late Sunday to contain the financial damage from Friday’s closure of Silicon Valley Bank, guaranteeing even uninsured deposits and offering loans to other banks so they don’t have to take losses on their fixed-income assets.
This is a de facto bailout of the banking system, even as regulators and Biden officials have been telling us that the economy is great and there was nothing to worry about. The unpleasant truth—which Washington will never admit—is that SVB’s failure is the bill coming due for years of monetary and regulatory mistakes.
Wall Street and Silicon Valley were in full panic over the weekend demanding that the Treasury and Fed intervene to save the day. It’s revealing to see who can keep a cool head in a crisis—and it wasn’t billionaire hedge-fund operator Bill Ackman or venture investor David Sacks, both frantic panic spreaders.
The Federal Deposit Insurance Corp. closed SVB, and the cleanest solution would be for the agency to find a private buyer for the bank. This has been the first resort in most previous financial panics, and the FDIC was holding an auction that closed Sunday afternoon.
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But there is political risk from a bailout too. If the Administration acts to guarantee deposits without Congressional approval, it will face legitimate legal questions. The White House may choose to jam House Speaker Kevin McCarthy if markets aren’t mollified. But Mr. McCarthy has a restive GOP caucus as it is, and a bailout for rich depositors will feed populist anger against Washington.
The critics have a point. For the second time in 15 years (excluding the brief Covid-caused panic), regulators will have encouraged a credit mania, and then failed to foresee the financial panic when the easy money stopped. Democrats and the press corps may try to pin the problem on bankers or the Trump Administration, but these are political diversions.
Author(s): WSJ Editorial Board
Publication Date: 12 Mar 2023
Publication Site: WSJ
Link: https://mishtalk.com/economics/yellen-said-no-bailout-but-its-a-huge-bailout-of-the-banking-system
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It won’t matter but I am pleased the Journal blasted Bill Ackman and venture investor David Sacks, as “frantic panic spreaders“.
There’s more in the article about how Rohit Chopra, an Elizabeth Warren acolyte on the FDIC board, is hostile to bank mergers on ideological grounds, perhaps preventing a merger.
The Journal speculates how Biden might illegally act to guarantee all deposits or pressure House Speaker Kevin McCarthy.
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Once again, the Fed kept interest rates too low, too long, encouraged speculation, then bailed out the banks.
Spare me the sap about this was a depositor bailout not a bank bailout.
When you value assets at par so that banks don’t have losses, what the hell is it.
Author(s): Mike Shedlock
Publication Date: 12 Mar 2023
Publication Site: Mish Talk
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A significant portion of U.S.-based asset managers think further Federal Reserve rate hikes would lead to a recession or some disruption in global financial markets, according to research last month by London-based CoreData Research.
The greatest anticipated risk of continued Federal Reserve rate hikes is a possible recession. Overall, 59% of survey respondents took a neutral look at a recession scenario, that there would be “a moderate recession in 2023, followed by a gradual recovery as central bank policies bring down inflation over time,” while 14% opted for a bull case, defined as “a mild recession in the first half of 2023, followed by a strong recovery, falling inflation and rising equity markets [in the second half of 2023],” and 27% said they agree with a bear case, defined as a scenario in which “stagflation and a deep recession [occur] in 2023, accompanied by a 10-20% fall in the equity markets, as central banks struggle to defeat inflation which remains high.”
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Within fixed income, 36% of respondents said they are increasing allocations to investment-grade corporate bonds, the most of any fixed-income subtype, and 33% are set to increase allocations to government bonds. A further 23% of respondents said they plan to cut their exposures to emerging-market debt as a consequence of higher yields domestically.
Author(s): Dusty Hagedorn
Publication Date: 24 Feb 2023
Publication Site: ai-CIO
Link: https://www.federalreserve.gov/econres/ifdp/the-inflationary-effects-of-sectoral-reallocation.htm
PDF: https://www.federalreserve.gov/econres/ifdp/files/ifdp1369.pdf
Citation:
Ferrante, Ferrante, Sebastian Graves and Matteo Iacoviello (2023). “The Inflationary Effects of Sectoral Reallocation,” International Finance Discussion Papers 1369. Washington: Board of Governors of the Federal Reserve System,
https://doi.org/10.17016/IFDP.2023.1369.
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The COVID-19 pandemic has led to an unprecedented shift of consumption from services to goods. We study this demand reallocation in a multi-sector model featuring sticky prices, input-output linkages, and labor reallocation costs. Reallocation costs hamper the increase in the supply of goods, causing inflationary pressures. These pressures are amplified by the fact that goods prices are more flexible than services prices. We estimate the model allowing for demand reallocation, sectoral productivity, and aggregate labor supply shocks. The demand reallocation shock explains a large portion of the rise in U.S. inflation in the aftermath of the pandemic.
Author(s): Francesco Ferrante, Sebastian Graves and Matteo Iacoviello
Publication Date: February 2023
Publication Site: Federal Reserve
Link: https://mishtalk.com/economics/how-many-rate-hikes-does-the-market-now-expect-of-the-fed
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Now Vs a Month Ago
- The market now sees a terminal rate of 5.36 percent in September, call it 5.25-5.50 percent.
- A month ago the market thought the terminal rate was 5.00 percent in June.
- Previously, the market expected a peak in June followed by two or three 25-basis point cuts all the way to 4.32 percent.
- The market now sees a a cut from 5.36 percent to 5.0 percent.
Author(s): Mike Shedlock
Publication Date: 11 Feb 2023
Publication Site: Mish Talk
Link: https://www.city-journal.org/fed-goes-underwater
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Before new trillion-dollar federal spending bonanzas became a regular occurrence, the Federal Reserve’s announcement that it lost over $700 billion might have garnered a few headlines. Yet the loss met with silence. Few Americans have noticed the huge increase in both the scale and the scope of the central bank or the dangers that it poses to the American economy. As Fed-driven inflation becomes the Number One political issue in America, that will change.
The Fed’s losses owe to a shift in the way it does business. Before the 2008 financial meltdown, the central bank tried to control interest rates by buying and selling U.S. bonds. A few billion in purchases or sales could move the whole economy, and this meant that the Fed, which operates much like a normal bank, could keep a relatively small balance sheet of under $1 trillion.
Since the financial crisis, the Federal Reserve, like other developed-world central banks, has used a different playbook. It provides enough funds to satiate the entire banking world, and it seeks to adjust the economy by paying banks more or less interest to hold those funds. These payments keep private-sector interest rates from dropping too low. When it first undertook this “floor” experiment, the Fed’s balance sheet exploded to more than $4 trillion. After the Covid pandemic, it approached $9 trillion.
A larger balance sheet means greater risks. And the Fed has added to that risk by purchasing longer-duration assets. Pre–financial crisis, the Fed bought mainly short-term federal debt. Only about 10 percent of all the U.S. bonds owned by the central bank lasted longer than ten years. Now, that figure has risen to 25 percent.
Author(s): Judge Glock
Publication Date: Winter 2023
Publication Site: City Journal