Inflation & Interest Rates: share your data sources, models, and assumptions

[Paper Chaser]

Total PPI and "core" PPI both came in hotter than expected, with the trend line appearing to flatten compared to recent declines:



Both were the highest they've been since May/June of last year:

[ChpBstrd]

The Producer Price Index for January was a whopper at +0.7% for final demand. The worst news was a +1.2% increase in the wholesale price of goods in January alone! Annualized PPI was 6.0% for Jan-Jan. 12-month Core PPI was 4.5%.
https://www.bls.gov/ppi/

These data reorient the conversation away from just housing.

Only a portion of the change in PPI is immediately passed onto consumers, though multi-year periods of divergence can occur. A while back, I wondered if CPI would rise to meet PPI. What happened instead was that PPI fell to meet the slower-moving CPI. Now we're close to parity, as measured from Jan 1, 2022.


In hindsight, we should have predicted the rapid rise in CPI/PCE inflation from the sudden rise in PPI that started in January 2021.


Now we're at the opposite inflection point, and the 12-month rate of change in PPI just fell below the 12-month rate of change in CPI. If the inverse of the 2021-2022 inflationary pattern applies, we should expect a lower CPI in the coming 10-11 months.

The FFR futures market is now discounting the possibility of a November rate cut but still believes in a 0.25% rate cut in December, much like how children can debunk the Easter Bunny while still believing in Santa Claus.

Cleveland Fed President Loretta Mester (a hawk who does not vote in 2023) is the latest in a very long line of Fed officials, including Powell, to tell markets they should expect no rate cuts in 2023. She also said unemployment will rise in 2023 as the FOMC raises the FFR "above 5% and hold it there for some time to be sufficiently restrictive to ensure that inflation is on a sustainable path back to 2%."

With the GDP Now estimate at 2.5%, all the latest signs point to solid economic growth and continued, stubborn inflation at 2-3x the Fed's target. Perhaps we discarded the Taylor Rule too soon, and now we're seeing the results of a policy stance that has just now hit neutral?

Personally, I think the FFR will hit 5.5% in May, and holds that level at least through the end of 2023. A couple more months like January, though, and we'll be talking about 6% in the same way we were talking about the prospects of 5% last fall!

[Paper Chaser]

Mester also mentioned that she would've supported a .5 increase last month over a .25. I can imagine there's growing sentiment within the Fed that agrees with her based on the latest data.

https://finance.yahoo.com/news/feds-mester-saw-compelling-case-for-050-rate-hike-this-month-135749680.html

[ChpBstrd]

I am anticipating a recession, but I appreciate contrary points of view. Thus, I appreciated this article which summarizes a longer, but unfortunately paywalled, post by an analyst in which 10 reasons are offered for why a recession won't occur:

1) In the post-war era, a U.S. recession has never begun with real interest rates deeply negative across the yield curve. If we focus on the level of interest rates instead of the rate of change, this monetary tightening is still the mildest in any cycle since the 1950s.

Negative real rates are at the heart of my view on inflation. That is, negative real rates encourage people to take on debt to buy things rather than to save, which encourages inflation, and then inflation further incentivizes people to pull ahead more purchases. However the author's "recession won't happen" call is odd because today's trend is rising interest rates and falling inflation, which means that by the later half of this year we could see deeply positive real rates. I'm not predicting a recession will start this month or next, I'm predicting it will start later this year or early next year after we see real interest rates around +2%.

The associated chart actually shows that recessions tend to start right after real rates flip suddenly from negative to positive, as in 2008 and several other points identifiable on the chart (49, 53, 74, 80). Recessions are associated with both rising interest rates and a sudden drop in inflation, which produces increasingly positive real interest rates. The two things often co-occur, but history shows a period of negative real rates does not rule out recession a short while later.

In practical terms, this method of predicting or debunking recessions is useless, because by the time we notice steep disinflation (as in 2008 or 2001) we're already in a recession and any long stock positions have already absorbed major losses. I just don't see a pattern here that gives a clear and advance signal. Instead, this is one of those things which appears obvious in hindsight.

2) Real long rates will remain negative even after the Fed funds rate reaches 5%. The U.S. yield curve is so deeply inverted that real long rates will remain negative even if inflation falls below 5% — unless the curve rapidly disinverts. Neither of these events is likely in the months ahead.

This statement underestimates the volatility of CPI. Imagine how unlikely it seemed in June 2022 to say that the 12-month rate of inflation would fall 3.6% in the next 6 months. It did, and now annualized CPI is 6.35%. What would happen if 12-month CPI fell another 3% in the next few months? The answer is we'd have deeply positive real rates by this summer.

3) Yield curve inversion is not a useful recession indicator. Inversions preceded all U.S. recessions since 1970, but there were several false or very premature predictions (in 1966, 1978, 2006 and 2019, unless you believe that COVID came from Wall Street, not Wuhan).

So we have this great way of predicting recessions with very high reliability and plenty of advance notice and you're going to call it not useful because 2 years' advance notice is "premature"? Exactly what would be acceptable? A predictor with three months' lead time and a 100% reliability? That doesn't seem to exist. Saying there were "several false or very premature predictions" is deceptive when all but one of these "several" predictions are considered "premature" because a line was drawn in the sand and labeled "premature".

4) The U.S. labor market is too strong for a recession.

The unemployment rate is usually low right before a recession. I.e. right before a recession "the bottom is in" on the unemployment rate. Moving on.

5) Aggregate real income has grown even while average real wages have fallen. That’s because “rapid employment growth has more than offset the decline in real wages.”

First, we know the unemployment rate can and typically does quickly zoom up during a recession, so let's not assume "rapid employment growth" is some permanent thing that must still exist 6 or 12 months from now. Second, the "real income has grown" statement refers to the last few months on some very zig-zaggy charts. Real Median Household Income, an annual series, has been falling since the 2019 high of $72,808. Real Disposable Personal Income, a monthly metric, is still lower than it was in February 2020. Real Disposable Personal Income is up 1.6% in the past 6 months, but it's still down 1.75% since December 2021.

6) Real wage growth will soon turn positive. With the labor market still extremely tight, wage gains should continue above 5% for the next few months while price inflation should ease to below 5%, unless there is another oil shock.

"should" + "should" = just another forecast. Besides, what is the connection between the fulfillment of these two conditions and there not being a recession? Recessions usually start during periods of positive real wage growth. It is the recessions themselves which turn this metric negative.

7) The stock of personal savings is still far above normal, thanks to government COVID handouts and cutbacks in consumption during lockdown. The order of magnitude is generally agreed to be $1-2 trillion, equivalent to between 5% and 12% of U.S. household consumption.

I've looked for a reliable source on the question of how much stimulus money / excess savings households are still hoarding. There are a lot of opinions, so there is nothing "generally agreed". I suspect it's not a lot considering how it's been well over a year since the last stimmie check was mailed. Also, if householders are doing so well, why did a December 2022 survey find that 57% of Americans lacked the savings to cover a $1,000 expense, and 25% - the highest percentage since 2014 - would go into credit card debt if they had an unexpected $1k expense?

Household Net Worth fell 4.72% in the first three quarters of 2022.

Finally, I suspect helicopter money amounting to 5-12% of household consumption evaporated a long time ago because inflation has absorbed more than that amount. To visually see the impact of inflation, I charted personal income vs. real personal income. Even though personal income is rising, real income has been flat since 2021. The widening gap between the two represents the bite that inflation is taking out of consumers' income. I think it's safe to say this gap is larger than the stimulus payments, which means people are worse off in real terms despite the payments which ended in 2021. Since January 2021, the real personal income minus personal income calculation reveals $2.536 trillion of workers' wages (in 2012 dollars!) have evaporated due to inflation. And high inflation is continuing for at least a few more months. There went the stimulus!

8) Housing is now stabilizing. Today’s 30-year mortgage rate is lower than at any time in U.S. history before the 2004-07 housing bubble.

This is putting a brave face on a Housing Affordability Index that has just risen a tiny amount above record lows. Additionally, Housing Starts have been plummeting since April 2022. A rapid fall in Housing Starts has preceded 7 of the 8 recessions since 1959, across a wide variety of mortgage rate levels.

9) Activity is shifting from goods to services. Big losses in manufacturing are compensated by smaller gains in the much larger service sectors. The net result is that the economy continues to grow.

I see no correlation between Manufacturing New Orders and recession. I also see nothing to suggest that service sector growth at a faster rate than manufacturing is a good or bad thing. Basically we're back to the issues raised above: The economy always grows before a recession, otherwise the recession would already be occurring!

