The Year of More of the Same

  

        I have two pieces of information before me on my desk. One is from Winters & Co. Advisors, LLC, an investment agent who I have worked with over the years. The Winters document contains a chart showing the swap yield curve for the last 4 years based on today’s date (swap rates tend to closely follow same maturity treasuries). The most recent 2 years shows an inverted yield curve in the 4% to 6% range. The curves for 2020 and 2021 show normal sloping curves in the range of 0% to 1.95%. The second document is a short story from the Wall Street Journal of today with the headline, “As inflation cools, economists see soft landing for US”. What a ride we have had for the last two plus years. We have been riding the Fed induced rollercoaster since mid-2021 when inflation started its climb from the benchmark of 2% (4.2% - Apr 2021) to its high of 9.1% in June of 2022. It slowly trended downward through the balance of 2022 and finally was back down to 3% in June of this year. The rate trended up to 3.7% through September and is 3.2% for October according to US inflation Calculator (usinflationcalculatior.com/inflation/current-inflation-rates/). Remember, the Fed moved the goal posts last year when it said that they would be happy if long term inflation would stay in the 3.0% range as opposed to its 30 year target range of 2.0%. The Wall Street article states “Economists continue to see the US economy approaching a soft landing as inflation data comes in better than expected, with little signs of impending recession. This would mark the first time in 80 years the Federal Reserve has brought down inflation without triggering a recession.” Not bad if it does happen, i.e. no recession triggered. However, the Fed doesn’t have a very good track record and they did move the goal posts to make it easier to claim success. So, change the rules, take 2 ½ years to do something that many times (one can’t say normally in economic situations) takes 6 to 8 months and declare victory at the new levels, maybe. I see that the Wall Street group is the first on the soft landing band wagon in this current time period. Do you remember the movie Those Magnificent Men in Their Flying Machines (1965 comedy). It goes on to say something like, they go uppity up up, they go downdity down down. I am afraid we have been doing the up down routine along the bottom of the economic landscape for the last 2 ½ years.

      No, we haven’t had an official recession yet but we haven’t had much growth in the economy either. We have a very high Federal Fund rate that looks to stay high for some time to come according to Chairman Powell. In the Associated Press article of November 1, 2023, “Federal Reserve leaves its key rate unchanged but keeps open possibility of a future hike” I quote;

The central bank’s latest statement noted that the economy “expanded at a strong pace” in the July-September quarter and that job gains “remain strong.” And it reiterated that future rate hikes, if the Fed finds them necessary, remain under consideration.

But it also acknowledged that recent tumult in the financial markets has sent interest rates on 10-year Treasury notes to near 16-year highs and contributed to higher loan rates across the economy — a trend that helps serve the Fed’s goal of cooling the economy and inflation pressures.

Powell himself suggested that Fed officials remain unsure about whether further rate increases might still be needed to defeat inflation. That stance marks a shift from earlier this year, when the policymakers had made clear that they leaned toward pushing rates higher.

I am curious to see if the Fed will consider inflation beaten at a 2% rate or the newer Fed suggested 3% rate. It sounds like the Fed is watching and ready to hike the Fed Funds rate more if necessary. Not a strong sign of reduced volatility as the higher rate tends to make other aspects of the economy volatile and unpredictable. The good news is the Fed hasn’t forgotten about the huge balance sheet problem which is and was one of the primary driving forces for the inflation explosion in the first place. Remember the huge balance sheet was fueled by artificially low borrowing rates for so very, very long. In a Reuters article of October 31, 2023 I again quote;

The eventual end of the Federal Reserve’s efforts to reduce its vast bond holdings increasingly appears tied to what happens with the central bank's "reverse repo" operations.

The program, launched nearly a decade ago, grew rapidly starting in the spring of 2021 and by June 2022 was consistently taking in more than $2 trillion a day in what was seen as clear evidence of the amount of excess cash sloshing around the financial system. Inflows have dropped sharply in recent months to around $1 trillion in the face of the Fed's aggressive policy tightening underway since last year.

Lou Crandall, chief economist with Wrightson ICAP, a research firm …  reckons the Fed still has time in this process, and speaking earlier this month, Cleveland Fed President Loretta Mester agreed.

