Year: 2023

Steady Jobless Claims Show Labor Market Remains Strong New applications for unemployment benefits fell by 1,000 last week

The four-week average of weekly claims, which smooths out volatility in the weekly numbers, edged lower last week to 196,250.

Claims have remained at or below the 2019 prepandemic average of about 220,000 for several months. The trend held even as large employers in interest-rate sensitive industries such as technology, finance and real estate cut jobs. (…)

But even with the job-cut announcements, there hasn’t been an uptick in filings for unemployment benefits. (…) Some workers may be forgoing applying for jobless assistance because they are quickly finding new work or are receiving generous severance packages. (…)

The level of insured unemployment is somewhat elevated from a low point of about 1.3 million last spring. Modestly elevated continuing claims could be a sign some beneficiaries are taking longer to find new jobs.

Claims always rise prior to recessions. Not happening yet. Continuing claims also always rise prior to recessions. There was a 23% jump last fall but flat since.

Gundlach Joins Powell-Is-Wrong Chorus Predicting Rate Cuts

(…) Swap markets are suggesting the Fed is probably done with its current cycle of rate increases, with the chances of a quarter-point hike in May falling to just one-in-three. The market is also pricing for at least three quarters of a point of easing by year-end, despite Fed Chair Jerome Powell’s insistence Wednesday that officials don’t anticipate cutting rates.

Gundlach, DoubleLine Capital LP’s chief investment officer, sees the Fed cutting rates “substantially” soon, according to posts on Twitter. He also warned of “red alert recession signals” emanating from the US yield curve. (…)

Traders have regularly underestimated the size of the Fed’s hikes. They first started anticipating a policy pivot in the middle of last year — betting the central bank’s rate would be lower in a year’s time than they expected it to be in six months — but so far all those wagers have proved fruitless.

“Investors are seeking safe-haven yields over fears of banking stresses and tighter financial conditions, worries about the commercial real estate industry and a general view that the Fed — and BOE today — have taken policy rates too deep into restrictive territory, for now,” said William O’Donnell, US rates strategist at Citigroup Global Markets. (…)

Banks Are Still Drawing on the Fed for $164 Billion of Emergency Cash Borrowing from the Fed’s new lending program rose to $53.7 billion.

US institutions had a combined $163.9 billion in outstanding borrowings in the week through March 22, compared with $164.8 billion the previous week, according to Fed data Thursday.

Data showed $110.2 billion in borrowing from the Fed’s traditional backstop lending program known as the discount window compared with a record $152.9 billion in outstanding credit the previous week. The loans can be extended for up to 90 days and the window accepts a broad range of collateral.

Outstanding borrowings from the Bank Term Funding Program stood at $53.7 billion, compared with $11.9 billion the previous week. The BTFP was opened March 12 after the Fed declared emergency conditions following the collapse of California’s Silicon Valley Bank and New York’s Signature Bank.

Fed loans to bridge banks established by the Federal Deposit Insurance Corp. to resolve SVB and Signature Bank rose to $179.8 billion from $142.8 billion the previous week.

“There’s nothing here, which suggests things aren’t spreading,” said Blake Gwin, head of US interest rates strategy at RBC Capital Markets. (…)

• Deutsche Bank Shares Slump as Credit-Default Swaps Surge The stock dropped 10%. The cost of insuring DB’s debt against default jumped as five-year credit default swaps widened by 24 basis points to 193 basis points on Friday morning, after jumping by the highest amount on record the day before.
• John Authers:

(…) That dive for the banks is one for the history books. Falls like this don’t happen at all often, and when they do tend to mean bad things for everyone else. The following chart, from the terminal, shows banks’ performance on one axis, and the S&P 500 on the other, both on a log scale. When banks fall badly relative to everyone else, the broader market tends to decline, as I’ve tried to mark with the colored rectangles. That’s because banks matter to the economy. When they’re in trouble, it’s much harder for anyone else to make a profit:

The implicit bet being made in markets at present is that the banks really are in trouble. That will lead to lower rates, and quickly. Those reduced rates will in turn buoy the stock market. The part missing from this equation is that troubled banks would damage economic activity, and it would only be because of this that rates fell. Absent confidence of a serious economic slowdown driven by the banking sector, the current bet on stronger stocks and lower bond yields involves fighting the Fed, which insists it won’t be cutting this year.