10) A U.S. recession in 2023 is “too good to be true.” If a mild U.S. recession happens this year, as most investors now expect, it will prove that Goldilocks, the Magic Money Tree and “immaculate disinflation” are serious economics, not just myths and fairy tales. If so, we will all have to reconsider what we thought we knew about fiscal prudence, sound monetary management and difficult political trade-offs.

I don't see the point being made here. Reading between the lines, perhaps the original author was saying something like when ALL the recession warning indicators are going off, the only thing that can happen is the impossible. E.g. the economy must avoid recession because all the signals are so deceptively clear and everyone is piling into one side of a trade, so to speak.

My doubts about this claim relate to consumer and business expectations. If everyone expected a recession, it would become a self-fulfilling prophecy. Consumers would cut spending and increase their savings in anticipation of layoffs. Businesses would reduce their inventories, order less from manufacturers, and preemptively lay off employees. None of these things are happening yet, which suggests most economic agents are not preparing for a recession. Neither businesses nor consumes are piling into one side of a trade by doing the things they should do in advance of an expected recession.

If they did make changes in anticipation of a recession, those changes would themselves cause the recession. This is where the crowded trade metaphor breaks down. Crowded trades push prices away from what the crowd expects. Recession expectations push the economy toward recession.

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At the bottom of the same article, it's noted that Anthony Scaramucci said on Twitter that the S&P500 has gone 18 sessions above it's 200-day moving average, and that has always in the past signaled the end of a bear market. Another poster noted that the S&P500 was higher 100% of the time 3 months after this pattern occurred, after at least a 20% decline:


First, why are we picking 18 days? Is that the cherry in the data? How does the reliability break down at 15 days or 22 days?
Second, what mechanism forces stocks higher after precisely 18d above the MA? Compelling values? Not at today's near-22 PE ratio for the S&P500, amid rising bond yields.
I'm a big fan of pattern identification, but this looks an awful lot like cherry-picked technical analysis. Bear market rallies in the 10%-15% range are typical, and it seems inevitable that at least some of these would poke above the X-day moving average for Y-days.

[Paper Chaser]

Just saw that about a week ago the Cleveland Fed (headed by Mester who cannot vote this year but has voiced support for a .5 hike at the last meeting and presumably the upcoming one as well based on recent data) released a working paper about their expectation for inflation being "higher for longer":

https://www.clevelandfed.org/publications/working-paper/2023/wp-2306-post-covid-inflation-dynamics-higher-for-longer

What's interesting is that this went mostly under the radar when it was released last week, but is being discussed now by reporters with close ties to the Fed. Could they be setting up expectations for a larger than expected rate increase at the next meeting?

Not entirely clear how these odds are being calculated (Should be taken with a grain of salt), but yesterday the futures market apparently thought there was a 21% chance of a .5 rate hike at the next meeting:



Today, after this report was highlighted by a Fed friendly reporter, they're up to 24%:

[ChpBstrd]

Just saw that about a week ago the Cleveland Fed (headed by Mester who cannot vote this year but has voiced support for a .5 hike at the last meeting and presumably the upcoming one as well based on recent data) released a working paper about their expectation for inflation being "higher for longer":

https://www.clevelandfed.org/publications/working-paper/2023/wp-2306-post-covid-inflation-dynamics-higher-for-longer

What's interesting is that this went mostly under the radar when it was released last week, but is being discussed now by reporters with close ties to the Fed. Could they be setting up expectations for a larger than expected rate increase at the next meeting?

Not entirely clear how these odds are being calculated (Should be taken with a grain of salt), but yesterday the futures market apparently thought there was a 21% chance of a .5 rate hike at the next meeting:



Today, after this report was highlighted by a Fed friendly reporter, they're up to 24%:

Mester, like Bullard, is on the "hawks" side of the scale, and are both non-voters in 2023. This means they're not accountable or responsible for delivering votes consistent with their commentary, but it also means they can say things the voting members can't. Bullard, more than anyone, was the most upfront about the need for an FFR much higher than the market consensus throughout most of 2022 (for example, this prediction of an FFR between 5% and 7%), and that was even despite his role as a voting member. Bullard was careful to couch all his statements in the context of previous Fed publications and statements, but I'm sure his activism ruffled some feathers.

In terms of voting, the doves are definitely in charge this year. From a dovish perspective, the FOMC can most effectively find the "restrictive" rate and not over-shoot by going a quarter-point at a time. This way they can absorb more information before the FFR gets too high. The cost, from their perspective, is reaching the terminal rate a few months later than otherwise, and the benefit is not overshooting as far.

E.g. if the terminal rate is 5.75%, we could either get there with 0.5% hikes in March and May, or we could get there with 0.25% hikes in March, May, June, and July. In the later scenario, policymakers get an extra two months of data to help them decide they've reached the "restrictive" level. In the former scenario, it is possible policymakers operating on limited information about the economy might continue erroneously hiking above 5.75%.

To a dove, a mere two-month delay in getting to the terminal rate is an acceptable tradeoff of the gradual approach, with the added benefit of reducing the damage of overshooting. Are inflationary expectations going to become entrenched in those 2 months? Probably not.

Businesses, however, would benefit from being granted a longer time to extend their debt maturities, optimize their debt/equity ratio for a higher interest rate regime, reset prices, reduce headcount through attrition rather than layoffs, shut down unprofitable units, etc. and these things could be the difference between a recession and a close call.

That's why I think it's all 0.25% hikes from here, regardless of where the terminal rate falls.

[Paper Chaser]

Right. I guess my point was that there's growing chatter (from non-voting hawks) about the possibility of a higher rate hike. And there seem to be some people that are listening and adjusting expectations as a result. The odds of a larger hike supposedly went up 3% in the last day, and we're still a month out from the next meeting with more data to come. If that data indicates things aren't cooling rapidly I think the odds of a .5 hike continue to rise.

[EscapeVelocity2020]

The PCE data this Friday better be good (e.g. lower than expectations), just sayin!  Expected 4.4% YoY Core PCE, so it's a tougher hurdle to clear...

[ChpBstrd]

The PCE data this Friday better be good (e.g. lower than expectations), just sayin!  Expected 4.4% YoY Core PCE, so it's a tougher hurdle to clear...

January's Core PCE should surprise just like January's CPI and Core CPI did. These things tend to move in similar directions, if not in direct correlation to one another.


If Core PCE managed to come in below expectations in the same month CPI/Core CPI came in above expectations, I would interpret that as bad news: It would mean prices are rising and consumers are running out of money.

[ChpBstrd]

Today's money supply and velocity of money supply reports show a continued trend of falling M2 and M1 due to QT.

M1 is down 4.9% since March 2022, and we have reversed money supply growth back to where we were in about July 2021. Meanwhile, as a shrinking pool of money gets spent on all the same things, monetary velocity increases. Monetary velocity is typically associated with inflation, though in today's case it's mostly a mathematical byproduct of QT/QE.

Meanwhile the NFCI released today shows the economy moving further away from tight financial conditions, and closer to a normal-like level. GDP reportedly came in at +2.7% in Q4'22.

Both initial claims and continuing claims dropped last week.

The Q4 personal savings rate was revised upwards from 3.4% to 3.9%, a MAJOR revision that probably explains some of the disinflation of Q4. Consumers were saving instead of spending in Q4, but what were they doing in January? Advance retail sales suggest they opened their wallets.

In other words, most* signs point to a hot PCE and Core PCE report tomorrow. However, there was a dip in January 2022 which will mess up the YoY comparison. Also complicating the picture, monthly PCE growth was negative for the past 2 months, a pattern which had not occurred since March-April 2020 and prior to that March-April 2013, with both episodes followed by a swift rebound. My prediction is PCE will rise 0.7% MoM and Core PCE will rise 0.6% MoM. My prediction is at odds with the 0.4%/0.4% MoM expert consensus.



*Gasoline and natural gas prices have plummeted though, which might drag down PCE.

[ChpBstrd]

My prediction is PCE will rise 0.7% MoM and Core PCE will rise 0.6% MoM. My prediction is at odds with the 0.4%/0.4% MoM expert consensus.

Both PCE and Core PCE came in at +0.6% in January. I didn't nail it, but I came closer than the consensus!
https://www.bea.gov/news/2023/personal-income-and-outlays-january-2023

[Paper Chaser]

With 3 weeks to go until the next Fed meeting, odds of a .5 rate increase have climbed to nearly 36% (3 weeks ago the odds were just 1%)

[wageslave23]

With 3 weeks to go until the next Fed meeting, odds of a .5 rate increase have climbed to nearly 36% (3 weeks ago the odds were just 1%)

They would look silly reacting to one month's worth of data. Especially after they insisted that they were looking at the long term when we had several months of lower inflation reports. I don't think they have a choice but to stick with .25 for the next meeting.  If they react to one month's data, they lose all credibility.

