Hello everyone. I'll preface this by saying this might be a bit more in the weeds than many of you will care to explore. Hey, I get it, not everyone is a financial spy, trying to figure out their next moves. But unfortunately I am.
Well, have you ever been in a situation, where you saw something that was going on, but you just couldn't exactly put your finger on it? That's what happened to me lately, as I was watching the Chinese do some very interesting things, but I couldn't follow the entire plot well enough to speak on it. But interestingly enough, Arnaud Bertrand did and he came up with some good conclusions. I'd like to explain them to you.
As you know, there's a lot of speculation about whether the BRICS will abandon the dollar and US debt. I happen to believe they want to distance themselves from it, but when you're talking about dismantling something that's been in place for decades, it's painfully slow, and you have to adjust for any and all pitfalls.
The story around China issuing USD-denominated sovereign bonds in Saudi Arabia is generating an enormous amount of buzz in China, and could potentially be immensely important. I strongly suspect it's a message to the upcoming Trump administration. Let me explain what seems to be going on. On the face of it, it's not a major story: China issued $2 billion in USD-denominated sovereign bonds in Saudi Arabia, which means that investors lent USD to the Chinese government that they promised to pay back. That's what a bond is. So far, relatively boring.
The first somewhat interesting aspect of it is that the bonds were oversubscribed by almost 20x (meaning $40+ billion in demand for $2 billion worth of bonds), which is far more demand than usual for USD sovereign bonds. Typically US Treasury auctions see oversubscription rate between 2x to 3x so there obviously seems to be very strong market appeal for China's dollar-denominated debt.
The second interesting aspect is that the interest rate on the bonds was remarkably close to US Treasury rates (just 1-3 basis points higher, i.e. 0.01-0.03%), which means that China is now able to borrow money - in US dollars (!) - at virtually the same rate as the US government itself. That's the case for no other country in the world. As a benchmark, countries with the highest credit ratings (AAA) typically pay at least 10-20 basis points over US Treasuries in the rare instances when they issue USD bonds.
The third interesting aspect is the venue itself for this bond sale: Saudi Arabia. This is unusual since sovereign bonds are typically issued in major financial centers, not in Riyadh. The choice of Saudi Arabia and the fact that the Saudis agreed to this is particularly significant given its historical role in the global dollar system, the so-called 'petrodollar' system which I don't need to explain... By issuing dollar bonds in Saudi Arabia that compete directly with US Treasuries, and getting essentially the same interest rate, China is demonstrating it can operate as an alternative manager of dollar liquidity right in the heart of the petrodollar system. For Saudi Arabia, which holds hundreds of billions in dollar reserves, this creates a new option for investing their dollars: they can invest it with the Chinese government instead of the US government.
Ok, that's all interesting but still not the main reason why Chinese social media is abuzz. The reason why is because they postulate that this is trial round by China to demonstrate to the US that they can effectively use their own currency against them, with potentially dramatic consequences.
How?
First of all, think it through, imagine if China scales this up and instead of issuing $2 billion worth of bonds, they start issuing 10s or 100s of billions worth of it. What this means for the US is that China would effectively be competing with the US Treasury in the global dollar market. Instead of countries like Saudi Arabia automatically recycling their dollars into US Treasury bonds, they could put them into Chinese dollar bonds that pay the same rate.
This would create a parallel dollar system where China, not the US, controls part of the flow of dollars. The US would still print the dollars, but China would increasingly manage where they go. Imagine that...
Another critical aspect is that every dollar that goes into Chinese bonds instead of US Treasuries is one less dollar helping to finance US government spending. At a time when the US is running massive deficits and needs to constantly sell Treasury bonds to fund itself, having China emerge as a competing dollar bond issuer that can match Treasury rates could pose immense financing problems for the US government. It could effectively end the US's so-called "exorbitant privilege".
But wait, you might ask yourself, what's the point of China having so many dollars? Don't they transfer the problem to themselves: they too need to find a place to invest all these dollars, don't they? You'd be right, the last thing China needs is more US dollars: in 2023 it ran a US dollar trade surplus of $823.2 billion, and for 2024, it's expected to be $940 billion. China is already absolutely awash with dollars.
But that's where the beauty of the Belt & Road Initiative comes in. Out of the 193 countries in the world, 152 of these countries are part of the BRI. And a very common characteristic many of these countries have is: they owe debt in USD, to the US government or other Western lenders. This is where China's strategy could become truly clever. China could use its US dollars to help Belt & Road countries pay off their dollar debts to Western lenders. But here's the key: in exchange for helping these countries clear their dollar debts, China could arrange to be repaid in yuan, or in strategic resources, or through other bilateral arrangements.
This would create a triple win for China: they get rid of their excess dollars, they help their partner countries escape dollar dependency, and they deepen these countries' economic integration with China instead of the US. For BRI countries, this is attractive because they can escape the trap of dollar-denominated debt (and the threat of US financial sanctions) and get likely better conditions with China, which will help their development.
In effect this would China placing itself as an intermediary at the heart of the dollar system, where the dollars still eventually make their way back to the US - just through a path that builds Chinese rather than American influence and progressively undermines the US's ability to finance itself (with all the consequences this has on inflation, etc.). At this stage you probably tell yourself “come on, there's no way China can do that, the US government surely has tools at its disposal to prevent this stuff". And the answer, surprisingly, is that there is actually little the U.S. can do that doesn't undermine them in some shape or form.
The most obvious response would be to threaten sanctions against countries - like Saudi Arabia - or institutions that buy Chinese dollar bonds. But this would further demonstrate that dollar assets aren't actually safe from US political interference, further encouraging countries to diversify, compounding the problem. The dollar's strength partly comes from network effects - everyone uses it because everyone else uses it - but as we've seen with Russia sanctions create a coordinating moment for countries to move away together, weakening these network effects.
Another option would be for the Federal Reserve to raise interest rates to make US Treasuries more attractive. But this would be self-defeating: it would increase the US government's own borrowing costs at a time when they're already struggling with massive deficits, potentially triggering a recession. And China, getting similar rates as the US, could simply match any rate increase. The US could also go for the "nuclear option" of restricting China's ability to clear dollar transactions but this would effectively immediately fragment the global financial system, undermining the dollar's role as the global reserve currency - exactly what the US wants to avoid. And with China being the most important trading partner of the immense majority of the world's countries, nothing is less sure that the U.S. would win at this game...
In short this seems to be like some sort of Tai Chi 'four ounces moving a thousand pounds' move by China, using minimal force to redirect the dollar's strength in a way that benefits China. Like I wrote at the beginning however, at this stage this is most likely just a message by China to the upcoming Trump administration: "we can do this so maybe think very carefully about all the nasty things you have in mind for us..." The beauty of this move is how strategically elegant it is: it costs China almost nothing to demonstrate, but forces Washington to contemplate some very uncomfortable possibilities.
Don't be deceived when you hear from the BRICS that they're not interested in shunning the dollar. You never tell your enemies your game plan. Just know that China hasn't done this for nothing. They're flexing muscles that the US didn't know it had, a loophole they didn't close.
Everywhere we look, there's war. Ukraine/Russia is escalating to a dangerous level. the Middle East is a powder keg. The ICC says they want to arrest Netanyahu for war crimes. Meanwhile, we've got a silent financial war raging.
May you live in interesting times comes to mind. Stay safe.
AI has a lot of people buzzing, with the "darling" high fliers like NVDA and AMD making these new high powered chips. But lost in the shuffle is one quite interesting fact. All these computers for AI need copper. Every single one of them and guess what? Copper is in supply/demand deficit.
SANTIAGO, April 12 (Reuters) - Copper's bull run should continue for at least the next three years, fueled by global supply challenges and hot demand for the metal to power energy transition and artificial intelligence technologies, industry analysts say.
The outlook is an optimistic harbinger for Freeport-McMoRan and other producers as decarbonization and technological shifts fuel copper's latest demand wave after China's rise powered a similar one two decades ago.
But with question marks hanging over a number of key projects, some estimate production will struggle to meet that demand.
These themes are expected to dominate conversations in the Chilean capital of Santiago at the CRU World Copper Conference from April 15-17, the largest annual gathering of industry executives, investors and analysts. Chile is the world's biggest copper producer but its output has faltered in recent years.
But with question marks hanging over a number of key projects, some estimate production will struggle to meet that demand.
These themes are expected to dominate conversations in the Chilean capital of Santiago at the CRU World Copper Conference from April 15-17, the largest annual gathering of industry executives, investors and analysts. Chile is the world's biggest copper producer but its output has faltered in recent years.
"Copper's second secular bull market this century is taking hold," said Citi analyst Maximilian Layton, who expects demand to outstrip supply by 1 million metric tons during the next three years. "Explosive price upside is possible over the next two to three years."
In a report published earlier this week, Layton and Citi said they expect copper prices to touch $12,000 a metric ton by December 2026, a forecast echoed in a similar report from Bank of America. Prices traded near $9,378 a metric ton on Wednesday, near a 14-month high.
I'm pretty much on record suggesting that commodities are going to be where the money goes, once the market bubble pops. Yes gold, yes silver. But it will be much more, like I'm writing here about copper. Every wire in your house, your car, your appliances, your computers your 'everything" has a copper component.
So, the question is... how do we play it? In Silver, we can buy the SLV, or the various miners that produce the stuff out of the ground. We can simply buy the metal itself, in coins or bars. But how does one play in the copper sector? Well, there is an ETF of copper producers, but it trades incredibly thinly and doesn't move very well. Symbol is ICOP.
As the Reuters piece mentioned, FCX is probably one of the most notable producers. But there are others and some of them trade quite nicely. BHP would be next up on the "big" list, while SCCO comes to mind in smaller outfits. TECK comes to mind. Finally RIO has to be in the mix.
One thing that's quite different when you're looking at commodities other than gold and silver, is that you rarely if ever want to take physical delivery of it. While Gold is 2400 an ounce and we suggest that people should own it, an ounce of copper is never going to make you rich. ( not that an ounce of gold will, but you get the picture) Six ounces of gold is over 12K. For that price you get over a TON of copper. Where are you going to put it? Same with oil, wheat, etc.