"We still have a very large balance sheet" so the balance sheet cuts can likely continue over the next year and half to two years, she said, adding when it comes to getting to the finish line, "it's going to take a while."

    So, what might we see regarding inflation, economic growth, and a return to normal (whatever normal may be 😊)? Well, that’s just it. I suspect more of the same which is a fair amount of uncertainty and ambiguity plus a large dose of prevarication by the various economic gurus, and financial and governmental leaders. I am afraid we aren’t going to know until we know. Or at the very earliest after the fact (yup, after the fact). Not much comfort. However what you can do is stay conservative in your investments. Don’t concentrate your holdings but spread things out. Don’t go for financial or investing fads. Save as you can, spend less, and find ways to enjoy things more like family, friends, the beauties around us. Don’t worry to much about the economy. It has survived several other difficult times regardless of what people, institutions and governments do to it. Things will of course certainly, almost without fail, very likely, probably, in most cases solve themselves, we think. (But don’t quote us on that.)

Articles cited.

Federal Reserve leaves its key rate unchanged but keeps open possibility of a future hike

https://apnews.com/article/inflation-interest-rates-prices-economy-federal-reserve-63f5a7ed041d6b55c7aa773d071a05fb

Fed’s reverse repo facility drawdown looms large in balance sheet debate

https://www.reuters.com/markets/us/feds-reverse-repo-facility-drawdown-looms-large-balance-sheet-debate-2023-10-31/

Recession, Banks, Debt Ceiling – You Must Believe Me Now

The question is, if it’s said loud enough will it be believed? Because this time it really is true (it is being said very loudly). Or is it?

The discussion about recession has been on-going for some time now. I started writing about recession possibilities over a year ago. The discussion has moved back and forth between how do we avoid one to how do we get a soft landing to what can we do to help those that will likely suffer if the landing isn’t so soft. We may see in the next several months various pronouncements by various talking heads. You notice I didn’t say anything about what phase this is. I don’t know and it doesn’t matter as much as most news personnel would like you to believe from their  strident and every increasing noise. Remember, it is important to keep the fans whipped up. We will be able to look back in several months when the National Bureau of Economic Research (NBER) will state that a recession started at such and such a point, or didn’t. Remember, only the Bureau is recognized as the official group that can declare such and they always include factors that are backward looking, meaning we don’t officially know until after the fact. This also means that we don’t officially know if we have had a soft landing, missed recession or face plant until after the fact either. There are other signs that may give us indications of various outcomes, however. We have been moving toward this point for months and months. It is dragging on longer than a normal news cycle so it gets recycled regularly. Expect to see it to continue. Again, the fans need to be whipped up to keep enthusiasm high. We are getting more comments like JPMorgan Chase CEO, Jamie Dimon (CNBC, Apr 14, 2023 Manie Dimon issues warning on rates: ‘It will undress problems in the economy’) that investors and business should plan on interest rates remaining higher for longer. The Fed still needs to “dry out” the economy, get the excess funds (easy money) out of the system. That hasn’t changed. We still have a recession we are trying to work around or work through depending on what you think may happen. Work around implies a soft landing or just a slowdown; The economy slows down, unemployment rises a bit. Banks tighten their lending policies. A few business and individuals suffer or go under. The Fed is able to get their balance sheet down without the stock and bond market tanking (it slows down, drops and recovers fairly quickly). We stumble a bit and slow down. No or mild recession and we carry on at a more measured pace. Work through implies a recession; we trip or worse, face plant and have to pick ourselves back up. We see bank failures, businesses and individuals declare bankruptcy. The Fed isn’t able to maintain a smooth decrease in its balance sheet or worse doesn’t reduce it. The stock and bond market react to all the uncertainty and failures by tanking. It takes a longer to climb out of the hole.

