Pages

Friday, March 31, 2023

2023-03-31

*** denotes well-worth reading in full at source (even if excerpted extensively here)


Economic and Market Fare:

The key macro/market charts for navigating risk vs opportunity this year...

1. Global Recession 2023:  All leading indicators continue to point to recession, and there has been nothing to negate or confound that signal. If anything, the banking crises only raise the prospect and proximity of a steep global economic recession.

“One of the most interesting pieces of work I undertook in 2022 was to perform a sort of meta-analysis on all the leading indicators I’ve developed over the years.  The key takeaway from that is whether you group leading indicators by type/factor, geography, or forecast window — they are all unanimous in pointing to a sharp downturn heading into early-2023. In many ways it’s a coming full circle of the massive stimulus that was unleashed in 2020. Or as I call it: “a strange but familiar cycle”.” ......'



The US economy may be on the brink of a recession if an early sign of distress in the credit markets is anything to go by. 






The chart below shows the implied path of the Fed funds rate based on a broad composite of inflation expectations and labor market indicators (over 20 individual data series — which serve to amplify the true signal vs noise).

We can clearly see how it was justified for the Fed to cut rates into the pandemic (perhaps even more than it did)… but that they should have removed the emergency measures shortly after reopening.  Instead, they made an active decision to take the risk of overcooking growth/inflation/speculation vs the risk of tightening too early and potentially scuppering the nascent recovery. 

A direct consequence of all this and everything else that’s gone on over the past year is the various leading indicators for the US economy have plunged to record lows (very high risk of recession now), so the Fed will probably need to pivot later this year as it continues to fight yesterday’s battle. But that will not be good news — contrary to popular narratives — because by the time it becomes obvious (and because of 1970’s inflation fears affecting decision making biases: it will need to be obvious) recession will already be underway.




In markets, it pays to remember that things take longer to happen than you think they will, and then they happen much faster than you thought they ever could.  It was only two weeks ago that the market was expecting up to another four rate hikes. Now it’s effectively pricing the end of the rate-hike cycle, and the first cut by the end of the third quarter.

But there are several reasons why there could be another abrupt alteration in the state-of-play, with the first cut coming as early as June, and potentially significant cuts priced in before the end of the year:
  • Signs of deterioration in the job market that gain momentum very quickly;
  • A recession that now looks unavoidable and could begin as early as June;
  • Inflation that is long past its cycle peak; and
  • A rapid fall in velocity leading to a stock-market selloff
One of the surprising aspects of this cycle has been the resilience in the labor market. But that looks about to change. Unemployment claims are one of the most leading measures of the job market. The headline number has remained low, but the real information content comes from looking under the surface. ...



An old saying cautions one to be careful of what one wishes for. Stock investors wishing for the Federal Reserve to pivot may want to rethink their logic and review the charts. ... Like Pavlov’s dogs, investors buy when they hear the pivot bell ringing. Their conditioning may prove harmful if the past proves prescient. .........




................ The CRE loan risk is yet to hit.  But it will hit the regional banks, already reeling, the hardest.  And it’s a vicious spiral.  CRE defaults hurt regional banks as falling office occupancy and rising interest rates depress property valuations, creating losses.  In turn, regional banks hurt the real estate developers as they impose stricter lending standards post-SVB.  This deprives commercial property borrowers of reasonably priced credit, crimping their profit margins and pushing up defaults.



When Silicon Valley Bank went down, many progressives, and much of the media, immediately pointed to malfeasance, special pleading and regulatory failures—a conditioned response with a strong pedigree. But if those were the real causes, then SVB (and Signature, and First Republic) would have been isolated cases. It’s clear now that they were not. A systemic crisis is unfolding—with a systemic cause. .......

................. So why did the Federal Reserve invert the yield curve? To fight inflation? To kill jobs and stall wages? If so, the stupidity—or the economistic groupthink—is shocking.  .............

....... The money will flow into the United States. Into the money market funds and the biggest banks. Enhanced swap lines—to keep dollars available to foreign central banks—were trotted out on Sunday. They signal that the dollar is still boss, and also that the entire global banking system, indeed most of the world economy—outside of China and Russia—is fragile. Hold on tight.