The only real way to play in the commodity game is via ETF's or indeed the producers themselves if they have a publicly traded stock. Some have both, for instance if you want to play in energy, you can buy the USO or XLE, ETF. But you can also invest in XOM, VLO, OXY, SLB, etc.
So are there good ETF's for a wide range of commodity exposure? Yes there is. For instance GLTR ( pretty catchy symbol for metals!) Most metal ETFs only provide exposure to gold and silver, but abrdn’s Physical Precious Metals Basket Shares ETF—its full name—offers exposure to gold, silver, platinum and palladium bullion. Much larger exposure to the four major metals.
Back in 2020, I mentioned that I wouldn't be against anyone taking a position in DBA, an agriculture ETF. It has gone on to do very well and I expect it to continue.
Real, tangible, 3 dimensional items that we use every day are getting harder and harder to come by. We've been running electric wires for well over 100 years. Imagine the amount of copper that's come out of the ground to make all that. And, just like gold or silver, the "easy pickins" have already been done, meaning it costs more to find more. So, the idea that commodities of all types will go up, isn't just because of our failing, depreciating currency. We have to include scarcity.
I'll be writing more about this topic in the future, because I believe that at some point, it will be where the big money flows. Stay tuned.
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Once again, Pam and Russ Martens have grabbed our attention with another zinger.
In today’s Wall Street on Parade newsletter, they feature Michael Hsu, the acting director of the Office of the Comptroller of the Currency (OCC).
The OCC charters, regulates, and supervises national banks, federally chartered savings associations and federal branches and agencies of foreign banks in the U.S.
They stand beside the Federal Reserve as a major regulator of banking institutions.
Specifically, the Martens write about how Hsu “undermined [already declining] public trust in the U.S. banking system” when he approved JPMorgan Chase’s acquisition of failed First Republic Bank in May.
(By now, readers know that JPMorgan Chase is America’s largest – and, by some measures, the riskiest – bank in the nation.)
The Martens go on to note that Hsu’s response to that “collapse in public trust” was to, yes, issue a survey measuring public trust in, yes (again), banks.
The Martens tie much of Americans’ lack of trust to the number of unlawful acts committed by the largest of the too big to fail banks over the last 23 years.
https://bettermarkets.org/wp-content/uploads/2023/10/BetterMarkets_RAP_Sheet_OnePager_10-2023.pdf
They report, as shown in the chart, that the six largest Wall St. banks have been subject to an astounding 490 legal actions, leading to more than $207 billion in fines and settlements over that period.
That’s according to the nonprofit, nonpartisan firm Better Markets.
An October Better Markets press release entitled “Wall Street’s Rap Sheet” says:
“Year after year, Wall Street’s biggest banks continue to rip off, discriminate against, and financially endanger their customers..."
“…Bank of America, Citigroup, Goldman Sachs, JPMorgan Chase, Morgan Stanley, and Wells Fargo…have racked up more than $9 billion in fines in just the past 15 months.”
Among just their 2023 ignoble deeds:
The Rap Sheet adds, “…[W]hile banks portray themselves as upstanding entities with a primary mission of helping Americans fulfill their financial dreams, in truth they each have a dark side as unrepentant recidivists, breaking virtually every financial law and rule imaginable, often multiple times.
“The banks’ ongoing, repeated, and unlawful conduct directly impacts the wallets and lives of Main Street Americans, many of whom are vulnerable and simply unable to bear the losses when they are victimized.”
Perhaps Hsu is more than undermining public trust by his seemingly cavalier approval of Morgan’s gratuitous acquisition of First Republic.
Indeed, as the Martens point out, Hsu – and Washington’s dysfunctional culture in general – is, as Sen. Elizabeth Warren warned over the summer “courting disaster.”
Their article goes on to describe the Office of Financial Research’s so-called Contagion Index.
The OFR is a branch of the U.S. Treasury Department whose responsibility it is to “promote financial stability by delivering high-quality financial data, standards and analysis principally to support [the] Financial Stability Oversight Council…”
Or, as the Martens characterize it, the OFR “serves as an early warning system for serious cracks in financial stability.”
https://www.financialresearch.gov/bank-systemic-risk-monitor/
The Contagion Index measures how specific a too big to fail bank default could result in a systemic contagion in the U.S. banking system as a result of its interdependence and leverage.
As shown above, as of the end of the 2nd quarter, JPMorgan Chase represented three times more of the potential contagion as Bank of America, the second largest bank in the U.S.
This is no way to run the financial system of a Banana Republic much less the United States of America.
As long-time readers know, I’m a strong believer in fundamental but focused governmental reform. In this case, I can’t say it any better than how the Martens conclude their column today:
“Until corporate and Wall Street billionaire funding of political campaigns is outlawed by Congressional legislation” (or, I might add, a very unlikely constitutional amendment);
“[U]ntil Wall Street’s revolving door is slammed shut;
“[U]ntil the U.S. President stops nominating (and the Senate stops confirming) partners at Wall Street’s law firms to run the U.S. Department of Justice…
“[T]his is the corrupt, predatory banking system that every American will be forced to attempt to navigate.”
`Amen to that!
]]>For months on end I’ve been suggesting that some form of credit market/debt market “event” was going to happen and if/when it does, all hell will break out. But, what could it be? The Japan carry trade collapse? A major bank has to “bail in” it’s depositors to save itself? A massive commercial real estate default? I don’t know which one, but something’s lurking out there.
On a day to day basis, you can set your watch by the correlation. Yield pulls back a few tenths, and equities go higher. Yield rises, stocks fall. Lockstep. So yeah, our “system” is creaking and groaning.
October is known as the crash month. Is a crash coming? I don’t know, but I do know that there’s enough evidence that we’re in such bad shape, one could happen. The FDIC has said during meetings with their members that the banking system is fraught with banks “on the edge.” JP Morgan said that if rates keep rising at this pace “something will break.”
So, on one hand we have an economic system, that has been intentionally dismantled, crushing small business and the middle class. All by design, not accident. You all know the plan. Make things so horrid that the populace screams for a solution, and they serve it up via their digital currency and social credit system. On the other hand, we have the satanic maniacs that infest such places as the WEF, The Club of Rome, the Bilderbergers, WHO, UN, Counsil of 300, etc.
The escalating risk from the global destruction in collateral value of fixed-income securities in a highly levered economy is profoundly concerning. The very individuals who previously dismissed the lagging impact of falling bond prices within the banking system are now claiming that worries about a recession are widespread. Well yeah.
The world is interconnected in ways you'll never understand. There's multiple derivatives layered upon multiple derivatives and so on. In some cases, the original foundation asset isn't even known any more.
The bottom line is the debt market is the biggest market on earth, worth multiples of quadrillions. That's a number I cannot comprehend. But one thing is certain, an unusual default in one area, can cascade through multiple layers and traunches of this ponzi.
The incredibly sharp rise in the yield on the ten year, speaks to instability in the debt market. Well yeah, and it's going to get worse. The BRICS are here and there's no turning back.
In the "old days" we had the US as the strongest military, and our dollar was the supreme currency...needed by all. But we abused that privilege. We used it to make other nations toe our line. We sanctioned them. We killed them. There was nothing they could do.
But now there is................ Subscribe to continue reading
]]>The drenching Hurricane-turned-Tropical-Storm Hilary is forecast to leave a destructive swath up the western U.S. this week as relief workers in Maui continue their search for any signs of life among the 850 missing residents of Lahaina over 3,000 miles away.
Meanwhile, economic prognosticators are wondering what’s in store this weekend at the Kansas City Fed’s symposium in Jackson Hole, WY.
The annual summer conference, which will be held Thursday through Saturday, features a slew of speakers who will largely be preaching to a pre-occupied choir.
They will mostly pontificate their profligate theories (or, if you prefer, officiously wax poetic) about this year’s theme – “Structural Shifts in the Global Economy.”
Dispassionate and Fedspeak enough to escape the attention of most common Americans? You betcha!
Although the stream of papers slated to be delivered and discussed at the event have yet to be released, one thing is clear:
Perhaps the most compelling mantras underlying the Structural Shifts theme should be focusing on the storm debt – public and private – brewing in the U.S.
As Jennifer Sor suggests in a recent Business Insider article, troubles are already bubbling up to the surface “as loans pile up and borrower confidence falters.”
Banks Were an Early Sign
Of course, Fitch's recent downgrading of the federal government’s credit rating and Moody's downgrading of 10 U.S. banks should make all Americans concerned about the nation’s creditworthiness and debt flowing out of the banking sector.
But she rightly puts the focus on “more granular problems mounting across debt markets as well.”
Those issues have arisen as the private and public sector are confronted by “a drastically different environment than they did” in the 2010s – when interest rates were at historic lows coming out of the Great Recession.
“If low rates spurred the sugar rush of heavy borrowing,” Sor says, “rising interest rates may be setting the stage for the sugar crash.”
We witnessed the initial domino fall in March with the implosion of Silicon Valley Bank – thanks to mismanagement of its balance sheet weighed down by longer-term bonds that quickly fell in value as interest rates climbed.
First SVB, then Signature and First Republic Banks quickly fell one after the other.
The initial fallout from those failures was somewhat held in check.
But then came Moody’s warning shot three months later when the ratings agency downgraded mostly smaller banks’ credit by one full notch – banks like Fulton, Commerce and M&T.
At the same time, Moody’s affirmed the ratings of 11 other banks but placed them on a negative outlook because of “a decline in the banks’ stability”: Ally, Simmons, OZK, Fifth Third, Regions, Cadence, First National Bank of PA, Citizens, Capital One, Huntington National and PNC.
And now, market pundits and investing icons – like hedge fund guru Ray Dalio and economist Nouriel Roubini – warning that a full-blown debt crisis could be on the way.
Warning Signs of Coming Crisis
Sor offers these five warning signs “flashing in U.S. debt markets”:
First, private debt levels are rising at a stunning rate.
Private debt levels have hit new records this year. Credit card debt just passed $1 trillion for the first time ever, according to the Fed.
Personal unsecured loans have also hit a new record high, reaching $225 billion in 2023, according to TransUnion.