One of the consequences of the higher rates is the financial sector including banks will feel the pinch. They have to change from an easy money mentality to a more measured lending stance. Easy money implies less diligence in protecting deposits and in shoring up a banks balance sheet. There is little or no profit in protecting deposits (lending them out is where money is made) or doing more than the minimum required or skirting regulations. Most banks try to balance the profits with the safety, we have seen the banks that didn’t. The price for skirting the safety regs in good times is minimal and it is hard to see which banks may be skirting until too late when times turn bad. The best we can do is go with financial institutions with a long record of being conservative. Credit Unions tend to be more conservative by their nature and charter requirements. Still, it’s hard to tell. There is something to be said for spreading money around between institutions. We also have deposit insurance which is helpful but in the Silicon Valley Bank and First Republic Bank failures the Fed stepped in and guaranteed all deposits which stressed the insurance provider FDIC (it almost broke it such that another big hit would cause serious problems). So, things are complicated, of course. By guaranteeing all deposit they essentially gave a green light to the poor practices of the bank. They also prevented a bank run on several similar shaky banks across the country. Whether that was the right thing to do or not should be debated for a long time. The current mentality is that the government can fix everything which makes them responsible. Hence more regulation and laws and more places for shady people to find loopholes. Notice that the defense for many of these funny practices is that the entity did nothing wrong, they were following the rules. It was the rules fault. So, of course, more rules are needed. That is a very bad spiral and you can follow it down to the final conclusion. Watch the financial sector for more stress in general and how they seem to take care of it. Look for more rules and regulations. I am glad I am finishing up my career in finance and not starting it. It is a very different and much more difficult place to work then 30-35 years ago when I was first involved.

                Now the debt ceiling question. I am not going to quote any articles. There have been so many. It is the current hot, hot, hot topic button and the news media are mashing it with their biggest and most massive sledge hammers (gleefully I might add). Do you feel like you have been beat up no, pummeled for weeks on end. Everywhere you turn someone or some organization is talking dire straits, doom, gloom, death, destruction, mayhem, the very end of the world as we know it, the end of civilization, the death of all we hold near and dear, (pause for dramatic breath!!!!!!) AURRRGHHHHHHHH. Why can’t you people see how important this is!!!!!!!!!!!

Sorry…., I got just a little bit carried away.

It won’t happen again (at least until tomorrow anyway.)

                This is the news and financial media at its finest. This it the current news media model and the debt ceiling is the ultimate opportunity to exercise its model to the fullest. The underlying question is the government has set some limits on its spending capability, a good thing. It has come around again that the government can’t manage its input and output. The easy solution is raise the debt ceiling or remove the debt ceiling requirement or better yet get spending under control. Now, granted, the answer is never that easy and that is also part of the problem. The solution is pretty complex but workable. However, we have powerful political forces that are using this debt ceiling to push their various points and agendas.  

As background information. The following is from Wikepedia, United States debt Ceiling;

The U.S. has never reached the point of default where the Treasury was incapable of paying U.S. debt obligations, though it has been close on several occasions. The only exception was during the War of 1812 when parts of Washington D.C. including the Treasury were burned.

In 2011, the U.S. reached a crisis point of near default on public debt. The delay in raising the debt ceiling resulted in the first downgrade in the United States credit rating, a sharp drop in the stock market, and an increase in borrowing costs. Congress raised the debt limit with the Budget Control Act of 2011, which added to the fiscal cliff when the new ceiling was reached on December 31, 2012.

The last time things got too close, government set new rules and they immediately went about figuring out where the loopholes are. And it is continuing. Is it a problem. Yes. Is it the end of things as we know them (as the news is telling us). No. Are there solutions. Yes. Should you be upset. Yes. Should we be acting like Chicken Little. No. It will play out. It will get close. There will be much rejoicing in the media when the “solution” is reached. Then the media will begin the analysis phase which will allow for continued coverage for many months. So it continues. Should you follow all the stories. DEFINATELY NOT. When this crisis passes the media will need something else to keep us tied to them. Look for the recession to come back in vogue. Don’t be lead around. The various financial crisis will continue in the news. You can always find them if you want. I suggest you don’t want to. Keep your finances simple. Keep debt low. Save as you can. Debt is good for some things, housing, education, transportation. Live simply.

                Remember what is important. It isn’t news. It is family, friends, the things you love. It is the beauties around you. It is relationships, the good earth, the joy of interacting. It is game nights, movies together, playing with kids (big and little ones). It is in quite walks, talking in person to friends and family. Meeting new people, a meal together, building something, watching a sunrise and sunset. Tell someone you love them. Share precious things, a hug a kind word, hope.