[Paper Chaser]

With 3 weeks to go until the next Fed meeting, odds of a .5 rate increase have climbed to nearly 36% (3 weeks ago the odds were just 1%)

They would look silly reacting to one month's worth of data. Especially after they insisted that they were looking at the long term when we had several months of lower inflation reports. I don't think they have a choice but to stick with .25 for the next meeting.  If they react to one month's data, they lose all credibility.

What if the "several months of lower inflation reports" were wrong?:

https://www.reuters.com/markets/us/us-december-consumer-prices-revised-higher-2023-02-10/

"U.S. monthly consumer prices rose in December instead of falling as previously estimated and data for the prior two months was also revised up.....

The consumer price index edged up 0.1% in December rather than dipping 0.1% as reported last month, the Labor Department's annual revisions of CPI data showed on Friday. Data for November was also revised higher to show the CPI increasing 0.2% instead of 0.1% as previously estimated. In October, the CPI rose 0.5%, revised up from the previously reported 0.4% increase."

The trend is that inflation didn't decelerate as much as initially reported last fall, and actually increased in December, and accelerated more in January. If you're going to be "data dependent" and pull back when things appear to be cooling, then it seems consistent to me to be "data dependent" and raise when data trends show that it was never as cool as originally thought, and seems to be getting hotter for 2 consecutive months.

And really, with all of the transitory talk, etc in recent years I'm not sure they had a ton of credibility to lose. 

That being said, the market seems to think that a .5 hike is still less likely than a .25. It's just that the chances of .5 have increased significantly for both March and May meetings from where they were after December. If more data comes out to indicate it wasn't as cool as thought in the past, and/or continues to stay hot I think the odds of a .5 hike will continue to rise.

[BicycleB]

With 3 weeks to go until the next Fed meeting, odds of a .5 rate increase have climbed to nearly 36% (3 weeks ago the odds were just 1%)

They would look silly reacting to one month's worth of data. Especially after they insisted that they were looking at the long term when we had several months of lower inflation reports. I don't think they have a choice but to stick with .25 for the next meeting.  If they react to one month's data, they lose all credibility.

What if the "several months of lower inflation reports" were wrong?:

https://www.reuters.com/markets/us/us-december-consumer-prices-revised-higher-2023-02-10/

"U.S. monthly consumer prices rose in December instead of falling as previously estimated and data for the prior two months was also revised up.....

The consumer price index edged up 0.1% in December rather than dipping 0.1% as reported last month, the Labor Department's annual revisions of CPI data showed on Friday. Data for November was also revised higher to show the CPI increasing 0.2% instead of 0.1% as previously estimated. In October, the CPI rose 0.5%, revised up from the previously reported 0.4% increase."

The trend is that inflation didn't decelerate as much as initially reported last fall, and actually increased in December, and accelerated more in January.

Fwiw, same author two weeks later (aka yesterday) quoted JPMorgan economist Daniel Silver as follows:

"so far the PCE price data are only getting the upward revision from the annual revisions to the underlying source data from recent months without getting the offsetting downward revisions to earlier months. This means that year-ago rates for the PCE price data in recent months are 'too high' right now and likely will be revised down in the BEA's own annual revision coming in the fall."

("MORE RATE HIKES" section, 8th paragraph)
https://www.reuters.com/markets/us/us-consumer-spending-surges-january-inflation-accelerates-2023-02-24/

[EscapeVelocity2020]

Very interesting to watch the FedWatch Tool - https://www.cmegroup.com/markets/interest-rates/cme-fedwatch-tool.html?redirect=/trading/interest-rates/countdown-to-fomc.html

Now predicting more rate hikes going longer in to 2023, and thus a higher peak rate.  This despite QT supposedly making up some of the Taylor Rule required tightening...

[dividendman]

At what treasury yield do we just junk a bunch of money in and let it ride?

For some reason I think if we can get LTTs for 5-6% it's going to be really tempting to not put all of my bond allocation in there. Too bad (or maybe good?) I have an IPS that prevents me from doing that.

[EscapeVelocity2020]

At what treasury yield do we just junk a bunch of money in and let it ride?

For some reason I think if we can get LTTs for 5-6% it's going to be really tempting to not put all of my bond allocation in there. Too bad (or maybe good?) I have an IPS that prevents me from doing that.

A better question will be why people would be willing to buy stocks at a 5% earnings yield (SPY PE ~20) if you can get the same yield 'risk free'...

I'm just happy I can move low yield cash to Vanguard Money Market at 4.5% nowadays.  Not sure why banks aren't even trying to keep up, mine is still offering less than 1%.

[ChpBstrd]

Very interesting to watch the FedWatch Tool - https://www.cmegroup.com/markets/interest-rates/cme-fedwatch-tool.html?redirect=/trading/interest-rates/countdown-to-fomc.html

Now predicting more rate hikes going longer in to 2023, and thus a higher peak rate.  This despite QT supposedly making up some of the Taylor Rule required tightening...

Very interesting indeed! Now markets are split between 5.5% or 5.75% as the terminal rate. Talk about going above 5% was considered alarmist just months ago! Maybe 6% is the new 5%?

Yet we investors cannot lock in these rates due to yield curve inversion. 10y and 20y treasuries are still yielding only around 4%. History suggests the yield curve inversion could get deeper as we get closer to recession. 



Thus any plan to lock in high rates for a long time is not likely to work - at least not with treasuries. Too many investors expect rate cuts in 2024 and beyond, so they are buying duration and pushing down the price of long-duration fixed income assets. This trade is so crowded it is unclear how they'll make any money even if their thesis pans out, because normalization of the yield curve would eat up the gains from rate cuts!

How about with corporate bonds? Current credit spreads between 10y treasuries vs. Baa bonds is at +1.87%. History suggests (1) this spread increases when recession occurs, as investors worry about bankruptcies increasing, and (2) the time to buy corporate debt is when this credit spread is above 3% - a milestone which often happens even without a recession. Thus we could see Baa corporate bond yields above (4% treasury yield + 3% credit spread =) 7% by later this year if recession fears get more acute.

I'm leaving myself the option to wait until the yield spread widens, and then buy all the duration I can buy. If my portfolio is yielding around 7%, inflation is plummeting, and I think imminent rate cuts will boost the value of my bonds, then I might be tempted to take a pre-FIRE sabbatical while interest payments are covering my entire expenses and until my bonds rise enough to meet my FIRE number, at which point I diversify into an 85/15 AA or something like that. After all, post-recession periods typically support 5% WR's.



If we chart the corporate bond credit spread against corporate bond yields and the FFR, it tells a story of how yields on corporate bonds fall a bit more slowly than the FFR. This is part of why I'm not all-in on corporate bonds. Their prices can drop and yields can rise during a recession if, as in 2008, there are serious and systemic solvency concerns. My short-duration treasuries and cash will be more ready to pivot into risk assets.



Looking ahead, we will likely face a mid-recession choice about whether to lock in 7%+ IG bond yields or catch the falling knife of stocks for even higher returns. I might get to the recession mostly in cash and treasuries, then get through the recession by picking up high-yielding corporate bonds as credit spreads get high, and then shift to 100% stocks as it becomes clear the recession is over.

My AA is currently:

58% short duration treasuries yielding around 4.5%
25% money market yielding near nothing - soon to be moved to short duration treasuries
10% IG bonds yielding around 7%
4%  preferred stock yielding around 7%
3% junk bonds yielding around 7.5%
0.1% stock ETF
0.1% long option

So basically I'm ready for the recession. Bring it Mr. Powell!

[EscapeVelocity2020]

To add confusion to why QT might not be having the intended 'liquidity draining' effect (i.e. lowering risk appetite), this article had an interesting take - https://www.marketwatch.com/story/the-secret-to-stocks-success-so-far-in-2023-an-unexpected-1-trillion-liquidity-boost-by-central-banks-43cc6f2?mod=home-page

The upshot is this: The Federal Reserve, European Central Bank and Bank of England have advertised that they’re trying to drain the ocean of banking-system liquidity, but on a global scale, liquidity has actually increased in recent months. That’s due in part to factors that are outside the control of policy makers.

In a research note shared with clients last month, Matt King, a global markets strategist at Citigroup Inc., detailed how the world’s largest central banks had recently injected $1 trillion into the global financial system.