The same for corporate debt, which has seen volumes grow to $7.8 trillion, per Janus Henderson.
Governmental debt looks even more dire. The gross national debt blew through $32 trillion for first time this year.
And, according to too big to fail Bank of America, $5 billion potentially could be added each day for the next 10 years.
The nonpartisan Congressional Budget Office projects that debt held by the public could rise from % of GDP this year to an astounding % by _ under current policies in place today.
Second, corporate defaults are swelling.
Sor points out that with rising interest rates and companies’ growing debt burdens, defaults in 2023 have already surpassed all of last year's total.
A total of 55 U.S.-based firms defaulted on their debt in the first six months of the year – a 53% increase from the 36 companies that defaulted in 2022, according to Moody's.
Sor adds that as much as $1 trillion in corporate debt could default if the nation faces a full-blown recession, according to a BoA warning.
Third, late payments are growing.
Sor reports that people and companies alike “are increasingly falling behind on their loan payments.”
Commercial property owners that were 30 days or more late on monthly payments – or that have already defaulted on their mortgages – rose to 3% in the 1st quarter this year, according to data from the Mortgage Bankers Association.
At the same time, the delinquency rate for all personal loans rose to 2.2% in the 1st quarter this year, up from just 1.7% in the same period of 2021, according to the Fed.
And, fourth, banks are itching to dump their risky debt.
Banks have been trying to dump loans that have a higher default risk, even if it means selling those assets at a discount (loss).
Too big to fails JPMorgan Chase, Goldman Sachs, and Capital One are among the WallStreeters trying to get rid of large commercial real estate assets, Bloomberg reported last week.
Sor notes that banks are also pulling back on their issuing new debt as financial conditions tighten, which she says “spells trouble for the commercial real estate industry.”
About $1.5 trillion of so-called CRE debt set to mature in the next few years will need to be refinanced – right now at higher interest rates.
Property owners could be surprised when they go to refinance their mortgages with higher rates and resulting lower property valuations.
And with fears of commercial real estate default looming, banks have already started to put a hold on lending – especially after the triad of bank failures earlier this year.
In fact, the credit crunch is already here, as banks have recorded the sharpest decline in lending on record.
QT…We Hardly Knew Ye
And it could get crunchier than a freshly opened box of Kapt. Krunch.
According to the minutes of their July policy meeting, Fed officials are seriously considering that they may not have to stop shrinking their massive balance sheet when they begin cutting interest rates:
“A number of participants noted that balance-sheet runoff need not end when the committee eventually begins to reduce the target range for the federal funds rate.”
Janelle Marte writes that this approach “could present communication challenges for the [Fed].”
She says that’s because reducing their portfolio of Treasuries and Mortgage- Backed Securities — the crux of Quantitative Tightening — is normally considered a strategy for tightening monetary policy.
Interest-rate cuts work the opposite way – loosening or easing policy by lowering borrowing costs.
Marte notes the Fed’s most recent economic projections from June, showing that policymakers expect to start lowering interest rates sometime in 2024.
She adds that although the goal of rate cuts are usually to stimulate the economy — think the early days of the pandemic — Fed officials are now trying to keep rates from becoming too restrictive as inflation falls, with the goal of avoiding a recession.
For that reason, some officials have said such rate cuts might not necessarily undermine the Fed’s efforts to keep shrinking its portfolio.
One of them, Dallas Fed President Lorie Logan, observed: “If we are lowering interest rates to get back to a neutral position, that wouldn’t be a reason to stop the decline.”
“My expectation,” she continued, “is that we have room for the balance sheet to continue shrinking for quite some time.”
Marte believes Fed officials want to keep reducing their balance sheet, which ballooned during the pandemic – to a peak of just shy of $1 trillion – to stabilize markets and support the economy.
Since last June, the Fed has been rolling off some of those balance sheet assets as they mature – at a pace of about $800 million a month.
The Fed’s balance sheet now stands at about $8.2 trillion. But Marte notes that efforts “to keep the runoff going could be interrupted for reasons unrelated to rate cuts.”
For example, the last time Fed officials were unwinding the balance sheet, circumstances forced them to halt the runoff — and start intervening in money markets.
Remember when reserves in the banking system fell too low and caused rates on overnight repurchase agreements to skyrocket?
More recently, a lot of liquidity drain has come from the Fed’s reverse-repo program. That’s where money-market funds can park their cash with the Fed overnight.
But, Marte warns, now that the decline in banks’ RRP usage has leveled off, some analysts are concerned that more cash could leak from other segments of the financial system.
The most important of those segments is bank reserves.
And if reserves would fall too much – because of their importance particularly to systemically important global banks (i.e., the too bigs to fail) – the Fed would likely slow or abruptly stop QT.
The moral of this convoluted story is, Eat your Kapt. Krunch while it’s still crunchy.
]]>We recall how the Covid pandemic upended our lives and economy – as well as those of people around the world.
The largely mandated shutdowns in early 2020 caused a devastating reduction of economic activity and huge job losses not seen since the Great Depression.
The downturn came as government restrictions and citizens’ fear of the virus kept people at home and businesses and schools shut – both here and abroad.
Workers in jobs that paid lower wages and required face-to-face encounters with consumers – in the hospitality and retail industries, for example – were especially affected.
Those facing massive employment and earnings losses were disproportionately women, workers of color, workers without a college degree, and foreign-born workers.
Congress, the White House and the Federal Reserve enacted significant fiscal and monetary relief measures in 2020 and 2021 to prevent the economy from facing a depression and to relieve hardships faced by everyday Americans.
Most economists agree that those actions helped fuel an economic recovery starting as early as May 2020, making the deepest recession in the post-World War II era also the shortest.
According to the National Bureau of Economic Research, the consensus arbiter of official business-cycle dating, the economic downturn lasted just two months – March and April 2020.
On the one hand, the CBPP says the expansion in economic activity in the recovery from the pandemic recession was stronger and quicker than initial forecasts.
Those cautious projections may have been tainted by the Great Recession of 2007-2009, which at the time was the worst recession since the Great Depression.
The recovery from which also was disappointingly slow, with high unemployment – in the range of 6-9% – lasting several years after the economy began to grow (see chart above).
A Study in Contrasting Recessions
On the other hand, CBPP points out that the causes of and policy responses to the two recessions couldn’t have been more different.
For one thing, the global financial crisis in 2008 turned a mild recession into the Great Recession, while a global public health crisis brought on the pandemic recession.
For another, as the CBPP adds, the recovery following the Great Recession “was impeded by the lingering effects of a burst housing bubble and banking crisis on households’ income and wealth and on bank lending.”
Those two factors, among others, hampered growth in consumer spending and business investment – two big factors in the size of economic growth.
Fast forward to 2020, the ebbs and flows of the pandemic economy was influenced by virus caseloads and the extent of lockdowns and social distancing measures to address it.
As public health improved, business and consumer activity began to pick up quickly.
Then there was the federal government’s fiscal response to the Great Recession, particularly the Troubled Asset Relief Program (TARP) and the 2009 Recovery Act, which the CBPP notes was “large for its time and effective at arresting an even sharper downturn.”
“But it was neither large enough nor sustained long enough to promote a rapid recovery with stronger job growth,” the chart book adds.
The response to the pandemic recession – including the CARES Act and three other laws enacted in March and April 2020, plus a December 2020 package, and the 2021 American Rescue Plan – was a lot bigger.
Does that mean, as the CBPP suggests, that “policymakers had learned key lessons from the Great Recession experience?”
Probably some, but luck has a place in this discussion as do unintended consequences.
The Fed took similar action in both recessions, cutting its benchmark interest rate for monetary policy effectively to zero and implementing large-scale purchases of government bonds (aka Quantitative Easing).
Without enough fiscal support from Congress, though, the easing of monetary policy fell short of stimulating a quick recovery or raising the inflation rate to the Fed’s policy target of 2% after the Great Recession.
In contrast, the CBPP notes, these policies, together with strong fiscal stimulus, supported a much faster recovery from the pandemic recession.
For more than a decade after the Great Recession and before the pandemic, inflation was just too subdued for the Fed.
It struggled to reach its policy target of 2% inflation, “which it believed was appropriate for the smooth functioning of the economy.”
Then came early 2021. Growing demand for goods and services crashed into severe supply snafus, and inflation exploded, rising far above 2%.
The Fed and many other economists viewed the surge in inflation as temporary, predicting that high inflation would be a “transient” event and that inflation would soon return to around 2%.
Monthly changes in inflation did cool a tad in the summer of 2021 but then rose back to a worryingly high rate, one we hadn’t seen – and experienced! – in four decades.
The annual change in the CPI peaked at 9.1% in June last year as energy prices skyrocketed. Of course, inflation has come down a lot since then and was 3.0% last month.
During the Great Recession’s aftermath, the Fed’s loosening of monetary policy was theoretically consistent with realizing the Fed’s dual-mandated goals of both high employment and also stable prices.
That required them to lower unemployment and raise the inflation rate. That was also the case after the pandemic recession.
But the development of high inflation in 2021 created a more challenging scenario for the Fed and its monetary policy, requiring them to lower inflation while maintaining high employment.
So, the Fed reversed its expansionary policy in March 2022 and began raising its Fed funds rate target – which has gone from a range of 0-.25% to 5-5.25%).
It’s also been reducing its massive holdings of long-term Treasuries and mortgage-backed securities (aka Quantitative Tightening) – the Fed’s balance sheet has fallen from its April 2022 peak of just shy of $9 trillion to $8.3 trillion last week.
Since the onslaught of QT, Fed Chair Jerome Powell and his Band have stressed that they’ll do whatever’s necessary to keep higher inflation from becoming a new normal.
Perhaps more importantly, the CPBB says that “even with strong job growth, challenges remain to achieving a full and equitable recovery and ongoing economic expansion…”
The next Fed policymaking meeting starts next week. As of today, 98% of Fed fund futures traders believe the Fed will raise rates another 25 basis points to 5.25-5.5%.
Count me among that group, although another six weeks of holding rates steady wouldn’t be the end of the world.
