CAMS Weekly View from the Corner – Week ending 3/31/2023
April 3, 2023
“Our banking system is sound and resilient, with strong capital and liquidity. We will continue to closely monitor conditions in the banking system and are prepared to use all of our tools as needed to keep it safe and sound. In addition, we are committed to learning the lessons from this episode and to work to prevent episodes—events like this from happening again.” Fed Chairman Powell, March 22, 2023 https://tinyurl.com/39eje4rx
As shared in recent editions there have been so many moving parts in the general econ/market’s landscape we have been unable to share many of the unfolding storyline’s and what they may point to downstream on the timeline. Less than two weeks ago the Fed held their interest rate setting policy meeting where their Federal Open Market Committee (FOMC) chose to increase their benchmark interest rate by an additional ¼% point. This was less than what the 30 day Fed Funds futures pricing data had expected. Per those trader’s overwhelming expectations (near 90% expectation) we would see a ½% increase (they must have been focused on the real problem – price inflation) while the FOMC chose ¼%. For the FOMC’s part they must have been focused on the banking issue which holding Chairman Powell to his stated word is not an issue in light of its soundness. That is, per our header excerpt quoting the Chairman’s prepared remarks in the press conference post FOMC meeting on the 22nd of March. With emphasis it was offered to the citizenry that importantly we do not have a banking issue as it is “sound and resilient.” At the same time, interestingly, this sound and resilient system will be closely monitored with policymaker’s prepared to use all their tools to keep it so and have already deployed said tools under the newly created Fed Bank Funding Term Program. This begs the question: If it is truly sound and resilient why would we need to have every tool necessary standing at the ready? This is loosely known as “Fed Speak” which in everyday society would be reduced to confusing speech if not illogical talk. Furthermore, yet again, the Fed per the Chairman is assuring the citizenry they are learning lessons from current banking system issues so it will not happen again. By some small chance if you happen to be a fellow student of Fed history or even a casual observer as a citizen surely you will smile or cringe, yet again, asking why is the citizenry consistently having to experience the downside of the Fed’s learning curve on a topic they are supposed to be trained experts on? That is, the economy and all facets of it. The Banking Regulator Role In addition to the Federal Reserve setting interest rate policies etcetera they also are a banking regulator. Without saying it we believe the Chairman is addressing their failure as a regulator. As one arm of the Fed has been raising interest rates at a historically aggressive pace seemingly the regulating arm was not on full alert to the fact that in a rapidly rising interest rate environment bank balance sheets, if not properly managed, could present problems. The extreme short of it is if you as a bank are holding a wealth of bonds on your balance sheet and interest rates rise rapidly and consistently said bonds will go down in value. This means part of your assets covering deposit liabilities (deposits are a liability on a bank’s balance sheet) will in reality be worth less than what you the bank have them valued at on your balance sheet. Simply then, if you have depositor’s seeking greener pastures because you are not paying high enough interest relative to other options they see you risk having to sell off some of those bonds at a price much less than the value you have them listed at to cover deposits leaving your bank. This becomes a problem in that you the bank get exposed in light of the true market value of the holdings you have covering your liabilities (i.e. deposits) is much less than what you stated them to be in light of market realities in a rising interest rate environment. If you the bank have to start selling some of those holdings to cover deposit flight you realize, in market reality, you do not have enough to cover deposit flight. This then can snowball. On the general banking side this is a failure of management (supposed to be trained experts) as well as a failure on the regulator side (supposed to be trained experts) in being able to read the financial tea leaves as they look downstream ensuring their balance sheets are positioned to the new on-going reality of a rising interest rate environment and the potential hazards it presents. How the Citizenry Pays for the Fed Lesson “The thief in the night” – “The invisible tax” – are just two adages assigned in slang to price inflation. It quietly and nearly invisibly robs the citizenry of their real wealth meaning their wealth when adjusted for price inflation which is the only wealth that matters. Effectively, wealth is only useful for what it affords its holder and if that is consistently eaten away via on-going price inflation everyone becomes less wealthy in real terms. The middle class is hit harder via the invisible tax while the lower middle class to poor classes are devastated. You get the point – the lower on the economic echelon the more you are impacted by said “tax” and the more you pay for the aforementioned management and regulator failures. Circling back to the beginning of this edition Fed Futures trader’s fully expected a ½% interest rate hike at the Fed’s most recent meeting. We surmise they were focused on the price inflation backdrop as recent price inflation releases offered little good news. This while the FOMC seen a potential banking crisis (of a “sound and resilient banking system” per the Chairman) on their hands and did not want to rock the boat even more. Reading through this we can see the Fed’s regulator errors coupled with general banking management errors offers price inflation will not be fought as aggressively (going forward) as it may need to be. The Fed’s Preferred Price Inflation Measure To this point the Fed’s long-held favorite price inflation measure known as the Personal Consumption Expenditures (PCE) price index was updated just this past Thursday. Inside the release the Services measure posted another higher high. This means its trend remains upward and now is the highest we have seen since 1984. We keep walking backwards on the timeline relative to “…the last time we have seen such an inflation level” which underlines the entrenched inflation issue, in particular for the important Services area of society. We highlight the Services component above in light of Chairman Powell speaking to it ad nauseam over many months now in post FOMC press conferences. To his focused measure no progress has been made. Not good. Simultaneously, per the Fed deploying their tools to aid the banking system their balance sheet has begun to grow again all while they have been offering for a year-plus now that they are aggressively fighting price inflation by tightening financial conditions via interest rates and reducing the size of their own balance sheet. This holds true no longer because it is growing again via the aforementioned Bank Term Funding Program. Now the Fed, in light of their own errors as well as general banking management errors will seemingly be forced to walk gently in the price inflation fight going forward. This while the economy continues to generally weaken all-the-while price inflation remains intact. Sounds like stagflation eh. I wish you well…
Ken Reinhart
Director, Market Research & Portfolio Analysis
Footnote:
H&UP’s is a quick summation of a rating system for SPX9 (abbreviation encompassing 9 Sectors of the S&P 500 with 107 sub-groups within those 9 sectors) that quickly references the percentage that is deemed healthy and higher (H&UP). This comes from the proprietary “V-NN” ranking system that is composed of 4 ratings which are “V-H-N-or NN”. A “V” or an “H” is a positive or constructive rank for said sector or sub-group within the sectors.
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