So how to justify the continued strength of the market while bank investors are so obviously worried? Maybe there’s hope for a bailout in some form that will hurt banks’ shareholders but rescue everyone else. That’s not outlandish. Or possibly, everyone else thinks that the investors are unnecessarily panicking — in which case we should expect a banking rebound pretty quickly. Or it’s just a Pavlovian reaction that any fall in rates is a reason to go out and buy tech stocks. Whichever alternative holds, the combination of deeply troubled banks and strong performance for the rest of the stock market cannot persist much longer. (…)

Bloomberg Economics has estimated that the stress on financials should translate to the equivalent of an extra 50 basis points on the fed funds rate in the US.

So, Wednesday’s 25bps rise was actually +75bps!

The FOMC sees tepid GDP growth ahead (my red bar is at the last 10 year average ex-pandemic):

But we know that the Fed’s forecasts can miss wildly. Prior to the last 7 recessions, the FOMC’s GDP growth estimates overshot by 2.9% on average per Rosenberg Research which adds

But worse is the Fed funds rate calls — the one thing they actually control they get wrong nearly two-thirds of the time. Just remember — at the end of 2019, the dot-plots were at 1-5/8% on the funds rate for the end of 2020 and we ended up at 0% (with everlasting QE). At the end of 2021, the call was for a 0.9% median dot-plot and we ended up north of 4%. What more do you need to know?

David’s math:

The one thing that was very interesting is the +0.4% real GDP growth forecast for 2023 (on a Q4/Q4 basis), and I say that because the Atlanta Fed Nowcast is +3.2% annualized growth for Q1 (front-loaded by the weather in January) — stringing out what this means for the balance of the year is a steady diet of -0.5% GDP prints (sequential) for Q2, Q3, and Q4.

So even as Powell suggested that this banking sector situation won’t spin out of control, the Fed is implicitly calling for a three-quarter recession starting two weeks from now!

And we know that the S&P 500 never ever bottoms when the recession is just getting started — looking over the valley means seeing the whites of the eyes of the economic recovery, which will be a 2024 story best saved to be having priced in by the fourth quarter of this year and not earlier.

Evergrande Strikes Deal for Bond Restructuring The restructuring has been agreed to by a group that holds more than a fifth of the property developer’s international bonds. Other bondholders have until March 31 to approve the restructuring.

(…) Evergrande had contracted sales of the equivalent of $4.6 billion in 2022, down from $64 billion in annual sales in 2021 and more than $100 billion before its financial problems mounted.

The company said its main objective over the next three years is finishing properties it is currently developing. It needs $36 billion to $44 billion of new funding to do that. Evergrande plans to use any money generated by its existing projects to pay back this new financing, rather than to settle old debt.

• Evergrande Restructuring Is a Warning to China’s Other Creditors Offshore creditors who lent property developer billions are discovering they have little recourse

(…) Many investors piled into those bonds on the assumption that Beijing would never allow a truly widespread property bust because of the fraught politics of homeownership in China. That assumption proved wrong, and now they are likely to pay a steep price. (…)

The fundamental problem is that most of Evergrande’s assets reside in the onshore operating company, which also has its own debts. Offshore creditors were lending to the holding company and would rank lower than those onshore creditors. Evergrande had about 613 billion yuan, the equivalent of $90 billion, of onshore liabilities at the end of 2021 and about 141 billion yuan of offshore liabilities. (…)

Evergrande’s restructuring plan may end up as a template for other beleaguered Chinese developers with lots of offshore debt such as Sunac and Kaisa. As in the case of Evergrande, offshore investors lent to an offshore holding company rather than the onshore entities directly holding assets.

That means that they, too, could end up last in line for repayment. The long-term damage to Chinese companies’ ability to borrow offshore may be substantial—but in the meantime foreign creditors are left holding the bag.