]]>“We hold these truths to be self-evident, that ]]>
Declaration of Independence –
“We hold these truths to be self-evident, that all men are created equal, that they are endowed by their Creator with certain unalienable Rights, that among these are Life, Liberty and the pursuit of Happiness.”
Preamble to the U.S. Constitution –
“We the People of the United States, in Order to form a more perfect Union, establish Justice, insure domestic Tranquility, provide for the common defence, promote the general Welfare, and secure the Blessings of Liberty to ourselves and our Posterity, do ordain and establish this Constitution for the United States of America.”
Happy Independence Day to a deeply divided America.
As we celebrate another 4th of July holiday, the rifts in our nation’s collective conscience have never seemed wider.
It’s always a good day to remind ourselves of the unrealized ideals set forth in our country’s founding documents.
Yes, you can argue – with hundreds of historical examples in hand – that it’s always been this way.
That “we the people,” “life, liberty and the pursuit of happiness,” and “one nation…with liberty and justice for all” have always been worthy – but unfulfilled – platitudes for our experiment in self-governance.
Indeed, it’s been almost two and a half centuries since that Declaration was adopted by representatives from the nascent 13 colonies.
But with 24-hour cable and internet news and round-the-clock social media diatribes overwhelming our daily realities, perceptions of a future dystopia abound.
This American Division is stark; some even think it’s irreconcilable. Perhaps they’re right. But that doesn’t mean a 21st century Civil War is inevitable.
It isn’t…not yet anyway (but see the end of this essay; another January 6th event could be lurking around the corner).
If we’re being honest with ourselves, Americans have been at war with ourselves since our founding – it’s the nature of a democratic republic.
On the one hand, as our nation’s first chief justice of the U.S. Supreme Court John Marshall observed, “Between a balanced republic and a democracy, the difference is like that between order and chaos.”
On the other hand, as the wise Ben Franklin once quipped, “If everyone is thinking alike, then no one is thinking.”
Indeed, unity per se was never a goal of the nation’s founders, except maybe in an apocryphal sense. Turns out, democracy is a messy, often ugly process.
And in any event, policymaking in a democratic republic was never expected to be unanimous; it’s always been the art of achieving what is possible at any given time.
The problem with our ever-evolving internal war of words is that it’s growing more and more un-civil.
And that’s what some fear is leading to another Civil War – one with guns and blood and Americans killing other Americans.
But we’ve struggled with that very experience since our founding…and it continues as we celebrate our nation’s 247th Independence Day.
One anecdotal piece of recent evidence of our national strife comes from last week’s Supreme Court decisions.
About half of Americans support last week’s court decision prohibiting the use of race in college admissions, while a third disapprove – with views split along racial and ethnic lines.
Majorities of White and Asian American respondents approve of the decision overturning affirmative action, while Latino and Hispanic Americans are evenly split.
And 52% of Black Americans disapprove in the ABC News/Ipsos poll published yesterday. Overall, 52% approve and 32% oppose.
Last week’s controversial court rulings, which also included overturning President Joe Biden’s student-loan relief plan for 30-something million Americans, injects three new policy issues into next year’s elections.
The court’s rejection of Biden’s student-loan forgiveness plan finds 45% approval in the ABC poll, while 40% disapprove.
Pres. Biden lashed out at the high court after the affirmative action ruling, saying “this isn’t normal,” adding, “The vast majority of the American people don’t agree with a lot of the decisions this court is making.”
Former President Trump, who’s seeking a return to the White House, praised the court’s decisions on Saturday – touting his appointment of three justices who supported the majority decisions.
Trump’s Vice Prez Mike Pence, who’s also running for the Republican presidential nomination, said the affirmative action ruling acknowledged minorities’ progress:
“I’m just very confident that African Americans, Hispanic Americans and other minorities are going to be able to compete and succeed.” Is it me, or do Pence’s words sound like wishful thinking?
Others worry that the court’s recent decisions signal a dangerous slide towards authoritarianism and centralization of power.
Now, almost half of the country views the last bastion of equal justice in America – the Suprememest of Courts in the land – as falling off the pedestal it built for itself and into the muck of politics as usual.
And Sam Baker says it's getting harder and harder to believe the justices aren't interested in wielding more power however it should land.
Public confidence in the Supreme Court is at its lowest in 50 years of polling, according to a 2022 Gallup poll. An analysis out this spring showed confidence was the lowest ever.
But look, the court hasn't become political. The U.S. Supreme Court is, and has always been, political – again by its nature. But perception is catching up to that reality. And that’s not good for our constitutional republic.
So, my humble advice this Independence Day is this:
Americans from all walks of life, who still care about leaving behind a livable planet for our children and theirs, shouldn’t just accept our differences as human beings – skin color, politics, whatever – we should embrace them.
Don’t let all the noise clanging around us cloud what’s really important in life – doing good to and for others, just as we would have them do to us.
I don’t know if we’ll ever achieve true “liberty and justice for all.” But that doesn’t mean they’re not ideals worth continuing fighting for – as civil fellow humans.
After all, the primary consequence of not heeding our founders’ vision is the following scenario that starts their Declaration’s July 4, 1776, proclamation:
“When in the Course of human events, it becomes necessary for one people to dissolve the political bands which have connected them with another, and to assume among the powers of the earth, the separate and equal station to which the Laws of Nature and of Nature's God entitle them, a decent respect to the opinions of mankind requires that they should declare the causes which impel them to the separation.”
]]>It's time to stock up on gold. Reuters' Seher Dareen reports that gold prices are near two-month lows in holiday-thinned trading today.
On the one hand, the "agreement in principle" to raise the nation's $31.4 trillion debt limit is easing investor worries.
On the other hand, chances that the Federal Reserve will raise rates at its next meeting in two weeks is tempering the demand for bullion.
Spot gold was mostly unchanged at $1,944 per ounce by 1:15 EDT this afternoon, while U.S. August futures were up to $1,962.
The news from the Capitol of a debt deal, which still has to pass both houses of Congress -- no done deal to be sure -- came on a low-volume day with the U.S. and parts of Europe on holiday.
Until a couple of days ago, most investors were betting that the Fed would keep its benchmark rate steady and wouldn't raise them on June 14th.
Last week's economic data changed that view, with investors now expecting the Fed's FOMC to raise rates for the 11th time since March last year.
Fed Fund futures now show a 59% chance of a 25-basis-points increase and a 41% chance of rates holding steady -- with rates peaking in July at 5.32%.
A little over two weeks ago, over 90% of futures traders were expecting a rate freeze, with only 10% seeing a 25bp rate hike.
Tim Waterer at KCM Trade said, "With a possible June rate hike by the Fed still in play, it is the greenback and U.S. treasury yields which continue to prosper."
Gold has no yield of its own, so it tends to fall out of favor with investors when interest rates rise and vice versa.
The dollar index was near a two-month high, and that's been weighing on gold prices. A stronger dollar makes bullion more expensive for holders of other currencies and vice versa.
Carlo Alberto de Case at Kinesis Money said, "As long as we remain above $1,900, I don't see too much risk of further decline."
Spot silver was down 0.63% today at $23.17, platinum was up 0.24% at $1,024, and palladium was down 0.63% at $1,412.
It's always good to add gold and silver to your nest egg. But from a pure pricing perspective, it's even better to be adding them today.
]]>You know what “they” say: past performance does not guarantee future results.
What we can say, however, is that some statistical measures are better at predicting the future than others that make investors’ lives easier.
And one such metric that's been capturing the attention of economists and investors for over 60 years is the New York Fed's recession probability tool.
Writer Sean Williams explains this indicator as the difference in yields between the 3-month and 10-year Treasury bonds (the “spread”) to forecast how likely it is that a recession will come to pass in the coming year.
A normal yield curve is sloped upward and to the right, showing bonds with longer maturities (10-20-30 years) with higher yields than bonds scheduled to mature sooner – kind of what we typically see in a healthy economy.
When troubles in the economy stir up, though, the yield curve tends to become inverted – that is, shorter-term bonds have higher yields than longer-term bonds.
A yield-curve inversion doesn't guarantee a forthcoming recession. But Williams (and others before him) note that every recession after World War II has been preceded by a yield-curve inversion.
According to the latest NY Fed's recession-probability indicator, there's a 68.22% chance the country will enter a recession over the next 12 months.
Williams notes that's the highest probability of a recession occurring in the next 12 months in over 40 years.
“Not coincidentally,” he says, “we're also witnessing the largest yield-curve inversion between the 3-month and 10-year note in more than four decades.
Since 1959, there have been eight instances when the NY Fed's recession-forecasting tool has exceeded a 40% probability of an economic downturn.
With the exception of October 1966, every other previous time a reading has been above 40% the economy has dipped into recession – that's 57 years without a miss.
One of the reason recessions matter is because no bear market has bottomed since World War II before the National Bureau of Economic Research has officially declared a recession.
In other words, Williams warns, the message from the NY Fed tool is that the Dow Jones, S&P 500, and Nasdaq stock market indexes may not have seen their bear market lows yet.
Watch Falling M2 and Tighter Bank Lending, Too
Remember, too, that the recession-probability indicator is just one of a several metrics that signal potential trouble for Wall Street and Main Street.
Williams points to one of them, money supply, which he notes “has been doing something truly historic on both sides of the aisle.”
The broader M2 money supply, which accounts for everything in M1 (cash bills, coins, and traveler's checks) and adds money market funds, savings accounts, and certificates of deposit below $100,000, skyrocketed by a record 26% annualized during the pandemic.
As of March 2023, M2 money supply had declined 4.1% year-over-year, which marks its largest drop in 90 years.
Although, as Williams explains, it's possible the decline in M2 “is completely benign, given how much the money supply had expanded during the pandemic,” the precedent for M2 declines of at least 2% isn't rosy.”
In the four previous times that M2 has dropped by at least 2%, three recessions and a deposit panic ensued.
Even though two of those events occurred before the Fed was even created – and the other two happened around 100 years ago – declining money supply has generally been an alarming sign.
Another indicator that Williams says is worth keeping an eye on is lending by U.S. banks.