Plus: Silicon Valley Bank, Money-Go-Round, Liquidity Coverage Ratios

.... The first thing to understand about banks is that they operate a unique financial structure. Other companies borrow from one group of stakeholders and provide services to another. For banks, these stakeholders are one and the same: their creditors are their customers. Most customers don’t realise this and as long as their loan to the bank (traditionally called a deposit) falls within the scope of their national deposit insurance scheme, they don’t have to.

........ For an analyst, this structure complicates things. No use looking at the ‘enterprise value’ of the business – the traditional barometer for measuring a business’ worth – because the debt is the business. No use looking at cash flow statements which disentangle cash generated in operating activities from cash generated in investing and financing activities because the operating activities are the financing activities.1

Because it’s where the customers sit, if you want to understand a bank, you have to look at its balance sheet. As a bank analyst, I would often peer over in envy as colleagues covering other sectors would go on factory tours or visit flagship retail outlets. I’d stay at home and study bank balance sheets. 

To some extent the balance sheet is the business. The rest is there simply to feed it – the store a device to attract new funding. Bank executives may not want to admit it because it seems overly reductive, but those that forget do so at their peril. ........

.... Banks have a licence to create money which confers on them a special status somewhere between private enterprise and public entity. Economists argue that commercial banks create money by making new loans. When a bank makes a loan, it credits the borrower’s bank account with a deposit the size of the loan. At that moment, new money is created. 

Bank analysts don’t quite see the world like this. In their view, banks need deposits in order to make loans. ‘Deposits before loans’ is a more useful model for an individual bank. ........

...... Wherever you sit in a bank’s capital stack, make no mistake: a higher authority sits above you.

...... Most companies thrive on growth. “If you’re not growing, you’re dying,” they say. For investors, growth is a key input in the valuation process. 

But if your job is to create money, growth is not all that hard. And if the cost of generating growth is deferred, because the blowback from mispricing credit isn’t apparent until further down the line, it makes growth even easier to manufacture. .........

....... The absolute foundation of banking is confidence. Depositors entrust their money to banks in the confidence that they will get it back according to the terms of their deposit. 

As Matt Levine of Bloomberg’s Money Stuff writes (emphasis mine):

“The bank doesn’t just put your dollars in a box and wait for you to take them out; the bank uses its depositors’ money to make loans or buy bonds, and just keeps a little bit around for people who need cash. If everyone asked for their money back tomorrow, the bank wouldn’t have it. But everyone is confident that, if they ask for their money back tomorrow, the bank will have it. So they mostly don’t ask for it, so when they do, the bank does have it. The widespread belief that banks have the money is what makes it true.” ........

..... The dirty secret among bank analysts is that it’s quite hard for an outsider to discern what’s going on inside a bank. Former bank analyst Terry Smith knows it. “I think it is precisely because I understand banks that I never invest in their shares,” he wrote in the Financial Times last week. It’s only after the fact it becomes apparent what questions to ask. ......



.......................... The CEPR authors note that there is a recent literature that links monetary policy decisions taken by central banks to financial system stability and that low interest rate eras increase “financial fragility” over time.

There is also a long dated literature in Post Keynesian economics that ‘discovered’ the same thing (years ago).

Minsky any one?

But the astounding part of the CEPR article is their next claim:

Why, though, do money and credit expand in the first place? By analyzing this question, we contribute to the strand of the literature that focuses on potential causes of credit booms. To the best of our knowledge, this strand is relatively thin.

The reality is that the literature is, in fact, very rich on this topic.
Knut Wicksell
Axel Leijonhufvud
Basil Moore
Marc Lavoie
Augusto Graziani
Wynn Godley
and others, have all provided the original contributions in this field over many decades.

It is just that mainstream economists have ignored their work for all these years because by acknowledging it one has to jettison all the main precepts in mainstream monetary theory, which then leads to the conclusion that the dominant paradigm has nothing interesting or valid to say about policy design.

But now, in 2023, these German economists based at the University of Würzburg are claiming a contribution.

The problem is the horse already bolted – years ago.

Their contribution is really no contribution but merely a useful summary of the state of knowledge in Post Keynesian economic thinking. .........