Bank Failure, Recession – What Is Happening

 

        I am composing this blog while listening to 5 songs, playing loudly, Living the Dream by Foreigner, Demolition Man by Sting, Bang a Drum by Jon Bon Jovie, Wheel in the Sky by Journey, and Dr. Heckyll & Mr. Jive by Men at Work. Mainly because they sound good loud, better louder, especially with more bass. The lyrics are a good mix of some of my feelings regarding the economy, economic policy and the people playing the various roles in this current economic play (especially Bang a Drum).

                I haven’t said anything for a few weeks as I was waiting for the news noise to settle down and we can pick through the points in a more reasoned manner.  The Associated Press article titled Fed raises key rate by quarter-point despite bank turmoil by Christopher Rugaber (3/22/23) is a good summary of the past several weeks and may hold some insight into future activities. I have put a link to the article at the end of this post.

                First, bank failures. The problem is 3-fold. One, with the Fed raising the Fed Funds rates and attempting to dry out the economy by removing money from the economy, all borrowing costs have increased as well as interest rates on all new debt instruments. Treasury rates have changed wildly and are higher across the board. Don’t worry about short term vs. long term differences, just know all rates are up, up a lot. The purpose is to remove money from the overall economy so that too much money is not chasing too few goods (one of the basic definitions of inflation). The higher rates affect you in many ways but especially if you have old bonds (bonds at old, lower rates) and you need to get the principal before the bonds naturally mature. Remember, interest rates and principal value are inversely related. If rates go up principal value goes down. However, this only happens if the bonds are sold before their maturity date. If the bonds don’t need to be sold early then no foul, no harm. When they talk about bonds losing or gaining value it only relates to having to sell them before maturity. It’s only a paper change based on current conditions. It is a way of looking at current opportunities vs. what was spent / invested previously. If you have an existing, older mortgage you are saying, boy what I deal I got. If you are looking at invested funds you are saying I wish I had my money free right now because I could earn a lot more if I invested now. You don’t owe any more interest on your mortgage or have fewer dollars coming in from your invested bonds. Now, if you need to borrow new money or invest some current excess funds then the current rates will apply. That is where you will see the impact of higher rates, on any new debt you want to acquire or new investments which will give you more earnings. If, however, you need to get the money out of your current investments you will have a problem which is what all the current news is talking about as lost money. Remember, there is an inverse relationship between rates and principal, as rates increase, principal decreases and vise-versa. In order for you to get your money back early (i.e., sell your current debt/bond) someone else will have to buy it and they are not going to want your old interest rate bond because it has a lower interest earnings rate than what that person can get if they were to take their money into the market today and buy a new debt instrument. In order to make it attractive to the new investor you need to make your old debt equal to the current debt they can get. Debt is equal to the value of the stream of remaining interest payments plus the principal payment. So if the interest payments are lower than current interest payments you have to take less principal to make up the difference (not quite that simple because compounding is also included). So, if current interest rates are higher and you have to sell your old debt then you will get less than the stated principal to make up the difference. If you were counting on that total principal amount you now have less.

                That leads to the second part of the bank failure problem. Banks make money by lending out their deposits and funds to borrowers (no problem). Banks learned a long time ago that they can’t lend all their deposit as they need some funds to cover regular transactions. If people can’t get their money in a timely fashion they won’t invest in the bank. The Fed has set various rules for how much banks must maintain in cash and cash equivalents to meet short term demand. (A discussion for another time is why does the Fed have to set the rules thus removing the need for banks to be their own monitors. That is why we have too big to fail banks and other problems, banks aren’t responsible for their poor decisions because the Fed picks up the responsibility, and cost.) One of the cash equivalents allowed by the Fed is the bank can hold Treasury bonds and high quality municipal debt (bonds). The bank should always be monitoring the impact of changing rates and if rates are moving then what is the value of the principal if the debt has to be sold immediately (can’t wait for maturity). Usually the bank will “hedge” the debt meaning they have various financial products that will allow them to cover the loss in having to sell before maturity. These instruments are not perfect and can have problems themselves.