With a couple of exceptions, the total amount of loans and leases outstanding from commercial banks has continued to climb.
There are, however, four times Williams notes when bank lending retraced by at least 1.5% since the start of 1973.
In three of those instances, the S&P 500 lost around half of its value; the fourth just occurred in the past few weeks.
Even the Fed is sounding an alarm. When the meeting minutes were released from the Fed’s FOMC March meeting, they included a warning that a "mild recession" was forecast for "later this year."
Again, no forecasting tool is perfect. But historically speaking, U.S. stocks suffered most of their bear market losses after, not before, a recession has been declared.
If you’re thinking that it’s time to insure yourself and family against the high probability of a coming recession and its many impacts, you would be right.
]]>Soulful Bob Marley keeps repla]]>
I’ve been trying to climb out of crisis mode lately.
Soulful Bob Marley keeps replaying in my head: “Don’t worry ‘bout a ‘ting. Cause every little ‘ting gonna be alright…”
But as we get ready to head into another spring weekend, I’ve been finding it hard to find a meaningful and timely topic to write about that doesn’t entail some impending disaster, tragedy or danger.
There’s the Inflation Crisis…
Fed governor Michelle Bowman traveled all the way to Germany to tell a crowd attending an ECB symposium that the Fed will likely have to continue raising interest rates if price growth and the jobs market don’t further cool down.
She's clearly an outlier right now. Over 83% of Fed Funds Rate futures traders on the CME believe the Fed will (although not necessarily should) pause rate hikes at the Fed's next meeting in mid-June.
I think they should have paused a few months ago -- mainly to avoid the coming recession -- but that's another story for another time.
(FYI...inflation, as measured by the CPI – All Urban Index, increased 4.9% year-over-year in April. Core inflation, which excludes food and energy prices, rose 5.5% annually – despite a 12.6% fall in oil and other energy commodities.)
And the Debt Crisis…
The government is another day closer to X Day when it runs out of extraordinary measures to continuing paying its bills – and when global financial markets start to implode.
But with President Biden and House Speaker McCarthy delaying until next week their next “negotiating” pow wow that had been scheduled for today – while their staffs presumably get closer to a blueprint for compromise, I’m waiting to write about that, too.
So, the Banking Crisis…
That’s what I’m sticking with today. In this week’s American Survival newsletter, I asked, Is PacWest Bank the next to fail?
We still don’t know the answer to that. But we do know that shares of PacWest were under pressure once again yesterday and today after the struggling regional bank announced that deposit outflows resumed earlier in the month.
The stock was down 23%, further extending its recent declines. Entering the day, PacWest’s shares had already fallen 40% this month and more than 70% for the year.
The bank said in a securities filing that its deposits declined 9.5% during the week of May 5th.
PacWest said the majority of those outflows came after media reports that said the lender was “exploring strategic options” – which many took to mean including a sale.
The bank also said it was able to fund those deposit withdrawals with cash on hand – i.e., $15 billion of available liquidity compared with just $5.2 billion in uninsured deposits.
If true and correct, the update marks a change from May 4th, when PacWest said that it wasn’t experiencing “out-of-the-ordinary deposit flows” and that total deposits had increased since the end of March.
During the 1st quarter, PacWest’s total deposits declined 17%, and the bank said it would use strategic asset sales to reshape its balance sheet.
Several Wall Street analysts speculated that the most recent outflows were coming from PacWest’s venture capital customers.
Jon Afrstrom at RBC Capital Markets said, “While the deposit news is not what the company wants to report, if the outflows are truly from the venture depositors and not the core bank, that is better news, despite the higher total outflow disclosure.
“The financial result is that the company is borrowing more to replace those deposits.”
Following PacWest’s filing yesterday, Western Alliance released its own update, reporting that total deposits have grown by $600 million since May 2nd.
Shares of that bank were up slightly yesterday. Elsewhere, shares of Zions Bancorp dipped 3.5% and the SPDR S&P Regional Banking ETF was down 1.4%.
The regional banking sector has been under pressure since early March, when concern about the impact of higher interest rates led to a run on deposits at Silicon Valley Bank, which was seized by regulators.
New York’s Signature Bank soon followed, and then San Francisco’s First Republic was seized and sold to five-time felon and too big to fail JPMorganChase – at a steep discount – in the wee hours on May 1st.
The Next Phase
And now, well-known economist Mohamed El-Erian says the U.S. has entered the second stage of the banking mayhem.
He outlined four ways to avoid a "significantly more damaging" third phase of financial unrest.
In an op ed published the other day, the chief economic adviser to Allianz opined that the first phase of the chaos – when depositors took their money from poorly-managed lenders and caused a trio of bank failures – has stabilized.
El-Erian was no doubt referring to the demise of Silicon Valley, Signature and, most recently, First Republic Bank over the past two months.
He added, "The current phase, which focuses on funding cost and balance sheet issues of less problematic banks that happen to operate in a highly unsettled neighborhood, can also be stabilized.
“Indeed, it must (emphasis added by me) if we are to avoid a third phase entailing considerably more financial and economic damage."
The good news, El-Erian believes, is that the U.S. is unlikely to see another "dramatic institutional collapse" similar to Silicon Valley Bank’s.
That's thanks largely to the federal government's handling of SVB’s failure by suggesting unlimited insurance on deposits – above the official $250,000 ceiling – and opening another funding window for lenders.
But, El-Erian added, U.S. regional banks still operate with "mismatches between their short-term liabilities and longer-term assets.
Their balance sheets are further hampered by shaky commercial real estate loans, which Melody Cedarstrom and I talked about on Tuesday’s Financial Survival program.
El-Erian continued, "This second phase can also be contained. First, banks must be careful in what they say and, generally, have very responsive communication with investors.
"Second, the Fed must strengthen its supervision regime. Third, public-private resolutions for banks need to be made to work to a tighter timeline if needed.
"Fourth, he added, the public sector needs to assure markets that it will work to revamp both the deposit insurance system and the regulation of banks erroneously deemed to involve no systemic threat."
"Doing so,” he warns, “is necessary if the U.S. is to avoid a third, and significantly more damaging, phase of the banking turmoil.”
By the way, in the time that I researched and wrote today’s blog this morning, PacWest shares, which opened at $4.78, hit a high of $4.90 before falling to $4.70 about two hours later – down another 1.7%. A year ago, it was trading at $30.50.
Don’t worry about a thing? I wish!
]]>
That’s what the Federal Re]]>
“The banking system is sound and resilient.”
That’s what the Federal Reserve’s press release said on Wednesday in the statement announcing another 25 basis point interest rate hike.
Sound and resilient.
A few hours later, multiple media sources reported that PacWest Bank is exploring strategic options, including a possible sale.
Is PacWest the Next to Fail?
Shares of PacWest stock were already down about 80% since February. After the news hit, the stock took another 50% nosedive.
In fact, since January 1st, its share price has tanked – having fallen from $22.95 to a new 52-week low of $3.17 as of yesterday’s market close.
Bloomberg’s Joe Wiesenthal noted in his Thursday column that “overall, the ‘banking system’ may be sound and resilient, but there's clearly anxiety surrounding individual banks that hasn't gone away.”
PacWest sank over 50% in early trading and was halted multiple times because of volatility.
At the same time, Tennessee-based First Horizon Bank also fell 33% after the regional lender and TD Bank announced that they were terminating their merger agreement.
The banks jointly said that the move was because of uncertainty around when (not if) TD would receive regulatory approval for the deal and was not related to First Horizon.
Other notable declines included a drop of 38% for Western Alliance and 12% for Zions Bancorp. The SIPDER S&P Regional Banking ETF (KRE) was down more than 5%.
Western Alliance’s fall came despite the company advising Wednesday evening that deposits have grown since the end of March.
KBW CEO Tom Michaud said, “That hasn’t taken the heat off of the stock, or the bond prices. Investors are very nervous.
“And I think what they’re nervous about is the fact that Silicon Valley lost 75% of their deposits in 36 hours. There’s not a bank in the world that could really sustain that.”
First Republic Won’t be Last Bank to Fail
All this news comes less than a week after L.A.’s First Republic was seized by the FDIC (see last Friday’s blog) and sold at a big discount to the U.S.’ largest bank and five-time felon JPMorgan Chase.
First Republic, the nation’s third bank failure this year, had searched for weeks for a market solution to stabilize itself after massive, near $100 billion deposit withdrawals in the 1st quarter, but no help came, so regulators stepped in.
Many regional banks saw deposit outflows in March around the collapse of Silicon Valley Bank, raising questions about the stability of their funding and the value of some assets on their books that were not marked to market.
Anticipated regulatory changes have also clouded the long-term profit outlook for the group.
JPMorgan CEO Jamie Dimon and Fed Chair Jerome Powell separately expressed optimism that the initial wave of bank failures has passed.
But the drops in a broader array of financial stocks show that investors – and depositors – don’t necessarily agree.
And now, after these recent events, confidence in America’s financial system is slipping.
What, Me Worry?
According to a new Gallup poll, almost one-half of the populace is either “moderately” (29%) or “very” (19%) worried about the safety of their money parked in banks.
Interestingly, the level of concern expressed in the latest poll is similar to the findings Gallup found shortly after the collapse of Lehman Brothers in September 2008.
Wiesenthal also points to another sentence in the Fed's release that reads, "Tighter credit conditions for households and businesses are likely to weigh on economic activity, hiring, and inflation."
And that, he says, “gets to the big macro takeaway” – namely, that while inflation “is still hot,” there’s now “a live possibility that the Fed has gotten to the end of the hiking cycle.”
In his post-meeting press conference on Wednesday, Powell claimed that no hike, or a pause, at the next meeting is a real possibility. He also said he was encouraged by the trajectory of the labor market:
Fewer job openings, lower wage growth, higher labor force participation –you know the gist.
As of the close of markets yesterday, the CME Group reports that about 80% of interest rate futures traders expect the Fed to keep rates steady at 5.00-5.25% at its next meeting in mid-June. The other 20% see a 25-basis point rate decline.
Let’s see what April’s jobs report brings and what kind of talk – and action – result.
]]>That’s what the Federal Re]]>
“The banking system is sound and resilient.”