Bubble Fare:

Beware: Artificial Intelligence Bubble

................. “Our 21 Lehman systemic risk indicators are pointing at the highest probability of a crash or a sharp drawdown in the next 60 days—the highest probability since COVID,”.
McDonald believes investors are ignoring the risk of a “rolling credit crisis and focusing too much on the rise of new technologies like artificial intelligence"



Quotes of the Week:

Wilson: When Markets Question the "Higher Powers," They Can Re-price Quickly: With bond markets questioning the Fed's dot plot, bond volatility has increased markedly. We think stocks are next as investors realize earnings guidance looks unrealistic. This is when the ERP typically reprices, and stocks may finally get ahead of the downside we see in earnings estimates.

Rubinstein: The first thing to understand about banks is that they operate a unique financial structure. Other companies borrow from one group of stakeholders and provide services to another. For banks, these stakeholders are one and the same: their creditors are their customers. Most customers don’t realise this and as long as their loan to the bank (traditionally called a deposit) falls within the scope of their national deposit insurance scheme, they don’t have to.


Tweet Thread of the Week:

***** Concodanomics: The Great Financial Tightening has thrown the global monetary system into disarray, prompting large interventions by financial leaders. Markets perceived their response as a pivot, but it was just a stopgap. The real hard landing now awaits us... 1/

Ever since the great financial crisis in 2008, the system has been sculpted not by sound pre-planning of monetary policy, but by a series of experiments created during a myriad of crises. The response to the latest banking panic was just a taster of the Fed's financial alchemy...

...................

Markets quickly perceived this as the Fed initiating another round of quantitative easing (QE), the Fed's mechanism for injecting the most liquidity. In reality, however, it's far from it. With QE, the Fed buys bonds and issues reserves to pay for them. This was different...

Quantitative Tightening (QT) is still underway. The Fed hasn't bought bonds outright and is (at least) trying to lower the size of the balance sheet. The sudden pop in assets reflects attempts to paper over cracks while the Fed KEEPS tightening. This is Quantitative Teasing™...

...........

Just because the Fed's actions weren't QE, however, that didn't prevent a bullish message from being sent to risk assets. After all, it's not whether you understand QE's mechanics, it's what the crowd believes to be true. And the crowd deemed another driver more influential...

.........

The recent banking panic and the Fed's response to it reveal a pivot is now fully off the table. Monetary authorities will do everything in their power to maintain order during further tightening, without reversing course. And the most likely outcome is a hard landing.



Charts:
1:
2: 
3: 

9: .




(not just) for the ESG crowd:






Toxic Spills Have Impacted Two Waterways Near Pennsylvania & Minnesota, Leaving Residents To Ask: Is Our Drinking Water Safe?



Sci Fare:

Long COVID functional manifestations differ from post-vaccine effects

Patients with functional neurologic disorder (FND) after SARS-CoV-2 infection had different symptoms than people with FND after COVID vaccines, retrospective data showed. ....

"We show for the first time evidence from a multicenter national study that FNDs after COVID-19 infections and vaccines are more common than previously reported and have distinct clinical profiles," Alonso-Canovas told MedPage Today.



AI:



Connor Leahy reverse-engineered GPT-2 in his bedroom — and what he found scared him. Now, his startup Conjecture is trying to make AI safe



There’s now an open letter arguing that the world should impose a six-month moratorium on the further scaling of AI models such as GPT, by government fiat if necessary, to give AI safety and interpretability research a bit more time to catch up. The letter is signed by many of my friends and colleagues, many who probably agree with each other about little else, over a thousand people including Elon Musk, Steve Wozniak, Andrew Yang, Jaan Tallinn, Stuart Russell, Max Tegmark, Yuval Noah Harari, Ernie Davis, Gary Marcus, and Yoshua Bengio.

Meanwhile, Eliezer Yudkowsky published a piece in TIME arguing that the open letter doesn’t go nearly far enough, and that AI scaling needs to be shut down entirely until the AI alignment problem is solved—with the shutdown enforced by military strikes on GPU farms if needed ........



I’ve long described the following as the most obviously helpful policy response to the possibility of advanced AI. But even though I’ve long known many folks who say they are very worried about AI, I have yet to motivate any of them to actually pursue this response. Let me now try again.

While far from obvious, it is plausible that someday machines may displace most all humans from their jobs. It is also not crazy to think that this might happen relatively suddenly, and without much warning. Which seems a pretty big problem, given that most people don’t own much more besides their ability to earn wages. Without some sort of charity or insurance, they might starve. Thus each of us seems well-advised to try to set up some insurance re this risk, instead of just hoping to rely on charity.