The bulk of this increase, according to King’s analysis, came from the People’s Bank of China, which has bucked the trend of global monetary tightening and instead opted to directly inject liquidity into its banking system, accounting for the largest share of the $1 trillion figure.
...
And while the size of the Fed’s bond holdings has shrunk since last spring by about $500 billion, according to data from the St. Louis Fed, another important component of its balance sheet, U.S. banking system reserves, appears to have flat-lined.

According to the latest weekly update released by the Fed, reserve balances at Federal Reserve banks stood at $3.01 trillion as of Feb 22. That’s a modest increase from $2.9 trillion at the end of September.

“The Fed is supposedly rolling off the balance sheet, but bank reserves are not falling,” Howell said.

This could also be helping to buttress equity prices as the amount of money available for U.S. banks to push into the financial system has expanded, instead of contracting, he said.

[Kevin Aster Tin Obin]

Thanks for posting your AA chp bstrd. followed this thread from beginning and wondered if you playing with side pot or all in on staying out of stocks. Interesting.  down 20% still from VTI highs and hard to pull out 20 years of 401k contributions now at 90/10 stocks. But other savings in treasuries at 4.5%+ is nice and like you said maybe throttle back and coast

[ChpBstrd]

To add confusion to why QT might not be having the intended 'liquidity draining' effect (i.e. lowering risk appetite), this article had an interesting take - https://www.marketwatch.com/story/the-secret-to-stocks-success-so-far-in-2023-an-unexpected-1-trillion-liquidity-boost-by-central-banks-43cc6f2?mod=home-page

The upshot is this: The Federal Reserve, European Central Bank and Bank of England have advertised that they’re trying to drain the ocean of banking-system liquidity, but on a global scale, liquidity has actually increased in recent months. That’s due in part to factors that are outside the control of policy makers.

In a research note shared with clients last month, Matt King, a global markets strategist at Citigroup Inc., detailed how the world’s largest central banks had recently injected $1 trillion into the global financial system.

The bulk of this increase, according to King’s analysis, came from the People’s Bank of China, which has bucked the trend of global monetary tightening and instead opted to directly inject liquidity into its banking system, accounting for the largest share of the $1 trillion figure.
...
And while the size of the Fed’s bond holdings has shrunk since last spring by about $500 billion, according to data from the St. Louis Fed, another important component of its balance sheet, U.S. banking system reserves, appears to have flat-lined.

According to the latest weekly update released by the Fed, reserve balances at Federal Reserve banks stood at $3.01 trillion as of Feb 22. That’s a modest increase from $2.9 trillion at the end of September.

“The Fed is supposedly rolling off the balance sheet, but bank reserves are not falling,” Howell said.

This could also be helping to buttress equity prices as the amount of money available for U.S. banks to push into the financial system has expanded, instead of contracting, he said.

Those are interesting points! If China is essentially doing QE with their dollars while the US is doing QT, it might be a wash, as the quoted analyst seemed to imply.

If Chinese USD holdings and patterns of behavior are so large they can offset federal reserve action, that’s concerning! It would mean the US has lost control of its own money supply. I still see China as a fast-growing sponge which soaks up US trade and government deficits, parking dollars in overseas accounts where they can’t affect prices as much. But the ups and downs of the Chinese economy could swing things in unpredictable directions within the US.

Seen in this light, the inflation of 2021-2023 corresponded with shutdowns in China. Those didn’t just create shortages of goods, they also created a situation where dollars were not so readily disappearing into Asian accounts or being recycled into US treasuries. Thus the fed might not be at fault as much as we blame them, and the fed may have less control than anyone thinks and China’s reopening and soon-to-be-fast growth might snuff out inflation within a few months.

[Paper Chaser]

With Powell's comments today, odds of a .50 rate hike at the next meeting have jumped significantly and now reside above 50%. Also note a new column for terminal rate of 6.25-6.5 has been added to the table.

[Must_ache]

My asset allocation:

Cash 33% more expected to be deployed to Treasuries in a couple of weeks.
Treasuries/CDs 27%
Stocks 13%
Energy Stock 10%
Insurance Stock 7%
Other Government Bonds 6%
Company Stock (also Insurance) 3%

[EchoStache]

@ChpBstrd Curious as to why you would have 25% of your assets in "money market yielding near nothing" when there's an easy 4.25-4.5% to be had in MMF's currently?  I know they haven't *been* that high, but they've been ramping up to substantially greater than 0 for some time now.

For example, I'm in SPRXX(Fidelity) which yields ~4.35 since the last rate increase.

Another question, if you don't mind since you seem to have your finger quite on the pulse for these types of things.  At what point do you think long term CD's and/or Treasuries will "top out"?  I'm assuming once the Feds get to the point where they are done or almost done raising rates, that 10 year+ CD's or Treasuries will also be topped out? 

[ChpBstrd]

@ChpBstrd Curious as to why you would have 25% of your assets in "money market yielding near nothing" when there's an easy 4.25-4.5% to be had in MMF's currently?  I know they haven't *been* that high, but they've been ramping up to substantially greater than 0 for some time now.

For example, I'm in SPRXX(Fidelity) which yields ~4.35 since the last rate increase.

In reality, I've used the cash to sell a put every now and then, getting close to earning the prevailing treasury rates over time. But rates keep getting better so it's making more sense to just drop the cash into treasuries.

My slowness in buying treasuries is one part laziness, one part my orders keep getting cancelled by my broker as prices move too fast, and another part realizing I could get another 0.25% just by waiting one more month. That last point has really been the thing reducing my urgency, because it's a tug of war between time in the treasuries versus continually rising yields. If the choice is between 7 months of duration at 4.75% annualized or waiting one month to get 6 months duration at 5% annualized, one loses nothing by waiting. Of course, this waiting rationale could go on forever, which brings us to the next point...

Another question, if you don't mind since you seem to have your finger quite on the pulse for these types of things.  At what point do you think long term CD's and/or Treasuries will "top out"?  I'm assuming once the Feds get to the point where they are done or almost done raising rates, that 10 year+ CD's or Treasuries will also be topped out?

I've been trying to pin down the answer to that question this entire thread. Until last fall, I was firmly in the camp that the Taylor Rule provided a good illustration of what we should expect. That is, a FFR a percent or so above inflation (presumably PCE). According to the Fed's own website,

...the central bank should raise the policy interest rate, over time, by more than one-for-one in response to a persistent increase in inflation and lower the policy rate more than one-for-one in response to a persistent decrease in inflation. For example, if the inflation rate rises from 2 percent to 3 percent and the increase is not caused by temporary factors, the central bank should raise the policy rate by more than one percentage point.

So this implies a FFR a percentage point or two higher than inflation. When I look at historical examples from the 1970's and 1980's, I notice that the "top" in the FFR often occurs months after the peak in inflation. The FFR exceeded inflation by 1-2% in times when rate hikes were successful at suppressing inflation for at least a year or two. Observations like these are where the Taylor Rule came from.

12-month Core CPI peaked (so far) at 6.6% in September 2022. Peak FFR would traditionally come months or a year later.

Of course, then last fall happened, and inflation (prior to recent adjustments) seemed to be dropping like a rock from July to December. I and others on this thread started wondering about the applicability of the Taylor Rule in a world where stimulus money was running out, China was reopening, energy and commodity prices were falling, and QT was occurring. Maybe the inflation was just a collection of one-time factors, and maybe a 1Q2023 recession was imminent?

Then January's inflation surprise and the revisions to earlier months came out, the economy continued roaring with growth signals, Fed officials warned about a FFR higher than expectations, and the Taylor Rule started looking a lot better.

The Taylor Rule had warned us an inflation resurgence was the outcome one might expect when we haven't got the FFR above inflation yet - policy is still stimulative and banks/consumers are still incentivized. The economy is still roaring. I've mostly swung back around to expecting a Taylor Rule prescribed outcome.

In reality though, the Fed has never in history raised rates by more than about 3.25% and escaped recession. The odds of escaping recession with a campaign of 5+% rate hikes seems nil in the historical context.

Last fall, I pivoted to thinking about a 2023 recession more so than a Taylor-Rule prescribed peak rate, because at +0.25% per Fed meeting the onset of recession might halt the rate hikes before we get to a Taylor-Rule prescribed level. Now I'm not sure which will happen first - recession or a 6.5%-7% FFR?

The futures market now has 75% odds of a 0.5% rate hike on March 22nd, so maybe a Taylor-Rule FFR could happen sooner than recession.