That’s what the Federal Reserve’s press release on Wednesday said in the statement announcing another 25 basis point interest rate hike.
Sound and resilient.
A few hours later, multiple media sources reported that PacWest Bank is exploring strategic options, including a possible sale.
Is PacWest the Next to Fail?
Shares of PacWest stock were already down about 80% since February. After the news hit, the stock took another 50% nosedive.
In fact, since January 1st, its share price has tanked – having fallen from $22.95 to a new 52-week low of $3.17 as of yesterday’s market close.
Bloomberg’s Joe Wiesenthal noted in his Thursday column that “overall, the ‘banking system’ may be sound and resilient, but there's clearly anxiety surrounding individual banks that hasn't gone away.”
PacWest sank over 50% in early trading and was halted multiple times because of volatility.
At the same time, Tennessee-based First Horizon Bank also fell 33% after the regional lender and TD Bank announced that they were terminating their merger agreement.
The banks jointly said that the move was because of uncertainty around when (not if) TD would receive regulatory approval for the deal and was not related to First Horizon.
Other notable declines included a drop of 38% for Western Alliance and 12% for Zions Bancorp. The SIPDER S&P Regional Banking ETF (KRE) was down more than 5%.
Western Alliance’s fall came despite the company advising Wednesday evening that deposits have grown since the end of March.
KBW CEO Tom Michaud said, “That hasn’t taken the heat off of the stock, or the bond prices. Investors are very nervous.
“And I think what they’re nervous about is the fact that Silicon Valley lost 75% of their deposits in 36 hours. There’s not a bank in the world that could really sustain that.”
First Republic Won’t be the Last
All this news comes less than a week after L.A.’s First Republic was seized by the FDIC (see last Friday’s blog) and sold at a big discount to the U.S.’ largest bank and five-time felon JPMorgan Chase.
First Republic, the nation’s third bank failure this year, had searched for weeks for a market solution to stabilize itself after massive, near $100 billion deposit withdrawals in the 1st quarter, but no help came, so regulators stepped in.
Many regional banks saw deposit outflows in March around the collapse of Silicon Valley Bank, raising questions about the stability of their funding and the value of some assets on their books that were not marked to market.
Anticipated regulatory changes have also clouded the long-term profit outlook for the group.
JPMorgan CEO Jamie Dimon and Fed Chair Jerome Powell separately expressed optimism that the initial wave of bank failures has passed.
But the drops in a broader array of financial stocks show that investors – and depositors – don’t necessarily agree.
And now, after these recent events, confidence in America’s financial system is slipping.
What, Me Worry?
According to a new Gallup poll, almost one-half of the populace is either “moderately” (29%) or “very” (19%) worried about the safety of their money parked in banks.
Interestingly, the level of concern expressed in the latest poll is similar to the findings Gallup found shortly after the collapse of Lehman Brothers in September 2008.
Joe Wiesenthal also points to another sentence in the Fed's release that reads, "Tighter credit conditions for households and businesses are likely to weigh on economic activity, hiring, and inflation."
And that, he says, “gets to the big macro takeaway” – namely, that while inflation “is still hot,” there’s now “a live possibility that the Fed has gotten to the end of the hiking cycle.”
Powell, in his post-meeting press conference on Wednesday, claimed that no hike, or a pause, at the next meeting is a real possibility. He also said he was encouraged by the trajectory of the labor market:
Fewer job openings, lower wage growth, higher labor force participation –you know the gist.
As of the close of markets yesterday, the CME Group reports that about 80% of interest rate futures traders expect the Fed to keep rates steady at 5.00-5.25% at its next meeting in mid-June. The other 20% see a 25-basis point rate decline.
Sound and resilient? Let’s see what April’s jobs report brings today and what kind of talk – and action – result.
]]>As the Wicked Witch of the West orders her minions toward the end of Wizard of Oz, “Seize them!”
And seize them, they did.
San Francisco bank First Republic was taken over by the Federal Deposit Insurance Corporation over the weekend and was sold to too big to fail JPMorgan Chase in the pre-dawn hours this morning.
All in a day’s work.
It was the third bank failure in two months and the second-largest in the nation’s history, and the one unanswered question now is, is there a systemic banking crisis or not?
What’s Going On?
JPMorgan, the country’s largest bank, will assume all of First Republic's $92 billion in deposits, including ones that weren't insured.
The FDIC didn't even need to invoke its so-called “systemic risk exception” to insure them, as it did with Silicon Valley and Signature Banks.
Members of Congress who run the banking committees in both houses generally praised the federal takeover of First Republic and called its sale to JPM an example of a successful public-private collaboration.
Rep. Maxine Waters of California and the top Democrat on the House Financial Services Committee said: “This prompt and cost-effective sale of the bank protects depositors, limits contagion, and ensures that no cost is borne to our nation’s taxpayers.”
Perhaps. Still, such effusive praise should raise our eyebrows, given the nearly $17 million in campaign contributions the commercial banking industry gave to members of Congress in 2022, according to OpenSecrets.org.
But as Pam and Russ Martens of Wall Street on Parade remind us, it shouldn’t be lost (but, apparently, it has been on the regulators that approved the sale and their fans in the Capitol) that JP Morgan is a five-time felon, with the same CEO – Jamie Dimon – at its helm.
But I digress…
Right now, we’re being told that JPM’s acquisition cost is much lower than expected.
But because there's a change of ownership, JPM will have to mark First Republic's book of loans at market value and take the losses on those loans.
Felix Salmon reports that those losses will be shared with the FDIC at a cost of about $13 billion to its insurance fund – far less than the $30 plus billion the market was expecting.
Under the Dodd–Frank Act of 2010, the FDIC is required to fund its Deposit Insurance Fund at a certain percentage of all insured deposits at eligible U.S. banks.
According to the FDIC, as of 12/31/2022, the agency held $128.2 billion in its DIF based on total insured deposits of $10.068 trillion (a reserve ratio of 1.27%).
As was first speculated several weeks ago, First Republic's shareholders and bondholders – like those of SVB – will likely be wiped out and receive just cents on the dollar.
And for now, First Republic's executives are now employees of JPM, but many of them will surely leave for greener pastures where the prospects of big-time bonuses will grace their pocketbooks again.
Bank regulators have made it clear since the Great Recession that it's never their preference to allow too-big-to-fail banks like JPM to grow by acquisition.
But by selling First Republic to JPM, the federal government seems to be suggesting that there’s a growing banking crisis that outweighs those concerns.
The California Department of Financial Protection and Innovation, which was First Republic's primary state regulator, said the bank had become "unsafe or unsound."
Any deal that gets announced at 4:30 on a Monday morning is going to be a tad messy. But Salmon says this transaction “is clearly designed to try to mop up the mess rather than to create more of it.”
Reports Confirm Faulty Oversight
Emily Peck notes that state and federal bank regulators were “well aware of the problems” at both SVB and Signature Bank when they failed in March but weren't able to prevent a major blow up anyway.
Three separate autopsies on the bank failures released last Friday by regulators each highlighted how bank supervisors fell short in their oversight.
The Federal Reserve released a 114-page report that blamed the collapse of SVB on the bank itself.
It also faulted Fed supervisors charged with overseeing it, not to mention some federal regulations that were watered down during the Trump administration.
The FDIC published its internal review of its own handling of the supervision of Signature Bank.
For its part, the FDIC emphasized certain weaknesses in its oversight, blaming part of the problem on a significant understaffing problem.
And the Government Accountability Office released a report that noted one thing the two bank failures had in common: turns out that in both cases, regulators saw the risks but weren't able to get the banks to alleviate them.
As a whole, Peck says, all three reports essentially call into question the regulators' ability to regulate.
She reports that FDIC supervisors appear to have gotten the runaround from Signature Bank officials who had “little interest in addressing risks.” The FDIC report says the agency could've been more "forceful" in its supervision.
Red flags flashed before regulators with the risks of Signature's roughly 90% of uninsured deposits – unusually high.
But the FDIC report says there was little recognition by the bank's senior management that risk was even an issue – much less there being a contingency plan to handle fleeing customer deposits.
And flee they did – big time. In fact, on Friday, March 10, the bank lost 20% of its deposits in a couple hours.
Yet, the report noted that Signature's president "rejected examiner concerns" that same day – not long before regulators took over the bank.
The Fed's report on the supervision of SVB suggests that even its own staff didn't fully understand the risks the bank was taking on.
And even when risks were revealed, they weren't dealt with: "[F]oundational problems were widespread and well-known, yet core issues were not resolved, and stronger oversight was not put in place.”
Senior fellow at Brookings Aaron Kline observed, "It seems like the Fed is still not adequately appreciating how poorly it is doing its job as bank regulator."
The FDIC and Fed now want to tighten regulations. The Fed says it’s considering stricter rules on banks, a process that could take years, especially if they will need congressional approval.
But CNBC’s Jeff Cox says interest on Capitol Hill to amend Dodd-Frank to tighten the reins appears to “have waned” after an initial rush in the wake of the SVB and Signature failures.
Seize ‘em and Sell ‘em is one way to look at what happened today with First Republic Bank. Perhaps the more apropos way to see it, though, is Seize ‘em and Appease ‘em.
]]>We now know that the economy has started to put on the ]]>
We now know that the economy has started to put on the brakes.
GDP growth slowed in the 1st quarter to 1.1%, the Bureau of Economic Analysis reported yesterday – significantly less than the consensus Wall Street expectation of 1.9%.
At the same time, one of the Fed’s preferred measures of inflation (if not its favorite), the Personal Consumption Expenditures index, headed in the wrong direction to 4.2%, higher than the expected 3.7%.
Some say that suggests the economy has continued to expand amid high inflation and tighter financial conditions, that growth rate isn't sustainable,
Pantheon Macroeconomics’ chief economist Ian Shepherdson believes the economy will slow further as households cash in their savings and more investments while dealing with more challenging financial conditions.
Shepherdson warns that the economy will enter a sharp slowdown over the current quarter, causing GDP to shrink by 2%.
"It would be dangerous,” he said, “to extrapolate that apparent strength in the 1st quarter into an expectation of a decent spring and summer."