One needs to set up insurance well before problems are realized or revealed. Yet it can be hard to motivate people to insure against risks that seem too unlikely or remote in time. Which might make the current moment an ideal time to consider this. Many are now worrying loudly about AI, saying that AI might soon take all the jobs, or worse. And yet I’m pretty sure that most investors see this risk as actually still pretty remote and unlikely. Maybe making now a great time to set this up. ......



Other Fare:


Mary-Jane Rubenstein is a scholar of religion, but her latest book is about Jeff Bezos, Elon Musk, and the “corporate space race.” For Rubenstein, the promises that these men offer of a human future in vast colonies on Mars or the moon have much in common with religious myths of a “promised land.” And like these other myths, the ideology underlying Silicon Valley’s space colonization missions can be used to defend unjust acts in the here and now to serve the glorious long-term destiny of the species. Rubenstein’s new book, Astrotopia: The Dangerous Religion of the Corporate Space Race, looks at the ways in which stories about great destinies have been used to rationalize conquest and exploitation. Rubenstein worries that just as “Manifest Destiny” was used as an excuse for genocide in the United States, plans to “expand into space” will be used to justify trashing Earth and ignoring the most pressing issues of inequality in our near-term future.



Tweets of the Week:






Posted by at No comments:

Sunday, March 26, 2023

2023-03-26

*** denotes well-worth reading in full at source (even if excerpted extensively here)


Economic and Market Fare:


If you have been watching the “inside of the stock market” over the past six months or so, you’ve been able to see the increasingly popular “soft landing” narrative regarding the direction of the economy play out in prices. Specifically, I’m referring to the the relative performance of things like transportation stocks, materials, retail and small caps. .....



Price gouging! That’s the culprit for high inflation. I like it as a thesis. I really do. It partly exonerates fiscal policy (although it’s a lot harder to gouge people who don’t have any money, so in that respect, you could argue that government transfer payments made people more “gougable”), and places the blame almost solely with “corporate greed” which, as a concept, nobody likes. In a Thursday note, SocGen’s Albert Edwards cited a hodgepodge of media coverage in suggesting that “wages are not the problem” when it comes to inflation, profit margins are. Certainly, negative real wage growth makes a decent case ......


Bailouts are back, but will the public bear them after a decade of inequality?


............ But why will we need more bailouts in the first place? Is it not done and dusted with Silicon Valley Bank, Signature and Credit Suisse all sorted out? Unfortunately, we likely just saw the first of several bailout waves. Why? A hard landing is firmly on the way for the US economy, and that will cause more pain for the financial sector ........



But the Fed may try again anyway

.......... Similar to the tardiness they displayed in responding to the inflation cycle upturn that began in autumn 2020, will they similarly ‘screw up’ the business cycle downturn and march forward despite a severe synchronized global recession currently unfolding?



Collapsing velocity will lead to financial conditions continuing to tighten even as the Fed rapidly expands its balance sheet.

When banks are in trouble, it has a geared impact on the rest of the economy. In 2008, money velocity (essentially, how many times each dollar changes hands in a given period) collapsed as banks stopped lending; central banks responded by cutting rates to zero and massively expanding their balance sheets.

To no avail, however, and velocity kept falling until 2020 when it started to rise again – it’s no coincidence we now have an inflation problem. The remedy has created a new nightmare for policymakers as banks around the world are reeling from the fastest rate-hiking cycles seen for several decades.

Central banks are now back in the game of trying to arrest the fall in velocity – deteriorating their balance sheets - to avert the deep recession that would result. The signs are so far it is not working. ....


The Minsky Moment and Theory of Reflexivity: What Minsky and Soros Taught Us About Instability

I’ve long believed that markets and economies trend towards disequilibrium (aka a loss of stability). And this is contrary to what we learned in economics – that a system tends towards equilibrium. And while equilibrium may sound good in theory; it doesn’t hold up in reality. Why? ....

Now, while many may cling to the idea of equilibrium and ‘rational’ markets, there were a few who disagreed with this train of thought and have made compelling findings to the contrary. But none more so than these two:
Hyman Minsky and his Financial Instability Hypothesis (aka the ‘Minsky Moment’).
And George Soros with his Theory of Reflexivity (aka reflexive financial systems).
Let me explain why they’re so important. . .