U.S. New Home Sales Edge Up from Downward-Revised Level Sales of new single-family homes increased by 1.1% in February to 640k units (saar). January sales were revised down sharply to 633k from 670k.

Inflation Has More U.S. Companies Ditching ‘Last-In, First-Out’ Accounting Roughly 30 U.S. companies switched their method for recording inventory in 2021 and 2022, compared with 13 the prior two years, data show

(…) One lever finance executives have to combat the impact of inflation on earnings is to make an accounting-policy change: moving to “first-in, first-out” accounting, or FIFO, instead of LIFO. Switching to FIFO can boost a company’s profitability because older inventory acquired at a lower cost is used to value the cost of goods sold on the income statement. Through FIFO, businesses can also better align their inventory accounting across global operations, as the method is allowed under International Financial Reporting Standards while LIFO isn’t. (…)

Businesses have been heading toward FIFO over LIFO for years—particularly with the rise of tech companies, whose costs tend to fall over time—but such activity appears to have accelerated amid a turbulent economy. About 30 U.S. companies total in 2021 and 2022 switched their inventory accounting method to FIFO from LIFO, according to a review of public filings from investment research firm Bedrock AI. That is up from a combined 13 companies in 2019 and 2020, when inflation was less of a concern. No companies have switched to LIFO from FIFO since 2019, Bedrock AI found.

On average, an estimated 55% of companies in the S&P 500 used FIFO as their primary inventory method and 15% used LIFO, according to Credit Suisse Group AG, citing annual reports from 2021 and 2022. The rest of the companies used other options such as the average-cost method or a combination of methods, Credit Suisse said.

LIFO allows companies to use additional cash up front from their lower tax bills to invest in their businesses, but it also increases reported costs of goods sold and hit earnings. The method is a cost assumption companies make on financial statements but generally doesn’t reflect the actual flow of inventory in their operations.

Some companies could view it as less costly to switch off LIFO since a 2017 law lowered the corporate tax rate to 21% from 35%, said Michelle Hanlon, an accounting professor at the Massachusetts Institute of Technology’s Sloan School of Management. (…)

Companies in other industries such as consumer goods, oil and gas, chemicals and medical technology also have made the move over the past year. (…)

EM: ANOTHER TYPE OF RISK

Political risk has become an increasingly important underwriting variable for investors in this asset class, as EM countries face the socioeconomic fallout from the pandemic. Preserving governability and social peace may be challenging moving forward, due to (a) the slow progress made in improving socioeconomic conditions in EM countries over the last decade, (b) citizens’ deep distrust of the political establishment, and (c) the increasing perception that economic and political systems are broken. (Oaktree)

Note where South American countries stand.

Fed Walks Tightrope Between Inflation, Financial Stability Central bank nods to bank woes but presses ahead with rate rise

(…) In its actions Wednesday, the Fed recognized that something was breaking. Recent data had pointed to economic growth accelerating and underlying inflation remaining stubbornly high. Fed Chairman Jerome Powell indicated to Congress earlier this month that the trends likely would require rates to rise above 5.25%, perhaps by a lot. The projections released Wednesday show Mr. Powell and his colleagues have abandoned those plans and still see the target range for the federal-funds rate, which is now 4.75% to 5%, topping out between 5% and 5.25% this year, unchanged from December’s meeting.

“We’re looking at what’s happening among the banks and asking, is there going to be some tightening in credit conditions,” Mr. Powell told reporters. “In a way, that substitutes for rate hikes.”

Because of the expected credit crunch, Fed officials nudged expected growth down to 0.4% this year from 0.5% in their December projections, and 1.2% next year from 1.6%.