Of course, all this talk about the FFR is not addressing your question, which was about long-duration rates. Yield curves can invert by multiple percentage points, and the 3mo yield is already 1.07% below the 10y yield. As the FFR rises, and as market participants with a longer range view continue to expect a future recession and rate cuts, yield curve inversions could get deeper and deeper, just like they did in the early 1980s. In other words, yields in the 10-30 year range may or may not have already peaked and the FFR/10y yield curve could be inverted by 3% or more this summer as the FFR approaches the 6% range. The answer to the question is I have no clue where the long-duration peak will occur, because it is not tied to the FFR.

The longer-duration rates reflect a balance between investors' anticipation of a recession and rate-cutting cycle and their fear that inflation has become a systemic factor. Things which could raise long-duration yields include:

• Verbal committments by Fed officials that they're committed to avoiding 1970's style outcomes and plan to hold rates high through a recession.
• A loss of confidence in the Fed's ability to control inflation, perhaps caused by a resurgence in inflation despite the rate hikes.
• A major recession in one of the US's creditor countries, like China, Japan, or the UK, which would reduce demand for long-duration US treasuries.
• Announcement of a new "Operation Twist" where the government sells short-duration debt and buys back its long-duration debt in an attempt to flatten the yield curve.
• A liquidity crisis, left unaddressed for days at a time, which leads to forced selling.

Edit: BBB Corporate bonds are only yielding about 1.55% higher than treasuries. This credit spread will likely widen as recession sets in, which is why I'm not too gung-ho on corporate bonds right now. I somewhat expect corporate bond prices to fall once markets start freaking out about an increase in the default rate, and when this occurs it might be our best opportunity to deploy cash to lock in high long-duration returns.

In summary, the top will be in on bond yields at about the time when a recession is occurring. This is good for those of us in cash or short-duration debt, because we will have lots of real-time buy signals.

[ChpBstrd]

I found a great article in the WSJ offering answers to a question I raised earlier: If the yield curve for treasuries is highly inverted, forecasting a recession, then why are risky assets like junk bonds and equities priced so high?

(may be paywalled, hopefully this redirect link from Yahoo works):https://www.wsj.com/articles/markets-are-telling-investors-two-things-at-once-f883f897?siteid=yhoof2

The article offers 3 possible reasons, and I added my evaluation of each:

1)

First is the simplest explanation: Treasurys aren’t warning of recession. If investors think the Fed will cut rates because inflation comes back down without recession, all the pricing is consistent. Short-dated Treasury yields suggest the Fed will keep raising rates for a while, and keep them high, as it says it will. Longer-dated yields indicate the Fed will eventually cut them back because long-run economic growth will be lackluster, but not awful.
...
If the Fed cuts rates enough once the economy slows, it could in principle avoid recession and un-invert the curve. Such a soft landing at the end of a series of rate rises has happened in the past, in the mid-1980s and mid-1990s—although in neither case had the curve inverted beforehand.

It was noted in the comments that the Fed could cut rates simply due to disinflation, regardless of what the economy is doing. I think that's possible, but it goes against the lessons of the 1970s about premature rate cuts and numerous Fed / JPow statements about "higher for longer". Plus I think the short-term incentive structure for the FOMC remains similar to what it was in the 70's. As inflation falls, they may try to dodge a recession, and such an attempt would be bullish for stocks. It's hard to imagine such a future, but we need to try.

A problem I have with this explanation is: Why is the treasury yield curve inverted but not the high-quality corporate bond yield curve? If markets were expecting a soft landing, wouldn't both be inverted? Investors are demanding much higher yields for long-duration AAA through A corporates than they are demanding for the same term treasuries. Those higher yields would be free money if we have a soft landing. Yet the fact that there is a major credit spread tells me investors are budgeting for defaults and downgrades from even the most liquid of companies. They're also budgeting for an expanding credit spread during the recession, which is typical. Even as treasury yields go down due to rate cuts, corporate bond yields will remain high because markets will be scared of their risk.

Traders' game plan will be to switch from long-duration treasuries to long-duration corporates just as the treasuries get a boost from rate cuts, but while the corporates are still depressed by temporarily high credit spreads. I see this as more consistent with the data than a widespread belief in a soft landing.

2)

The second explanation: Bond investors are just better at sensing recession. To stereotype, shareholders are optimists on the lookout for good news, while bondholders are pessimists forever watching for recession. It shouldn’t be surprising they tend to spot it a year or two before stock markets wake up to reality. The reason I don’t like the explanation is that most people have both stocks and bonds, and there is plenty of money that moves between the two depending on the outlook.

You can actually see this dynamic play out in the historical data: Stocks tend to "burn up" until right before the recession starts, whereas bond markets position themselves correctly far ahead of time. IDK if this is because there are different fund managers with different temperaments and incentive structures in charge of stocks versus bonds, or if stocks don't fall because the short-term traders who set prices still have incentives to trade even if the long-term trend is down or if the risks are mounting. Given the wide range of timeframes between past yield curve inversions and recessions - up to a couple of years - they probably feel like they have plenty of time to play.

Regardless of cause there is a repeating pattern, and nobody with any historical awareness should point to high prices for risk assets as evidence there will be no recession. For all we know, risky assets could be expensive because they're so risky. For example, shares might be in demand to use as hedges for short put positions sold at high prices to nervous investors!

3)

The third possibility: There is far too much money floating around. Stimulus checks and Fed bond buying filled up bank accounts and boosted corporate profits, and it hasn’t all gone away. One sign of the spare cash is that money-market funds have banked $2.2 trillion at the Fed, via its reverse-repurchase facility. Some, of course, was wasted on meme stocks, bitcoin and exercise bikes, but plenty is invested, helping hold up share prices, junk bond prices and Treasury prices—and so hold down yields.

Short-dated yields are closely tied to Fed interest rates, so there is little effect from investors buying Treasurys there. But longer-term yields should be depressed by the weight of money, and seem to be: The New York Fed’s gauge of the “term premium,” the extra yield offered by Treasurys above (or, as now, below) the expected path of future interest rates, has been the lowest over the past year of any time since 1962, aside from the pandemic.

This is a chicken-egg problem. Are investors plowing into long-duration treasuries because they have lots of money, because they expect rate cuts and recession, or both? The author notes multiple reasons could be operating at the same time, keeping the price of risky assets higher than might be considered rational in a time when we're looking at almost 5% of rate hikes over the past 12 months.

However, there might be something to this observation. A few years ago when fixed income yielded next to nothing, people went into stocks because TINA (there is no alternative). Maybe now risk assets are priced so high and the outlook seems so bleak that some investors have concluded TINA to long-duration treasuries! That shift in investor demand would invert the yield curve, but it's not a good reason in itself to think the economy will slow down. Massive numbers of bond investors are sometimes wrong, as they were in 2021-2022.

I'll note my own behavior. After 25+ years of investment experience, I bought my first ever treasury in late 2022. If bond novices like me are flooding the market for long-duration treasuries because we anticipate recession (I am going short-duration, but most others could be long-duration), then we could conceivably have an inverted curve for that reason alone. Recall that the website for US treasuries froze up late last year as non-institutional investors tried to pick up iBonds at the last minute. This is all very hypothetical.

[gary3411]

This SVB meltdown is big, very big.

It is reasonable to assume other regional banks have a similar or WORSE exposure to medium duration bonds, that could have looked great on their capital reports, but in reality are down BIG. Even if there are no deposit runs, said bank must pay 4%+ to their depositers, while at the same time the "safe' bonds they bought in 2019-2022 were only yielding 1-2%. So now they're earning negative spread, even if they can in fact hold these bonds to maturity (extremely unlikley now that everyone has woken up to these facts after SVB).

I think the FED is watching this very carefully. Things are moving fast. We could have a Pause at the next meeting due to this, surely 50 is off the table IMO. Just like that in 2 days.

[gary3411]

Crazy this fellow literally called SVB's meltdown verbatim in January.

https://twitter.com/RagingVentures/status/1615826088038473733

[blue_green_sparks]

The CEO of Silvergate Bank talking about crypto 2018. I think his justifications lack substance and the last sentences I quoted just tells me he probably had a clue about the shady side.

https://www.cnbc.com/2018/05/31/meet-silvergates-alan-lane-whos-bankrolling-cryptocurrency-exchanges.html

Undeterred, Lane is one of the most aggressive executives in cryptocurrencies. Alongside the recent surge of interest in bitcoin and its rivals, Silvergate doubled its assets to $1.9 billion last year. The bank now has more than 250 international clients in the industry, drawing new customers by acting more like a 24/7 clearinghouse for cryptocurrency exchanges.