The market’s in a highly unstable state right now. These violent swings show the inadequacy of the standard models that the Fed and other mainstream analysts use. The Fed assumes so many things about markets that are simply false, like that markets are always efficient, for example. They’re not. Under volatile conditions like these they gap up and down — they don’t move in rational, predictable increments like the “efficient-market hypothesis” supposes. The problem is that the Fed’s models are empirically false.











Banking Fare:


Janet Yellen is once again on thin ice inside the Biden Administration over her bungling of the banking crisis that keeps roiling markets, The Post has learned. The question is when will Sleepy Joe & Co. finally act? They need to put Yellen out of her misery and end ours by handing her job to someone who knows how to deal with the very real possibility of banks failing on a scale not seen since the 2008 financial crisis and a possible deep recession. ......



Financial crashes like revolutions are impossible until they are inevitable. They typically proceed in stages. Since central banks began to increase interest rates in response to rising inflation, financial markets have been under pressure. ....

........ There is a concerted effort by financial officials and their acolytes to reassure the population and mainly themselves of the safety of the financial system. Protestations of a sound banking system and the absence of contagion is an oxymoron. If the authorities are correct then why evoke the ‘systemic risk exemption’ to guarantee all depositors of failed banks? If there is liquidity to meet withdrawals then why the logorrhoea about the sufficiency of funds? If everything is fine, then why have US banks borrowed $153 billion at a punitive 4.75% against collateral at the discount window, a larger amount than in 2008/9? Why the compelling need for authorities to provide over $1 trillion in money or force bank mergers? ........






How a 166-Year Old Financial Giant Fell Apart, and What the Fallout Could Mean for the Global Financial System



Quotes of the Week:

Yellen: As I said last week, the U.S. banking system is sound. The federal government’s recent actions have demonstrated our resolute commitment to take the necessary steps to ensure that depositors’ savings remain safe.
then Yellen again: As I have said, we have used important tools to act quickly to prevent contagion. And they are tools we could use again. The strong actions we have taken ensure that Americans’ deposits are safe. Certainly, we would be prepared to take additional actions if warranted.



Charts:
1: 
2: 



...
....


(not just) for the ESG crowd:

Federal scientists are using recon flights and field research to track down metals that are key to the energy transition.






Other Fare:



We’re finally starting to see the truth about the vexing condition. It’s not what we thought.




Fun Tweet of the Week:



Posted by at No comments:

Friday, March 24, 2023

2023-03-24

*** denotes well-worth reading in full at source (even if excerpted extensively here)


Economic and Market Fare:


....... We find the following to be the base-case now:
  • The Fed will hike by 25bps to try and regain control of the narrative
  • The Fed will soon thereafter admit to it being a mistake and communicate an end-date for QT
  • Emergency cuts are in play already before the May meeting, if the crisis accelerates
  • 200 bps worth of cuts to arrive before 2024



When it comes to the Morgan Stanley house view, it's not just Michael Wilson that is borderline apocalyptic, most recently warning on Monday of a "vicious" end to the bear market, one which drags stocks to fresh cycle lows: it appears that the bank's global head of research, Katy Hubary, is not too far behind.
In her latest weekly closely read "Charts that Caught my Eye" report (available to pro subs here), she writes that there has been a lot of market debate over the past year about whether yield curve inversion, which historically has been a precursor of US recessions, meant that a recession was inevitable this time, in light of key idiosyncrasies in the current environment.
She then points to an "interesting section" of the bank's Cross-Asset Strategy team’s latest dispatch which examines the confluence of five macro developments that, like inversion, are consistent with a strong economy that is starting to slow and leads to a sharp drop in risk assets:
  1. S&P 500 forward earnings are declining relative to three months ago;
  2. The yield curve is inverted (or has been over the last 12 months);
  3. Unemployment is below average;
  4. US Manufacturing PMIs are below 50; and
  5. More than 40% of US banks, on net, are tightening lending standards.
Pointing to the chart below, which shows that these five events tend to cluster just before major market crises (2007, 2001) that "all five are in place today, which is rare" .....