If the Fed’s forecasts and assumptions turn out right—with the bank instability largely contained and inflation now gliding back toward 2% from 5% to 6%—then the balancing act will have been a success. A truly systemic financial crisis will have been avoided at relatively low cost, in terms of financial market wreckage or inflation. (…)

• Fed Raises Rates but Nods to Greater Uncertainty After Banking Stress Officials voted unanimously to increase their benchmark short-term rate by a quarter percentage point

(…) Fed Chair Jerome Powell said officials had considered skipping a rate hike after banking stress intensified last week. And he hinted that Wednesday’s increase could be their last one for now depending on the extent of any lending pullback that follows a bank run earlier this month. (…)

Estimates of just how much any credit contraction could reduce hiring, economic activity and inflation were “rule-of-thumb guesswork, almost, at this point. But we think it’s potentially quite real, and that argues for being alert as we go forward,” Mr. Powell said at a news conference after the Fed’s policy meeting. Later, he said, “it could easily have a significant macroeconomic effect.” (…)]

New projections showed almost all 18 officials who participated in the meeting expect the fed-funds rate to rise to at least 5.1%, implying one more quarter-point increase and no rate cuts this year. The quarterly projections were little changed from those released in December. (…)

Wednesday’s statement said, “Some additional policy firming may be appropriate. (…)

(Bloomberg)

Powell’s Own Guide to Recessions Shows Rate Cuts Are Coming

A recession is certain and so are rate cuts this year. That’s the message from the bond market metric Federal Reserve Chairman Jerome Powell highlighted a year ago as the best guide to tip-off economic troubles in the US.

The expected three-month T-bill rate in 18 months’ time dropped to 134 basis points under the current rate. That’s below the previous record nadir it hit in January 2001 — about two months before the US economy fell into recession.

“Frankly,  there’s good research by staff in the Federal Reserve system that really says to look at the short — the first 18 months — of the yield curve. That’s really what has 100% of the explanatory power of the yield curve. It makes sense. Because if it’s inverted, that means the Fed’s going to cut, which means the economy is weak.” — Fed Chair Powell on March 21, 2022 (…)

• Differing Powell and Yellen Messages Were a Lot for the Stock Market to Digest

(…) “It’s astounding that Yellen and Powell would have given contradictory messages on bank deposits at the same time,” said Steve Chiavarone, senior portfolio manager and head of multi-asset solutions at Federated Hermes. “Powell essentially said that all deposits are safe, Yellen said, ‘Hold my beer.’ You would have thought that they would have coordinated.”

Asked about a broad increase in deposit insurance, Yellen said that it was “not something that we have looked at. It is not something we are considering.” That happened right around 3 p.m. in New York, after Powell said that the banking system was sound. (…)

“Her comments clearly affected bank stocks negatively, but her comments roughly coincided with Powell’s comments that they will continue to do what take to fight inflation, including raising rates more than anticipated,” said Steve Sosnick, chief strategist at Interactive Brokers. “It’s tough to untangle them.” (…)

John Authers:

(…) This is a tad unfair. Powell was offering distinctly boilerplate assurances that depositors needn’t be worried, while Yellen was answering a specific question about an extreme option that would take much political heavy lifting to put together. It’s also possible to argue that Yellen was doing no more than state the facts of the situation. She doesn’t have the power to insure all deposits, even if she wants to. That would need legislation and presidential assent. But the incident speaks to the degree of angst among investors, and the ease with which that angst could be turned into full-blown panic by a few misplaced words.

What should we make of this? On the face of it, universal deposit insurance should be really bad news for bank shares. The extra supervision and tight regulation that would have to accompany a government guarantee would destroy their profitability, and they would become no more interesting as investments than water companies. But the instant reaction to Yellen’s reassurance that such a plan was not in the works was to sell bank shares. This is the market equivalent of when audiences throw toast and hurl epithets at the screen on cue. It shows, if a re-demonstration was needed, that anxiety about the banks remains intense, and in financial terms not wholly rational. While that anxiety is greatest about the banks themselves, it spreads to the rest of Corporate America — every economic sector of the S&P 500 fell for the day.