On the surface, the 56- year-old seems much more like a college professor, or a priest, than a wheeling-and-dealing bank executive. During a recent interview, Lane took off his glasses before answering a question he has clearly been asked before: Why would you bet this small bank’s reputation on one of the biggest headline risks of the past five years?

The grandfather of 21, and devout Catholic, said he became interested in cryptocurrency in 2013. At the time, he had been reading about bitcoin and how it might disrupt banking, an industry he had grown to love and started working in when he was a student at San Diego State University. Because of what’s known as “distributed ledger” technology, people could theoretically become their own banks, without the need for third parties, he found out.

“I thought “uh oh, what am I gonna do?” Lane said with a laugh.

The first thing he did was buy some. In his research, he also learned that companies trading bitcoin were being turned down left and right by other banks.

“I put two and two together and I thought, well it might disrupt banking long-term but in the short-term these companies need banks,” he said. “They’re not doing anything wrong. They’re not doing anything illegal or immoral. If they were we wouldn’t be banking them.”

[gary3411]

The CEO of Silvergate Bank talking about crypto 2018. I think his justifications lack substance and the last sentences I quoted just tells me he probably had a clue about the shady side.

https://www.cnbc.com/2018/05/31/meet-silvergates-alan-lane-whos-bankrolling-cryptocurrency-exchanges.html

Undeterred, Lane is one of the most aggressive executives in cryptocurrencies. Alongside the recent surge of interest in bitcoin and its rivals, Silvergate doubled its assets to $1.9 billion last year. The bank now has more than 250 international clients in the industry, drawing new customers by acting more like a 24/7 clearinghouse for cryptocurrency exchanges.

On the surface, the 56- year-old seems much more like a college professor, or a priest, than a wheeling-and-dealing bank executive. During a recent interview, Lane took off his glasses before answering a question he has clearly been asked before: Why would you bet this small bank’s reputation on one of the biggest headline risks of the past five years?

The grandfather of 21, and devout Catholic, said he became interested in cryptocurrency in 2013. At the time, he had been reading about bitcoin and how it might disrupt banking, an industry he had grown to love and started working in when he was a student at San Diego State University. Because of what’s known as “distributed ledger” technology, people could theoretically become their own banks, without the need for third parties, he found out.

“I thought “uh oh, what am I gonna do?” Lane said with a laugh.

The first thing he did was buy some. In his research, he also learned that companies trading bitcoin were being turned down left and right by other banks.

“I put two and two together and I thought, well it might disrupt banking long-term but in the short-term these companies need banks,” he said. “They’re not doing anything wrong. They’re not doing anything illegal or immoral. If they were we wouldn’t be banking them.”

What is the relevance of this to this thread?

[gary3411]

The twitter user I just cited, said a smart investor he respects, says there could be FFR *CUTS next week.

[ChpBstrd]

I've avoided the financial sector for the past year because:

1) If a recession is coming, they will experience losses due to loan defaults, and
2) If higher rates are on the way, their collateral assets (generally treasuries with some duration) will go down in market price, potentially causing them to fail stress tests or be vulnerable to bank runs.

So far, nobody seems to have understood these things because banks don't have to mark-to-market their bond holdings. They can simply assign them a "held to maturity" tag and claim they are worth their par value, when in fact they've lost value.

SVB and SI experienced bank runs, had to liquidate some of their "held to maturity" bonds to pay creditors, and therefore had to finally recognize their bond losses. The realization is sinking in among investors that even their friendly neighborhood bank that would never make a loan against digital assets is in this same situation, because every bank's bonds have lost value.

Nobody has to recognize that the bonds on the books aren't worth what the books say they're worth, until deposits fall (e.g. people stop depositing as many paychecks in a recession) or defaults rise (e.g. people stop paying their loans during a recession) and the bank must be recapitalized by selling those bonds. Then the paper losses become real losses that appear on the books, and the banks must recapitalize due to both the original problem PLUS the now-realized losses on bonds! So the bank sells more bonds, realizing more loses, requiring more recaitalization.... you get the point.

If banks had to mark-to-market all their bonds, many of them might have zero or negative equity. Except right now, those same banks are worth billions in the stock market! But this is merely because the losses haven't been recognized. When you buy a bank stock, you are purchasing a bunch of fixed liabilities secured by a bond portfolio that can only cover the liabilities if the bonds are allowed to mature over many years into the future. As a depositor, you have to think about whether the bank has enough assets to cover your withdraw!

Ironically, the investment banks are what blew up in 2008 and adversely affected the traditional deposit banking side. This time, it might be the traditional deposit banking side that seizes markets. It will be a busy year for the FDIC, and SVB was just the start.

[gary3411]

I've avoided the financial sector for the past year because:

1) If a recession is coming, they will experience losses due to loan defaults, and
2) If higher rates are on the way, their collateral assets (generally treasuries with some duration) will go down in market price, potentially causing them to fail stress tests or be vulnerable to bank runs.

So far, nobody seems to have understood these things because banks don't have to mark-to-market their bond holdings. They can simply assign them a "held to maturity" tag and claim they are worth their par value, when in fact they've lost value.

SVB and SI experienced bank runs, had to liquidate some of their "held to maturity" bonds to pay creditors, and therefore had to finally recognize their bond losses. The realization is sinking in among investors that even their friendly neighborhood bank that would never make a loan against digital assets is in this same situation, because every bank's bonds have lost value.

Nobody has to recognize that the bonds on the books aren't worth what the books say they're worth, until deposits fall (e.g. people stop depositing as many paychecks in a recession) or defaults rise (e.g. people stop paying their loans during a recession) and the bank must be recapitalized by selling those bonds. Then the paper losses become real losses that appear on the books, and the banks must recapitalize due to both the original problem PLUS the now-realized losses on bonds! So the bank sells more bonds, realizing more loses, requiring more recaitalization.... you get the point.

If banks had to mark-to-market all their bonds, many of them might have zero or negative equity. Except right now, those same banks are worth billions in the stock market! But this is merely because the losses haven't been recognized. When you buy a bank stock, you are purchasing a bunch of fixed liabilities secured by a bond portfolio that can only cover the liabilities if the bonds are allowed to mature over many years into the future. As a depositor, you have to think about whether the bank has enough assets to cover your withdraw!

Ironically, the investment banks are what blew up in 2008 and adversely affected the traditional deposit banking side. This time, it might be the traditional deposit banking side that seizes markets. It will be a busy year for the FDIC, and SVB was just the start.

Well said. It seems everything has beeb pulled forward very quickly here. I'm assuming whatever chance you had assigned an FFR of 6-7% has come down? You can be sure the FED is paying attention to this, as it is very in their wheelhouse. .5% is completely off the table IMO. Maybe a .25% raise but they say theyre ready to pause QT? But if another bank or 2 goes down here soon, oh boy.

[dividendman]

I've avoided the financial sector for the past year because:

1) If a recession is coming, they will experience losses due to loan defaults, and
2) If higher rates are on the way, their collateral assets (generally treasuries with some duration) will go down in market price, potentially causing them to fail stress tests or be vulnerable to bank runs.

So far, nobody seems to have understood these things because banks don't have to mark-to-market their bond holdings. They can simply assign them a "held to maturity" tag and claim they are worth their par value, when in fact they've lost value.

SVB and SI experienced bank runs, had to liquidate some of their "held to maturity" bonds to pay creditors, and therefore had to finally recognize their bond losses. The realization is sinking in among investors that even their friendly neighborhood bank that would never make a loan against digital assets is in this same situation, because every bank's bonds have lost value.

Nobody has to recognize that the bonds on the books aren't worth what the books say they're worth, until deposits fall (e.g. people stop depositing as many paychecks in a recession) or defaults rise (e.g. people stop paying their loans during a recession) and the bank must be recapitalized by selling those bonds. Then the paper losses become real losses that appear on the books, and the banks must recapitalize due to both the original problem PLUS the now-realized losses on bonds! So the bank sells more bonds, realizing more loses, requiring more recaitalization.... you get the point.

If banks had to mark-to-market all their bonds, many of them might have zero or negative equity. Except right now, those same banks are worth billions in the stock market! But this is merely because the losses haven't been recognized. When you buy a bank stock, you are purchasing a bunch of fixed liabilities secured by a bond portfolio that can only cover the liabilities if the bonds are allowed to mature over many years into the future. As a depositor, you have to think about whether the bank has enough assets to cover your withdraw!

Ironically, the investment banks are what blew up in 2008 and adversely affected the traditional deposit banking side. This time, it might be the traditional deposit banking side that seizes markets. It will be a busy year for the FDIC, and SVB was just the start.