The Fed’s actions to stave off the banking crisis should not be taken as a loosening in financial conditions – far less QE – and in fact tighter conditions should be expected.
The banking crisis led to an almost $300 billion rise in the Fed’s balance sheet last week, reversing almost half of the decline since QT began last June. But even more relevant is the change in reserves. Reserves are generally higher velocity, and therefore the true economic and financial impact from QT comes from the changes in reserves. Reserves are now actually higher than they were before QT began. ....


via the BondBeat: Donovan: What is profit-led inflation?
  • Developed economies have had three waves of inflation since the pandemic: transitory inflation for durable goods; commodity inflation; and finally profit margin-led inflation.
  • Profit margin-led inflation is not caused by a supply-demand imbalance. Profit margin-led inflation is when some companies spin a story that convinces customers that price increases are "fair," when in fact they disguise profit margin expansion.
  • Technically, companies are able to use stories to reduce their customer's price elasticity of demand.
  • Raising rates to reduce demand will eventually squeeze profit margin-led inflation, but it is a crude and unnecessarily destructive policy approach. Convincing consumers not to passively accept the price increases is a potentially faster and less destructive way of reversing profit margin-led inflation. Social media might have a role to play in this process.
… The leap up in US retailers’ profits as a share of GDP is exactly what is expected in a profit-margin inflation episode. For over a decade, pricing power was moderate, and the amount of profit retailers took was fairly steady. But in the second quarter of 2021, as the economy reopened, US retailers were able to persuade consumers to accept far higher prices. At the same time, retailers were able to keep down wage costs, and so profit margins exploded.


Prometheus: Cyclical Outlook
Tightening Liquidity + Recession Signal = Short Equities?

.................... While many today have been focused on the here-and-now of the financial system, our systematic approach has kept us abreast of economic developments, where we see further evidence of recessionary conditions emerging. Below, we show our monthly estimates of real GDP along with official GDP data. Additionally, we offer a projection for real GDP based on historical analogs. Finally, we offer in the shaded areas our systematic regime recognition of recessionary conditions, which allows us to estimate impending recessions:

.............. The combination of these factors leads us to believe that the criteria for future recessionary conditions have been met. Now, while many may suggest that the labor market has not indicated recession, we think it is important to recognize that by the time labor markets have confirmed recession, the opportunity to profit from it in markets is long gone. Therefore, to profit from recessionary conditions, we need to be positioned before labor market weakness, not after. Below, we show one of our Prometheus Cycle Strategies, which applies the concepts discussed here to trade markets. The intuition of the strategy is straightforward; as recessionary conditions as described above build, we seek to short stock markets; otherwise, we remain long. We show the cumulative performance below: ...

As we can see, this approach has been an able guide in navigating recessions. This strategy has turned short this month. Keep in mind this strategy only trades real growth contractions— not inflation, liquidity, or other factors. Based upon our construction of this regime recognition, it is unlikely we will experience whipsaw in the recession signal, i.e., it is highly likely to persist. If so, forward-looking equity returns are likely to be weak at best, significantly negative at worst. Until next time.





Federal Reserve Chair Jerome Powell and his entire team should be cognizant of the fact that rents have been declining for many months. Despite this, Powell has been examining laggard data that persistently appears inflated. 

The latest CoreLogic report adds to the mounting evidence of leading rental market indicators showing rent inflation has been cooling for the ninth consecutive month in January, as the yearly growth rate slid to the lowest point since 2021. ...


In an uncertain economy, companies post ads for jobs they might not really be trying to fill


***** Keen: The Fractured Fairy Tales That Led To Today’s Banking Crisis


Mitchell: Former Bank of Japan governor challenges the current monetary policy consensus

In the latest IMF Finance and Development journal (March 2023), there is an interesting article by the former governor of the Bank of Japan, Masaaki Shirakawa – It’s time to rethink the foundation and framework of monetary policy. It goes to the heart of the complete confusion that is now being demonstrated by central bank policy makers. With their ‘one trick pony’ interest rate attacks on inflation, not only have they been inconsequential in dealing with that target (the so-called price stability responsibility), but, in failing there, they have undermined the achievement of the other central bank target (financial stability) and probably worsened the chances of sustaining the third target (full employment). Sounds like a mess – and it is. We are witnessing what happens when Groupthink finally takes over an academic discipline and the policy making space. Blind, unidirectional policies, based on a failed framework, steadily undermining all the major goals – that is where we are right now. And not unsurprisingly, those who have previously preached the doctrine are now crossing the line and joining with those who predicted this mess. ........