Chris Zaccarelli, chief investment officer of Independent Advisor Alliance added, “[Yesterday’s] data was the worst of both worlds, with growth down and inflation up.”
For over a year now, some of the financial world’s so-called best and brightest – billionaire investors, hedge fund managers, and economists – have cautioned that rising rates will eventually trigger a recession.
But Fortune’s Will Daniels says the latest GDP and inflation numbers have some experts worried that stagflation – the harmful combo of slow growth and high inflation that crippled the economy in the ’70s – “could be on the menu too.”
Chris Campbell at the global risk consulting firm Kroll and former assistant secretary of the Treasury, says that he still believes a recession will start after July 1st.
Perhaps more importantly, he too is “growing increasingly alarmed about the possibilities that the U.S. might well be facing stagflation.”
And, according to the April Global Fund Manager Survey of too big to fail Bank of America, 86% of fund managers say that stagflation best describes the outlook from the global economy over the next 12 months.
Even though some economists believe the economy can avoid a recession or stagflation, Campbell reminds us that it’s a lagging measure: “I expect that we will see more people unemployed as we get deeper into this calendar year.”
Fed officials have increased their benchmark interest rate from virtually zero last March to a range of 4.75% to 5% to try to rein-in inflation to their 2% target. And it’s almost certainly going 25 basis points higher next week.
Economist Eugenio Aleman at Raymond James is just one of the experts who believes that – given that the latest inflation numbers are still substantially above the Fed’s target.
He added that the recent data “strengthens our conviction that there will be no rate cuts in 2023.”
Zaccarelli endorsed those comments, warning that “the Fed clearly needs to keep raising rates…and they are going to be raising rates right into a slowdown.”
Jeffries economist Thomas Simons also argues that the latest data confirmed that GDP will “start to slow substantially in Q2 and start to contract in the second half [of 2023].”
He added, “Policy drag is about to kick into a higher gear that will unleash a full-blown layoff cycle and recession by midyear.”
And too big to fail Morgan Stanley’s chief U.S. economist Ellen Zentner noted that she expects “to see significant slowing into 2Q23” as tighter money and banking pressures “push growth into negative territory.”
Hold onto your hat. Economic uncertainty is only growing. More volatility is sure to follow. Further, if First Republic Bank fails in the coming days or weeks, things could get a lot worse real fast.
And if Congressional Ds and Rs and the White House fail to agree on a debt ceiling resolution, it probably won’t matter whether a recession or stagflation are worse; all bets will be off.
]]>In one of its banner anthems from the early 2000s – “Roll with the Changes” – the popular classic rock band REO Speedwagon belts out the sing along chorus, “Keep on rollin’, keep on rollin’…”
NY Times columnist David Brooks seems to feel the same way about the American economy.
In a recent column, he observed: “You can invent fables about how America is in economic decline…But the American economy doesn’t care. It just keeps rolling on.”
Brooks’ colleague David Leonhardt notes that when it comes to economic innovation and productive might, no country can match the U.S. – with Apple, Google, Amazon, Tesla and OpenAI blazing new trails.
Leonhardt writes, “The standard measure of a nation’s economic performance is per capita gross domestic product — the value of the economy’s output divided by the size of the population.”
He points out that even as China’s share of global GDP has skyrocketed over the past few decades, the U.S. still comprises virtually 25% of worldwide output – about the same as in 1990.
But as Nobel laureate and economist Paul Krugman reminds us, GDP doesn’t measure everyday Americans’ standard of living.
Because per capita GDP is an average, it can be distorted by outliers. One major example: income inequality in the U.S. is significant, which means the wealthy own a much larger share of output than in other countries.
As Leonhardt points out, per capita GDP in the U.S. has risen 27% in the new millennium – from around $50,000 in 2000 to a little over $60,000 at the end of 2021 (it was less than $25k in 1970).
“But median household income has risen only 7%,” while income for the top 0.1% of earners has [soared] 41%.”
Broader quality of life metrics show even more clearly how the U.S. isn’t looking so good relative to other comparable nations.
Leonhardt notes we have the lowest life expectancy of any high-income country, with “uniquely poor access to health insurance and paid parental leave.”
Krugman says, “It’s always important to bear in mind that GDP, at best, tells us how much a society can afford.
“It doesn’t tell us whether the money is well spent; high GDP need not translate into a good quality of life. Individuals can be rich but miserable; so can countries.
“And there are good reasons to believe that America is using its economic growth badly.”
Leonhardt thinks it’s a mistake to see the economy as separate from living standards:
“The unequal American economy continues to churn out an impressive array of goods and services while also failing to deliver rapidly improving living standards. And polls suggest that most people aren’t fooled.”
Is This the New Normal?
Perhaps more importantly, Axios’ Courtenay Brown and Neil Irwin say we’re now in the early stages of “adapting and readjusting to the end of ultra-low interest rates that were a basic assumption across the global economy.”
They add that events like the failure of Silicon Valley Bank and the UK’s debt and currency market fiasco last year are examples of what could be a series of other headaches ahead.
Indeed, they warn, as the world adjusts to a new “normal” where money is no longer free, it's hard to envision a smooth road in the coming years.
Boomers are retiring, with smaller generations filling in behind them, threatening labor supply, pressuring wages – and, in the U.S., putting pressure on Social Security and government revenues in general.
Some are even warning that we may be in the early stages of deglobalization, as companies try to make their supply chains more sustainable.
Plus, there’s the deteriorating relationship between the U.S. and China, the U.S. and Russia, and the U.S. and Iran.
But some observers believe that large-scale investment is underway. Brown and Felix Salmon say look at activity in semiconductors, battery manufacturing and solar cells, which some Wallstreeters are calling the "mother of all capex cycles."
Many policy experts, they report, view these developments as “long-lasting forces, not likely to dissipate any time soon.”
Fed chair Jerome Powell said late last year that "it feels like we have a structural labor shortage out there."
ECB president Christine Lagarde argued this week global supply will be less elastic in the new normal – meaning routine disruptions will cause bigger price hikes than in the past.
If these views are correct, Brown and Irwin warn, something resembling today's rates of about 5% will become part of the new normal — with the risk of them going even higher.
The problem, they add, is that banks, governments and investment funds have built their business models around a different landscape replete with interest rates near, at or even in come cases (Europe) below zero.
The question then is what other pockets of the global financial system will have a similar readjustment as the impact of higher interest rates multiplies through global economies.
Will banks face big losses on especially commercial real estate loans when low-rate debt matures and have to be rolled over into higher-rate debt — coupled with a loss in office rental income from people working at home?
Will the U.S. actually run future budget deficits of 6% or more of GDP over the next decade, as forecast by some – a level that in the past occurred only during wars or recessions?
And will higher rates and/or a debt ceiling impasse cause a crisis in the Treasury market?
Brown and Irwin say there’s good cause to think that “ripples from higher rates will not cause the kinds of financial catastrophes seen in 2008; [that] the damage should be much more contained.”
In fact, a few (excluding yours truly) believe that the U.S. may actually avoid a recession altogether.
Getting Back to Wages
For months, central bankers around the world — including those at the Fed — feared that rising wages would be a big problem for inflation. Felix Salmon says for now, that doesn't appear to be the case.
Yes, inflation is still higher than we want and need it to be. But don’t blame rising pay as the primary factor fueling price increases at the moment.
Late last year, Powell said wages were not "the principal story of why prices are going up."
His Euro counterparts had a similar message. Just last month, ECB officials noted wages "had only a limited influence on inflation over the past two years" there.
Since Powell's comments, worker pay gains have slowed down more and are now below inflation.
In the 4th quarter of 2022, average hourly earnings rose at a 4.7% annual rate. But last quarter, wages increased at a 3.2% vs. the CPI’s 3.7%
Salmon says that pace of wage growth “is consistent with inflation settling at the Fed's 2% target. It's also similar to the pace seen in the same time period in 2019.”
Indeed, economist James Knightley at ING warns that higher labor bills are "going to be fading as an excuse for companies to keep prices rising."
He believes much of the inflation we’re seeing now “is basically margin expansion” (higher corporate profits).
He adds that should those profit margins start to come down (don’t hold your breath just yet!), “that could aid in painlessly lowering inflation.”
Keep your eye on this Friday’s release of the government’s Employment Cost Index. You know that Jay Powell & Co. will be.
]]>The government’s Producer Price Index for March, out today, showed that wholesa]]>
The government’s Producer Price Index for March, out today, showed that wholesale prices out and out declined from February – a possible sign, some say, of further cooling in prices in the coming months.
Axios’ Courtenay Brown and Neil Irwin say the latest numbers highlight a shift in America's inflation dynamics – namely, falling energy prices earlier this year, which is putting downward pressure on overall inflation.
The PPI, which is a measure of the change in the cost of suppliers' goods and services, fell 0.5% in March after a flat reading the month before.
The index is up 2.7% year-over-year through March (PPI peaked at more than 11% last June).
A good chunk of last month’s decline is a result of plunging energy prices that fell 6.4% in March (they’ve been rising again since then). Food prices rose 0.6%, after three straight months of declines.
Economist Bill Adams at Comerica says, "PPI surprised to the downside, but its details show the release is unlikely to bring the Fed off of the inflation fighting warpath."
That’s a sentiment shared by others. Over two-thirds (68%) of CME Fed futures traders see another 25-basis point rate hike announcement at the end of the next FOMC meeting on May 3rd.
Adams explained, "March's slowdown was concentrated in goods prices, especially energy goods.
“By contrast, core services prices are still running hotter in year-over-year terms than they were between last April and January."
Speaking of the Fed…
Brown and Irwin point to a bit of tongue-and-cheeking by Fed officials over the past year, especially Fed chair Jerome Powell.
They say he’s been gradually “making more explicit acknowledgments that a recession may result from the [Fed's] monetary tightening. Now, the subtext has become the text.”
Fed staff are now anticipating a "mild recession" later this year as their baseline forecast, followed by a 2-year recovery, according to the minutes of the FOMC’s last meeting in March.