                The third part of the bank failure. Silicon Valley  and Signature Bank had depositors that included venture capitalists and other very sophisticated investors. The investors realized that the bank was either not hedging their funds properly or had lent out too much in relation to what they needed to cover their short term needs. The investors fairly quietly started taking their deposits back. Problem is many watch venture capitalists very closely. It took only a few days for a run to start on the bank meaning not just a few but lots of people want their money back, now. The bank had to sell their cash equivalent funds (because they didn’t have enough cash) which were in treasury bonds, considered very safe (and they are because the federal government will always pay what they owe) but they had to sell in a rising interest rate market. Investors won’t pay the full principal amount because interest rates are higher than the rates on the bonds. Hence, less principal coming back. The bank sold something like $21 billion in securities and lost $1.8 billion. They needed to make up the difference and tried to sell new stock to raise it. That sent more shockwaves through bank customers which led to a run on the bank. No one wanted to buy the stock. The bank was overwhelmed by withdrawals and couldn’t meet the demand. The Fed stepped in and closed the bank.

                Many are suggesting that the Fed’s interest rate policy led to the bank failures. High interest rates certainly caused the problem of the lost principal when the bank was forced to sell before maturity. The bank was supposed to be monitoring such things. According to reports, the bank’s mix of securities and cash was substantially different (worse) from industry averages.

The Fed this week increased the Fed Funds Rate by only 25 basis points, recently it was expected to be 50 basis points. There is news noise that the Fed should stop, increase, change. There are calls for Congress to do something (more regulation), again news noise. There may well be new regulations but let it sit a bit before you start looking / commenting. Previous Federal policies and regulations made much of this mess, they may or may not be able to do some good. I am not particularly hopeful but one never knows. There is much noise around the Treasury and Federal Reserve’s move that guaranteed all deposits not just those of $250,000 or less (FDIC insured) at the failed banks. That move was to keep the bank runs from spreading to other banks. It seems to have worked at this point but things are still dicey in the banking sector. Questions are being asked about what other banks may have similar situations to SVB and Signature bank. There have been rumblings in other parts of the country. We have had many public officials making official public announcements. Remember news noise, we don’t know yet in spite of all the words. Back to the guaranteeing of all deposits. That releases all responsibility of the banks and the big depositors. The system wasn’t designed to cover those types of costs. Biden and Yellen have promised that taxpayers won’t cover this cost. There isn’t enough money in the FDIC funds to cover the cost of insuring those uninsured deposits. The insurance premiums are collected from bank fees to all banks. You and I pay those fees. I don’t see how we aren’t going to pay the costs. Unless public officials come up with some other plan, we can hope they will. Now we have another precedence set for banks to rely on the Federal government to bail them out, tying them closer still to the government.

                A recession is still very much on the table. The Fed needs to balance the problems caused by tighter policy (higher rates) with the expected problems generated by those policies, yes expected (the problems aren’t new). They also include stalled growth (which is needed but how long might it last), increasing unemployment, higher borrowing costs. Markets really, really hate, loth, fear, you name it, all this uncertainty. They don’t like it and tend to rebel (do things that the Fed isn’t expecting or prepared for – like bank failures). Expect to see this continue. It’s all part of the process. Remember, we have survived this sort of thing before (recession). It is NOT the end of the world as we know it. It is NOT going to go on forever. The sky is NOT falling. (Things you will hear in the news noise.) It is part of the process of getting the economy back on track and working better. It is going to work, it has worked before and it will work again. Hang in there. Remember what is important and that important things are NOT found in news noise. They are found in friends, family, loved ones and enjoying life. It is doing things together and learning new things. It is in seeing all the beauty around us and enjoying that. It is found in loving and caring more.

            I am now stepping off my soapbox and turning down the music volume.

AP news article -

https://apnews.com/article/federal-reserve-inflation-banks-interest-rates-jobs-91a9185ebce972bbf5ab1f46654f1a53

The Sword of Damocles - Recession Discussion & Related Thoughts

Sword of Damocles
by Richard Westall

            We start the new year with the sword of Damocles poised over the national and world financial markets. The articles are a smattering of comments, commentary and conjecture from market gurus (both national and world) and federal officials tasked with knowing what is going on. Much of the thinking is still relating to recession but a new term is being introduced into the discussion. Additionally, many are discussing just what and when a recession may or may not occur and Powell (Fed Chairman) is trying to keep the Fed focused on is core responsibility. A typical month in the life of the financial world with many pronouncements, much hand wringing and many loud protestations. So, let’s dive into the murky waters and see just what we can see (or not see).