Bubble Fare:

***** Hussman: Edge of the Edge

The simplest thing that can be said about current financial market and banking conditions is this: the unwinding of this Fed-induced, yield-seeking speculative bubble is proceeding as one would expect, and it’s not over by a longshot.

I expect that FDIC-insured, and even most uninsured bank deposits will be fine. I also expect that hedged investments will be fine. In contrast, a great deal of market capitalization that passive investors count as “wealth” will likely evaporate, possibly including steep losses to bank shareholders and unsecured bondholders. Investors and policy-makers have confused speculation and extreme valuations with “wealth creation,” but it never was. A parade of seemingly independent “crises” will emerge as this bubble unwinds, including bank failures, pension strains, and market collapses, but they all have the same origin.

The chart below shows our estimate of likely 12-year total returns for a conventional passive investment mix invested 60% in the S&P 500, 30% in Treasury bonds, and 10% in Treasury bills, along with actual subsequent total returns. At present, this estimate stands at just 1.03%, matching the level of August 1929. By contrast, the average return for this conventional portfolio mix across history is just over 7% annually, which is where current pension return assumptions stand. That’s another way of saying that investors are setting their return assumptions based on average historical returns, ignoring the valuations that actually drive those returns. As explained in more detail at the end of this comment, I continue to expect a loss on the order of -58% in the S&P 500, from current levels, over the completion of this cycle. Nothing in our investment discipline relies on that outcome, but having correctly anticipated the extent of the 2000-2002 and 2007-2009 collapses, it’s best not to rule it out.

Notice that by late-2021, a decade of speculation by yield-starved investors had driven prospective investment returns to negative levels. That’s something that didn’t even occur at the 1929 and 2000 extremes. The sudden crises and financial strains emerging today are just the consequences of the extreme valuations and inadequate risk-premiums engineered by reckless zero-interest rate policies. .........



.......... In addition, during today's press release, Powell asserted that Silicon Valley bank collapse was an "outlier". So he is ignoring all of the dominoes falling, exactly as the Fed did in September 2008 when Lehman failed 
As we know, Treasury Secretary Janet Yellen was there in that exact same  FOMC meeting back in September 2008. Today, in her testimony to Congress, after weeks of vacillation  she said that there is no plan to implement blanket FDIC insurance: .......





Banking Fare:







Lessons should be drawn from how the crisis at the bank developed



The incompetence of our financial regulators, most of all the Fed, is breathtaking. The great unwashed public and even wrongly-positioned members of the capitalist classes are suffering the consequences of Fed and other central banks being too fast out of the gate in unwinding years of asset-price goosing policies, namely QE and super low interest rates. The dislocations are proving to be worse than investors anticipated, apparently due to some banks having long-standing risk management and other weaknesses further stressed, and other banks that should have been able to navigate interest rate increases revealing themselves to be managed by monkeys.
What is happening now is the worst sort of policy meets supervisory failure, of not anticipating that the rapid rate increases would break some banks.1 Here we are, in less than two weeks, at close to the same level of bank failures as in the 2007-2008 financial crisis.
As we’ll explain in due course, the regulators’ habitual “bailout now, think about what if anything to do about taxpayer/systemic protection later” is the worst imaginable response to this mess. For instance, US authorities have put in place what is very close to a full backstop of uninsured deposits (with ironically a first failer, First Republic, with its deviant muni-bond-heavy balance sheet falling between the cracks). But they are not willing to say that. So many uninsured depositors remained in freakout mode, not understanding how the facilities work. Yet the close-to-complete backstop of uninsured deposits amounted to another massive extension of the bank safety net. ...............
.................
Of course, the Fed could have addressed the problem of interest rate increase overshoot directly by cutting interest rates by 50 basis points and making noises that quantitative tightening was on hold for the moment. But panic is too far advanced for that sort of simple intervention to now have much impact.
Finally, back to a main point, that yet more subsidies of banks will simply enable more incompetence and looting absent getting bloody-minded regulators, a prospect that seems vanishingly unlikely.
Elizabeth Warren is again taking up her bully pulpit of calling for more bank reform, but technocratic fixes are inadequate with a culture of timid enforcement. The only remedy in all the years I have read about that might have a real impact quickly creates real skin in the game. It proposed by of all people former Goldmanite, later head of the New York Fed William Dudley.
Dudley recommended putting most of executive and board bonuses in a deferred account, IIRC on a rolling five-year basis. If a bank failed, was merged as part of a regulatory intervention, or wound up getting government support, the deferred bonus pool would be liquidated first, even before shareholder equity. Skin in the game would do a lot more to curb reckless behavior than complex new rules. Of course, Dudley’s proposal landed like a lead balloon.