At the same time, Fed officials projected that the headline unemployment rate will rise by a full percentage point by the end of the year – something that’s happened previously only during a recession.
The Fed raised interest rates at that meeting anyway – by 25 basis points – and, again, appear poised to rinse/repeat in May.
Yes, hope springs eternal that, in Brown and Irwin’s words, “Immaculate Disinflation” will swoop in and save the day.
Yet, they say persistent inflation coupled with the ongoing banking turmoil make an Alice in Wonderland scenario look more far-flung than it was just a few months ago.
Economist Matt Colyar at Moody’s Analytics warned, "…the uncertainty caused by the sudden (banking) crisis threatens to kick off a slower-burning, potentially more pernicious dynamic."
On the other side of the podium, White House press secretary Karine Jean-Pierre said at press briefing yesterday, "Recent economic indicators are not consistent with a recession or even a pre-recession.”
That’s disappointing but certainly not surprising, given the growing certainty that her boss, the president, will be running for reelection.
]]>Over the last several months, consumers’ expectations of future inflation have been steadily falling – a sign perhaps that Americans had confidence in the Fed's war on prices.
Courtenay Brown and Neil Irwin, who say that changed last month, pointed out today that for the first time in six months, median inflation expectations of everyday households in the year ahead rose.
They increased, in fact, by a half-percentage point to 4.7%, according to the New York Fed's latest Survey of Consumer Expectations.
The report comes as expectations for the level of price increases for everyday goods and services — like food, gas, rent and medical care — decreased in March.
After 2023's hotter-than-expected inflation reports, the March data suggest that the public now believes inflation won’t fall quite as much as they have been anticipating.
Brown and Irwin caution, however, that one month of new numbers doesn’t necessarily mean that “inflation expectations are becoming unanchored. But,” they add, “more readings of this kind could worry officials.
Median inflation expectations at the three-year-ahead horizon ticked up by 0.1%, to 2.8%, but they fell slightly (by 0.1 percentage point) to 2.5% at the five-year-look-ahead timeframe.
Consumers also pushed up expectations for household income growth and, for the first time since last fall, how much they plan to spend.
Mean unemployment expectations — or the mean probability that the unemployment rate will be higher one year from now — increased by 1.3 percentage point to 40.7%.
The average perceived probability of losing one’s job in the next 12 months decreased by 0.4 percentage point to 11.4%. But the average probability of voluntarily leaving one’s job declines by 1.5 percentage points to 19.3%.
They warned, too, that it was getting harder to get a loan – a point Brown and Irwin say is worth watching in the wake of the recent bank failures and bailouts.
The share of households reporting that it was more difficult to access credit compared to one year ago rose to the highest level in the survey's 10-year history.
Notably, year-ahead expectations about households’ financial situations also improved – with fewer expecting to be worse off and more respondents expecting to be better off a year from now.
Labor Market Time Machine
Given distortions in the cosmic time warp – thanks to Covid, economic uncertainty and geopolitical volatility, some observers believe the labor market is showing shades of 2019.
But Brown and Irwin say that understanding how now and four years ago are the same and different is key to grasping where things are likely to go from here.
They write that the “high-water mark of the longest expansion in history was 2019,” which included a healthy job market with low inflation.
The question now, they add, “is whether the remainder of 2023 can keep the former while returning to the latter.”
They note these comparisons of 2019 vs. the first quarter of 2023:
(1) Headline unemployment rate: average of 3.7% in 2019, 3.5% so far in 2023;
(2) Average hourly earnings growth: 2.9% compared to 3.2% annualized rate; and
(3) Average share of 25-54 year olds working: 80.0% then vs. 80.5% now.
Fed chair Jerome Powell "has been dying for the economy to look like it did in 2019 and [Friday's] jobs report is basically like a really strong 2019 one," so said Peachtree Creek Investments' Conor Sen.
But the differences are important, too: Both job growth and labor force participation are a lot stronger today. The labor force has risen by 588,000 people a month so far this year, compared to 125,000 a month in 2019.
In the same vein, job creation has been faster this year, with an average of 345,000 a month vs. 163,000 a month in 2019.
And most importantly, the decent job growth and earnings in 2019 occurred in a synergy of much, much lower inflation, so rising wages translated into rising living standards.
The question for the remainder of 2023, Brown and Irwin say, is “how those differences resolve themselves” – that is, how, if and when inflation comes down and the rate of job creation normalizes.
If you’re a betting man or woman, chances are you like the upcoming scenario.
On one side is high inflation persisting, which would further put a crunch on Americans’ buying power and lead to yet more Fed tightening, with all the future pain that would entail.
Or, some combination of tightening already in the system and a freeze-up in bank credit due to last month's events leads to a sudden downturn, where the early 2023 robust labor market is overtaken by something weaker.
Current Fed projections seem to embrace the latter scenario, with the median policymaker seeing the headline jobless rate rising a full percentage point to 4.5% by year-end (8.5% counting discouraged job seekers).
The CPI for March is due out on Wednesday. Toward the end of the month, the Employment Cost Index promises a more updated look at wage growth and whether it’s slowing the way last Friday’s jobs report suggests.
As Brown and Irwin conclude, it took a pandemic to stop an 11-year bull cycle. So, “If things turn cloudy in 2023, it will likely be a different culprit: the Fed.”
]]>A lot of news competing for our attention – financial, political and otherwise – as a new week unfolds:
But here’s the story I want to highlight today:
David Hollerith reports today that depositors pulled another $126 billion out of U.S. banks in the week ending March 22nd – primarily from the nation's largest institutions.
The largest 25 banks in the U.S. by asset size lost $90 billion (on a seasonally adjusted basis), according to the Fed.
Smaller banks, which suffered a huge run the previous week as regional lenders Silicon Valley and Signature Banks were going bust, were able to stabilize their assets, gaining back $6 billion.
Total industry deposits fell to $17.3 trillion, down 4.4% from the same week a year ago – the lowest level since July 2021.
Hollerith says the new numbers reinforce some trends that were already in place.
For example, deposits had been falling at all banks before the Silicon Valley failure in the first two months of 2023. Deposits for all banks were also down 5% annually in last year’s 4th quarter.
Many observers attribute this systemic shift to pressure being applied by the Fed’s aggressive (obsessive?) campaign to bring down inflation closer to its 2% target.
During the early part of the pandemic, when interest rates were virtually zero, banks were drenched in deposits.
When the Fed started raising those rates last March to cool the economy, customers who had deposits began seeking out places with higher yields.
The first year-over-year deposit decline for all banks came in the 2nd quarter of 2022.
As we’ve pointed out, some of this money has been flowing to money market funds, which are offering investors a rate of return in the range of 4-5%.
Since January 1st, investors have poured over $500 billion into those funds, according to too big to fail Bank of America.
That’s the highest quarterly inflow since a peak earlier in the pandemic, and another $60 billion was added to these funds in the past week.
Government and banking officials have been working to prevent massive deposit outflows in the aftermath of last month’s bank failures.
Federal regulators pledged to cover all depositors at both banks they seized, hoping that would calm any panic, and also promised to help other regional banks if needed.
Eleven megabanks also decided to provide another troubled regional lender, First Republic, with $30 billion in uninsured deposits to stabilize its dire situation.
The challenge that outflowing deposits create for all banks is that if they raise rates on their deposits to keep or attract customers, their profits fall, making shareholders wary.
But if they lose too many customers, as SVB did, they lose critical assets and may have to sell assets, like long-term Treasuries, at a loss to cover withdrawals.
SVB customers withdrew $42 billion in one day, leaving the bank with a negative cash balance of $958 million, forcing regulators to seize the bank, which was the 16th largest in the U.S.
Are Reverse Repos to Blame?
In 2013, the Fed’s big concern was that, with the world inundated in dollars they had created, they wouldn't be able to raise interest rates even when they felt they had to.
Their solution was a tool that ten years later has swelled to a massive $2.6 trillion (as of last Wednesday).
It’s making bank officials angry, because they believe it’s a major factor in their recent loss of deposits.
The Fed’s "overnight reverse repurchase agreement facility" (ONRRP) lets money market mutual funds accept vast sums of investors' money and pay their customers higher interest rates than banks typically do.
That's great for conservative savers who want higher yields on their cash but, as Neil Irwin writes, “is contributing to the destabilization of the banking system” as depositors pull their funds.
A decade ago, the Fed worried that when it decided to raise rates, it wouldn’t be able to actually change the price of money across the economy unless money market funds and other entities could access cash at that rate from the Fed.
The ONRRP was supposed to be a solution to that problem.
Irwin notes that it allowed money funds to park money at the Fed if there aren’t enough Treasuries and other super-safe investments available to buy at something close to the Fed's target interest rate.
Irwin points out that usage of the reverse repo was zero two years ago but has soared as the Fed tightens. In fact, these repurchase agreements are now a major holding of popular money market funds.
For example, of the Fidelity Government Money Market Fund's $246 billion in assets at the end of February, $136 billion (or 55%) were repurchase agreements with the New York Fed.
Banks view this as unwelcome competition. Their access to liquidity and safety from the Fed are threatened by the lightly regulated money market funds.
The Bank Policy Institute, the research arm of the bank-lobbyist-industrial complex, this week called the ONRRP "a black hole for bank deposits."
The BPI's Greg Baer and Bill Nelson argue that the reverse repo is essentially sucking money out of the banking system that would be put to more productive use for the economy – if it stayed in banks.
But Irwin argues this is largely the banks' fault, because they’ve enjoyed the benefits (and resulting profits) of paying depositors rates that are far below the Fed's policy rate.
And banks themselves have the ability to park money at the Fed and receive interest on it, in the form of reserves in excess of their regulatory requirements – plus, banks also have access to the ONRRP.
Former Fed vice chair Richard Clarida noted last week, "[I]f the reverse repo facility were to go to zero as it did in 2017, that would be roughly $2 trillion that would flow into the banking system."
"I do think,” he continued, “at some point the Fed does have to think about what the role of the reverse repo facility is."
He added that it worked well for its purpose of keeping a floor under interest rates during his time at the Fed, but "it's not doing that now. It's a question mark and I'll leave it at that.” So will I…for now.
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