                A new term is being floated to describe the current financial situation, “slowcession”. Apparently the phrase was coined by Cristian deRitis and used by Moody’s Analytics chief economist Mark Zandi. It means economic growth “comes to a near standstill but never slips into reverse [recession].” Every economic downturn and upturn for that matter, is a bit different and past historical data can only give limited help in describing any current situation. We won’t know how this recession or as noted above, slowcession, will look until after the fact. It will probably have several differing characteristics from previous recessions but will meet the basic definition of recession. Do we know how this recession will play out, no. Are there some ideas, yes, many. Will any of the ideas be correct. Maybe. Then again they may all be wrong or at least mostly wrong. Then again, with all the possible ideas and conjectures floated over the past 12 months there is likely to be a couple of the ideas that will hit close to what actually happens. Remember, we have had so many possible scenarios described from the death of the markets to no recession that all possible options have at least been considered. Something has to hit, given enough shots taken. So, we don’t really know but we have some ideas on a recession and its impacts.

                The Guardian (London) collected comments from a variety of international economists and financial gurus and gives us a cross-section of thinking. They suggest from their sources that we should “brace for another turbulent year in the financial markets”. (Nothing new there.) Their comments suggest possible improvement and likely fall of markets, particularly the US. The head of the International Monetary Fund suggests that a third of the world’s economies are in recession which is likely “because the three big economies – US, EU and China – are all slowing down simultaneously”. Some are suggesting a global recession this year. Much of the speculation is based on what economists and other believe will be the response by central banks to the high inflation rate, which will be raising governmental monies interest rates. An interesting side comment, the article suggests that Russia’s economy is already in recession caused in large part by Putin’s failure to find an easy way out of the war.

                I have selected 3 articles on recession comments. The Bond Buyer (1/24/23) brings several analysts’ comments together suggesting recession is necessary. Some economists are suggesting a modest recession (Wells Fargo Securities and others) during 2023, others think more than modest. There is now discussion about the impact of the recession on inflation. Remember, recessions are supposed to kill inflation. Some are suggesting inflation will remain above the Fed target of 2.0% and be in the range of 2.5% to 3.5% for at least a decade. The solution to higher than target rates, the Fed can always move its target upward and declare victory in the war on inflation. That wouldn’t surprise me. Finally, there is some discussion that we will have a split year. Good for half and bad for half. Don’t know which half first. BNN Bloomberg (1/5/23) is a discussion by St. Louis Fed Reserve Bank President James Bullard that Fed Funds Rates are getting closer to high enough to bring down inflation. The thought by many from his comment is that the Fed still has some increases to come. The question is will they be .25% or .50% increases. The market views a slowing increase as positive at this point. Several Fed officials are still concerned that inflation is to high or way to high. That points to bigger increases. The 3^rd article from Reuters (1/25/23) is about the impact of all this to investors. The article warns that many “heavyweights [are] warn[ing] of pain ahead despite market’s recent reprieve”. Even though recent market movements have been positive or optimistic, most are warning that recession is still likely. The article states, “correctly gauging the economy is crucial for investors”. The statement is absolutely correct and impossible to do. Remember that. Don’t try. No one can. Ever. Don’t do it. In spite of what many say especially talk radio financial hosts and slick financial advisors. And of course many believe they know more. Some very few will get very lucky and be correct and you will hear about them and their phenomenal good skills (luck is not a skill). The majority (most) will get it wrong and there will never be any report on them or their numbers.

                Stay your course. Don’t panic or as the British war message stated “Keep Calm and Carry On”. Keep your debts manageable / low. Don’t borrow without careful thought. Save and above all….. enjoy life, friends, family and the beauties around us. Be grateful. I am.

Articles used:

https://www.theguardian.com/business/2023/jan/02/global-economic-forecast-for-2023-a-stormy-start-followed-by-a-ray-of-hope

https://www.cnn.com/2023/01/03/economy/moodys-us-economy-slowcession/index.html

https://www.bnnbloomberg.ca/fed-s-bullard-says-rates-are-getting-closer-to-sufficiently-high-1.1866262

https://www.reuters.com/markets/us/wall-street-heavyweights-warn-against-goldilocks-hopes-2023-01-25/