Well said. It seems everything has beeb pulled forward very quickly here. I'm assuming whatever chance you had assigned an FFR of 6-7% has come down? You can be sure the FED is paying attention to this, as it is very in their wheelhouse. .5% is completely off the table IMO. Maybe a .25% raise but they say theyre ready to pause QT? But if another bank or 2 goes down here soon, oh boy.

Umm... What? Employment remains strong and inflation is high, those are the feds mandates, not bank failures. The rates are going up, and 0.5% wouldn't be a surprise.

[gary3411]

I've avoided the financial sector for the past year because:

1) If a recession is coming, they will experience losses due to loan defaults, and
2) If higher rates are on the way, their collateral assets (generally treasuries with some duration) will go down in market price, potentially causing them to fail stress tests or be vulnerable to bank runs.

So far, nobody seems to have understood these things because banks don't have to mark-to-market their bond holdings. They can simply assign them a "held to maturity" tag and claim they are worth their par value, when in fact they've lost value.

SVB and SI experienced bank runs, had to liquidate some of their "held to maturity" bonds to pay creditors, and therefore had to finally recognize their bond losses. The realization is sinking in among investors that even their friendly neighborhood bank that would never make a loan against digital assets is in this same situation, because every bank's bonds have lost value.

Nobody has to recognize that the bonds on the books aren't worth what the books say they're worth, until deposits fall (e.g. people stop depositing as many paychecks in a recession) or defaults rise (e.g. people stop paying their loans during a recession) and the bank must be recapitalized by selling those bonds. Then the paper losses become real losses that appear on the books, and the banks must recapitalize due to both the original problem PLUS the now-realized losses on bonds! So the bank sells more bonds, realizing more loses, requiring more recaitalization.... you get the point.

If banks had to mark-to-market all their bonds, many of them might have zero or negative equity. Except right now, those same banks are worth billions in the stock market! But this is merely because the losses haven't been recognized. When you buy a bank stock, you are purchasing a bunch of fixed liabilities secured by a bond portfolio that can only cover the liabilities if the bonds are allowed to mature over many years into the future. As a depositor, you have to think about whether the bank has enough assets to cover your withdraw!

Ironically, the investment banks are what blew up in 2008 and adversely affected the traditional deposit banking side. This time, it might be the traditional deposit banking side that seizes markets. It will be a busy year for the FDIC, and SVB was just the start.

Well said. It seems everything has beeb pulled forward very quickly here. I'm assuming whatever chance you had assigned an FFR of 6-7% has come down? You can be sure the FED is paying attention to this, as it is very in their wheelhouse. .5% is completely off the table IMO. Maybe a .25% raise but they say theyre ready to pause QT? But if another bank or 2 goes down here soon, oh boy.

Umm... What? Employment remains strong and inflation is high, those are the feds mandates, not bank failures. The rates are going up, and 0.5% wouldn't be a surprise.

Bank failures (and financial system robustness) are definitely part of the fed's mandate.

Also, those are backward looking assumptions. Do you know how many businesses may have next week's payrolls sitting in an uninsured SVB account? Nobody really does, but it could be a lot. It's certainly not zero. That could be instant furloughs from hundreds of companies in the same week.

The US economy is forever changed after today.

[gary3411]

I've avoided the financial sector for the past year because:

1) If a recession is coming, they will experience losses due to loan defaults, and
2) If higher rates are on the way, their collateral assets (generally treasuries with some duration) will go down in market price, potentially causing them to fail stress tests or be vulnerable to bank runs.

So far, nobody seems to have understood these things because banks don't have to mark-to-market their bond holdings. They can simply assign them a "held to maturity" tag and claim they are worth their par value, when in fact they've lost value.

SVB and SI experienced bank runs, had to liquidate some of their "held to maturity" bonds to pay creditors, and therefore had to finally recognize their bond losses. The realization is sinking in among investors that even their friendly neighborhood bank that would never make a loan against digital assets is in this same situation, because every bank's bonds have lost value.

Nobody has to recognize that the bonds on the books aren't worth what the books say they're worth, until deposits fall (e.g. people stop depositing as many paychecks in a recession) or defaults rise (e.g. people stop paying their loans during a recession) and the bank must be recapitalized by selling those bonds. Then the paper losses become real losses that appear on the books, and the banks must recapitalize due to both the original problem PLUS the now-realized losses on bonds! So the bank sells more bonds, realizing more loses, requiring more recaitalization.... you get the point.

If banks had to mark-to-market all their bonds, many of them might have zero or negative equity. Except right now, those same banks are worth billions in the stock market! But this is merely because the losses haven't been recognized. When you buy a bank stock, you are purchasing a bunch of fixed liabilities secured by a bond portfolio that can only cover the liabilities if the bonds are allowed to mature over many years into the future. As a depositor, you have to think about whether the bank has enough assets to cover your withdraw!

Ironically, the investment banks are what blew up in 2008 and adversely affected the traditional deposit banking side. This time, it might be the traditional deposit banking side that seizes markets. It will be a busy year for the FDIC, and SVB was just the start.

Well said. It seems everything has beeb pulled forward very quickly here. I'm assuming whatever chance you had assigned an FFR of 6-7% has come down? You can be sure the FED is paying attention to this, as it is very in their wheelhouse. .5% is completely off the table IMO. Maybe a .25% raise but they say theyre ready to pause QT? But if another bank or 2 goes down here soon, oh boy.

Umm... What? Employment remains strong and inflation is high, those are the feds mandates, not bank failures. The rates are going up, and 0.5% wouldn't be a surprise.

Care to make a friendly wager on that 0.5% hike? I'd bet the house against that.

[blue_green_sparks]

The CEO of Silvergate Bank talking about crypto 2018. I think his justifications lack substance and the last sentences I quoted just tells me he probably had a clue about the shady side.

https://www.cnbc.com/2018/05/31/meet-silvergates-alan-lane-whos-bankrolling-cryptocurrency-exchanges.html

Undeterred, Lane is one of the most aggressive executives in cryptocurrencies. Alongside the recent surge of interest in bitcoin and its rivals, Silvergate doubled its assets to $1.9 billion last year. The bank now has more than 250 international clients in the industry, drawing new customers by acting more like a 24/7 clearinghouse for cryptocurrency exchanges.

On the surface, the 56- year-old seems much more like a college professor, or a priest, than a wheeling-and-dealing bank executive. During a recent interview, Lane took off his glasses before answering a question he has clearly been asked before: Why would you bet this small bank’s reputation on one of the biggest headline risks of the past five years?

The grandfather of 21, and devout Catholic, said he became interested in cryptocurrency in 2013. At the time, he had been reading about bitcoin and how it might disrupt banking, an industry he had grown to love and started working in when he was a student at San Diego State University. Because of what’s known as “distributed ledger” technology, people could theoretically become their own banks, without the need for third parties, he found out.

“I thought “uh oh, what am I gonna do?” Lane said with a laugh.

The first thing he did was buy some. In his research, he also learned that companies trading bitcoin were being turned down left and right by other banks.

“I put two and two together and I thought, well it might disrupt banking long-term but in the short-term these companies need banks,” he said. “They’re not doing anything wrong. They’re not doing anything illegal or immoral. If they were we wouldn’t be banking them.”

What is the relevance of this to this thread?

Crypto related lack of due diligence, regulation and all that fraudulent FTX nonsense is now impacting mainstream financial markets and possibly interest rate hikes. I bet the fed is thinking twice about a big hike, given this episode.

[gary3411]

The CEO of Silvergate Bank talking about crypto 2018. I think his justifications lack substance and the last sentences I quoted just tells me he probably had a clue about the shady side.

https://www.cnbc.com/2018/05/31/meet-silvergates-alan-lane-whos-bankrolling-cryptocurrency-exchanges.html

Undeterred, Lane is one of the most aggressive executives in cryptocurrencies. Alongside the recent surge of interest in bitcoin and its rivals, Silvergate doubled its assets to $1.9 billion last year. The bank now has more than 250 international clients in the industry, drawing new customers by acting more like a 24/7 clearinghouse for cryptocurrency exchanges.

On the surface, the 56- year-old seems much more like a college professor, or a priest, than a wheeling-and-dealing bank executive. During a recent interview, Lane took off his glasses before answering a question he has clearly been asked before: Why would you bet this small bank’s reputation on one of the biggest headline risks of the past five years?

The grandfather of 21, and devout Catholic, said he became interested in cryptocurrency in 2013. At the time, he had been reading about bitcoin and how it might disrupt banking, an industry he had grown to love and started working in when he was a student at San Diego State University. Because of what’s known as “distributed ledger” technology, people could theoretically become their own banks, without the need for third parties, he found out.