DiMartino Booth: Too Small to Not Fail
A Short History of the World
................................. As I often quote, the global nonbanking financial sector was $220 trillion as of the end of 2020; that compares to $180 trillion in the regulated conventional global banking sector.
How are we to have any inkling as to what the effect of high interest rates, illiquidity and a global recession is in a mammoth sector that regulators can’t even see? Private capital is exponentially more dependent on ZIRP. We’ve only just begun to see risk bubble to the surface in the lowest rated publicly traded credit. The default and bankruptcy cycles have barely started.
What is visible is the deep freeze securitization is entering, which poses an existential risk to the U.S. auto and commercial real estate markets. ........................



Yves here. This is deceptively important post. We’ve regularly mentioned that mainstream economists and the monetary economists at the Fed and presumably many other central banks adhere to the “loanable funds” theory of investment and lending. That model posits that loans come from a pre-existing pool of savings. The credit view, which the Bank of England, and even Greenspan and Bernanke have effectively admitted is how things really work, is that banks create loans out of thin air, and simultaneously, the related deposit. The check on this process is the cost of money (the central bank’s policy rate). This model, unlike the loanable funds story, explains how central bank policy influences credit and money supply growth. 
Recent research has shown that the stance of monetary policy can influence financial stability. This column provides an explanation for the effects of monetary policy on credit growth based on a ‘credit creation theory of banking’. In this framework, ‘funds’ are liquid bank deposits created by the banking system independently of private saving(s). The central bank policy rate has a direct effect on credit supply by influencing the refinancing costs of banks. This provides a clear mechanism through which central banks can influence bank lending and financial stability. .............



Quotes of the Week:

StenoLarsen: First, “there is nothing to see here, but we are monitoring the situation closely”. Second, “this bank is an outlier, and the system is fine”. Third, “we will add liquidity as a safeguarding measure, but we don’t see broad-based risks.” We are slowly but surely seeing the first stages of the crisis playbook unfolding and the next steps are likely to follow in coming weeks even if central banks are not admitting to it yet.

Levitin: There's talk about removing the FDIC deposit insurance caps in response to the "Panic of 2023"®.  There's a refreshing realism about such a move. But let's also be clear about the distributional impact of such a move:  it's a huge cross-subsidy from average Joes to wealthy individuals and businesses.

Levitin: The idea that regulators simply will not order abandon ship until the bow is below water is reinforced by the history of regulatory (inaction) on all sorts of other legal violations by banks, be it for AML or consumer protection. Exhibit A here is Wells Fargo, a repeat recidivist, still having a charter. If regulators will not take away the charter of a bank that engages in repeated and egregious violations of law, when will they ever do so?

 


Charts:
1:
2: 
3: 




(not just) for the ESG crowd:

Summary for Policymakers 




The failure of the Swiss bank leaves a hole in the debt-for-nature market that analysts said could one day exceed $800 billion.

The collapse of Credit Suisse isn’t just worrying for the global financial system. It’s a banking crisis that also has real consequences for the fight against environmental degradation.

Before its rescue by Swiss rival UBS, Credit Suisse had quietly become a major player in an obscure market that purports to help developing countries ease their debt burdens in exchange for protecting nature. Known as debt-for-nature swaps, the complex financial instruments help governments restructure their debt to raise money that can be used to fund conservation efforts.

Credit Suisse was the sole structurer and arranger of the world’s largest debt-for-nature swap, a $364 million deal that it orchestrated in 2021 along with The Nature Conservancy, a charity, for Belize. Last year, it sealed another $150 million deal for Barbados. ....


Posted by at No comments:
Subscribe to: Posts (Atom)