“I thought “uh oh, what am I gonna do?” Lane said with a laugh.

The first thing he did was buy some. In his research, he also learned that companies trading bitcoin were being turned down left and right by other banks.

“I put two and two together and I thought, well it might disrupt banking long-term but in the short-term these companies need banks,” he said. “They’re not doing anything wrong. They’re not doing anything illegal or immoral. If they were we wouldn’t be banking them.”

What is the relevance of this to this thread?

Crypto related lack of due diligence, regulation and all that fraudulent FTX nonsense is now impacting mainstream financial markets and possibly interest rate hikes. I bet the fed is thinking twice about a big hike, given this episode.

You do know SVB is not Silvergate, right?

[blue_green_sparks]

The CEO of Silvergate Bank talking about crypto 2018. I think his justifications lack substance and the last sentences I quoted just tells me he probably had a clue about the shady side.

https://www.cnbc.com/2018/05/31/meet-silvergates-alan-lane-whos-bankrolling-cryptocurrency-exchanges.html

Undeterred, Lane is one of the most aggressive executives in cryptocurrencies. Alongside the recent surge of interest in bitcoin and its rivals, Silvergate doubled its assets to $1.9 billion last year. The bank now has more than 250 international clients in the industry, drawing new customers by acting more like a 24/7 clearinghouse for cryptocurrency exchanges.

On the surface, the 56- year-old seems much more like a college professor, or a priest, than a wheeling-and-dealing bank executive. During a recent interview, Lane took off his glasses before answering a question he has clearly been asked before: Why would you bet this small bank’s reputation on one of the biggest headline risks of the past five years?

The grandfather of 21, and devout Catholic, said he became interested in cryptocurrency in 2013. At the time, he had been reading about bitcoin and how it might disrupt banking, an industry he had grown to love and started working in when he was a student at San Diego State University. Because of what’s known as “distributed ledger” technology, people could theoretically become their own banks, without the need for third parties, he found out.

“I thought “uh oh, what am I gonna do?” Lane said with a laugh.

The first thing he did was buy some. In his research, he also learned that companies trading bitcoin were being turned down left and right by other banks.

“I put two and two together and I thought, well it might disrupt banking long-term but in the short-term these companies need banks,” he said. “They’re not doing anything wrong. They’re not doing anything illegal or immoral. If they were we wouldn’t be banking them.”

What is the relevance of this to this thread?

Crypto related lack of due diligence, regulation and all that fraudulent FTX nonsense is now impacting mainstream financial markets and possibly interest rate hikes. I bet the fed is thinking twice about a big hike, given this episode.

You do know SVB is not Silvergate, right?

They share a customer base as both banks are at the heart of Silcon Valley's financial system. Bank runs are fear based.

[ChpBstrd]

Earlier this week, options markets assigned 75% odds to a 50 basis point rate hike.

Now there's a 60% probability of a 25 basis point hike.

I think - and previously thought - a 25 basis point hike would be the most likely outcome. So far, the bank runs have been limited to those banks which either dealt with risky assets or had clients 90+% uninsured, and therefore prone to run. It remains to be seen whether bank runs become contagious.

[EscapeVelocity2020]

Earlier this week, options markets assigned 75% odds to a 50 basis point rate hike.

Now there's a 60% probability of a 25 basis point hike.

I think - and previously thought - a 25 basis point hike would be the most likely outcome. So far, the bank runs have been limited to those banks which either dealt with risky assets or had clients 90+% uninsured, and therefore prone to run. It remains to be seen whether bank runs become contagious.

And today we are back to a 68% chance of 50 bps!  The FedWatch tool has lots of nice features to watch the drama unfold...  We are getting in to a territory where there may not be a 'right' answer for what the Fed should do.  Maybe two 25 bps hikes, one on the 22nd and another interim hike if needed?  Job creation is still far too strong for them to let inflation run.

[gary3411]

Earlier this week, options markets assigned 75% odds to a 50 basis point rate hike.

Now there's a 60% probability of a 25 basis point hike.

I think - and previously thought - a 25 basis point hike would be the most likely outcome. So far, the bank runs have been limited to those banks which either dealt with risky assets or had clients 90+% uninsured, and therefore prone to run. It remains to be seen whether bank runs become contagious.

And today we are back to a 68% chance of 50 bps!  The FedWatch tool has lots of nice features to watch the drama unfold...  We are getting in to a territory where there may not be a 'right' answer for what the Fed should do.  Maybe two 25 bps hikes, one on the 22nd and another interim hike if needed?  Job creation is still far too strong for them to let inflation run.

Wow, either folks behind the scenes know the FDIC is moving quick as we speak to find a buyer and make deposit holders whole, or I am totally wrong about the contagion risk here.

[MrGreen]

It sure seems like SVB was significantly more exposed than other large banks. Plus now all the reporting is bringing to light that if people would have remained calm this would have been a non-issue. I don't think big institutional investors at other banks want to risk triggering a run other places. They're basically playing chicken on who would get screwed and who would get their money out before a takeover. No small investors are likely over the insured limit so regular people are not at risk.

Compare that to the continued inflation risk of moderating hikes over bank fears and maybe inflation is still the bigger concern.

[EscapeVelocity2020]

A good summary of the situation at both Silvergate and SVB - Two US Banks Just Failed - What Happened, and What Now?

[MustacheAndaHalf]

Wow, either folks behind the scenes know the FDIC is moving quick as we speak to find a buyer and make deposit holders whole, or I am totally wrong about the contagion risk here.

I would not have guessed "Monday", but that is the FDIC's goal.

March 11 (Reuters) - The Federal Deposit Insurance Corporation (FDIC), which is overseeing the emergency breakup of SVB Financial Group (SIVB.O), is racing to sell assets and make a portion of clients' uninsured deposits available as soon as Monday, Bloomberg News reported on Saturday, citing people with knowledge of the situation.

https://www.reuters.com/business/finance/fdic-racing-start-returning-some-uninsured-svb-deposits-soon-monday-bloomberg-2023-03-12/

[Paper Chaser]

Wow, either folks behind the scenes know the FDIC is moving quick as we speak to find a buyer and make deposit holders whole, or I am totally wrong about the contagion risk here.

I would not have guessed "Monday", but that is the FDIC's goal.

March 11 (Reuters) - The Federal Deposit Insurance Corporation (FDIC), which is overseeing the emergency breakup of SVB Financial Group (SIVB.O), is racing to sell assets and make a portion of clients' uninsured deposits available as soon as Monday, Bloomberg News reported on Saturday, citing people with knowledge of the situation.

https://www.reuters.com/business/finance/fdic-racing-start-returning-some-uninsured-svb-deposits-soon-monday-bloomberg-2023-03-12/

Nearly identical timeline back when WaMu failed and was purchased by JPMorgan

[BicycleB]

Wow, either folks behind the scenes know the FDIC is moving quick as we speak to find a buyer and make deposit holders whole, or I am totally wrong about the contagion risk here.

I would not have guessed "Monday", but that is the FDIC's goal.

March 11 (Reuters) - The Federal Deposit Insurance Corporation (FDIC), which is overseeing the emergency breakup of SVB Financial Group (SIVB.O), is racing to sell assets and make a portion of clients' uninsured deposits available as soon as Monday, Bloomberg News reported on Saturday, citing people with knowledge of the situation.

https://www.reuters.com/business/finance/fdic-racing-start-returning-some-uninsured-svb-deposits-soon-monday-bloomberg-2023-03-12/

Nearly identical timeline back when WaMu failed and was purchased by JPMorgan

Looks like they didn't find a buyer. FDIC announcement says it will make all depositors whole but assess a fee on banks to pay for it, while SVB shareholders and some SVB bondholders will be unprotected:

https://www.federalreserve.gov/newsevents/pressreleases/monetary20230312b.htm

[ChpBstrd]

I noticed some SVB bonds posted for sale around $470 (yield to maturity >50%). Maybe someone is willing to gamble on there being some leftover assets.

This is a stark reminder about bank bonds.

[MrGreen]

February CPI came in at 6.0%. Looking at the month over month data, if the next few months continue to look like the last few, we should continue to see moderate decreases in overall CPI as the really hot months from the first half of 2022 fall off the calculation. MOM CPI was running over 1% through June 2022. On this trend alone, I think by the time we get to the July CPI release in August inflation would be in the 4s. Not awful, and would certainly support the notion of the Fed slowing down the rate hikes.

The food at home category continues to alarm me at 10.2%.