Still, broader deposit insurance has some passionate advocates. Just read these tweets from the hedge fund manager Bill Ackman, who runs Pershing Square Capital. I’m dubious as to whether it’s responsible to make predictions about bank runs, but his comments are well and truly in the public square now. Even Elon Musk has piled in to tell his 132 million followers that, “This foolish rate hike will worsen depositor flight.” (…)

The questions of how unstable the banking system really is, and how much heat it will take out of the economy, now comfortably trump the issues that have been preoccupying everyone involved in the fight against inflation. Until there is some clarity on this, the banks’ health will matter more than the tight labor market, inflation expectations, or the Fed’s monetary reaction function.

Here’s what Powell actually said:

“Well, I’m not saying anything more than I’m saying. But what I’m saying is you’ve seen that we have the tools to protect depositors when there’s a threat of serious harm to the economy or to — or to the financial system, and we’re prepared to use those tools. And I think depositors should assume that their — that their deposits are safe.”

In all, the Fed is saying that the Fed Funds rates will be above 5% in December. The market is still betting against this: the implied rate for December is significantly lower at 4.2%.

Maybe we should look at what’s happening in Canada where the BOC is not as data dependent:

Bank of Canada Didn’t Debate Hiking Interest Rates in March

Bank of Canada officials didn’t actively consider raising interest rates in early March and were “comfortable” that inflation would slow further despite some stronger-than-expected economic data, according to a summary of their discussions.

Governor Tiff Macklem and four other policymakers saw clear signs that eight consecutive rate hikes were “dampening demand,” and talked about how consistent recent economic developments were with the forecasts in their January monetary policy report. (…)

The bank’s governing council was “comfortable with the MPR outlook that inflation will continue to ease this year as monetary policy tightening works its way through the economy and base-year effects pull down 12-month rates of inflation,” according to the summary published Wednesday in Ottawa. (…)

From David Rosenberg:

Canada’s CPI came in light in February at +0.1% MoM, the fourth straight mild print. Over this period, the index has slowed to a +2.2% annual rate (was +6.8% a year ago) — not seen since October 2020. The core was tad heftier at +0.3% but the numbers here have been contained at that pace or slower since last October.

Over the last four months, the core CPI is up the grand total of +3.4% at an annual rate (was running closer to +7% SAAR in mid-2022). Excluding food, energy and mortgage costs, inflation has also been running at around a 2.3% pace over this period.

Compare and contrast to the United States, where consumer prices bounced up +0.4% in February and running hotter at a +3.7% annual rate. But it’s not really “hotter” — it’s just that over 40% of the index south of the border is complete imputed guesswork by the BLS (like how it does nonfarm payrolls with a “birth-death” model).

The YoY headline inflation rate decelerated to 5.2% from 5.9% in January to stand at a thirteen-month low. The BoC’s trimmed-mean CPI measure has receded nicely from +5.5% in November to +5.3% in December to +5.1% in January to 4.8% in February. On a seasonally-adjusted basis, services rose +0.3% and have moderated significantly over these past three months, while goods deflated 0.1% dropping for two of the past three months despite the Canadian dollar weakness over this period.

The tight economic relationship between Canada and the U.S. is well known and understood:

But it also valid on inflation. The correlation between the Canadian an American headline inflation rates is 87.8% since 1960. It is even better at 94.3% since 2010.

The BOC is now comfy that inflation is waning, seeing “clear signs that eight consecutive rate hikes were dampening demand”. The FOMC is not there yet, even if it is now dealing with a potential credit crunch.

Goldman Sachs reckons that each 1% hit to lending reduces GDP growth by around 0.1pp over the next year in the US and by 0.3pp in the Euro area.

We therefore expect a total growth drag from tighter lending conditions of 0.3-0.5pp in the US and 0.3-0.4pp in the Euro area in 2023, consistent with our US and European economics teams’ recent estimates. However, risks around these numbers are likely skewed toward a larger drag, particularly in the event of further bank failures, significant regulatory changes, or continued deposit outflows that increase the sensitivity of lending to bank capital.

Mr. Powell said yesterday that the FOMC did not take into account an eventual credit contraction. Give their current projections, the gap between their soft landing forecast and a recession is very narrow.

As shown Monday, there’s a pretty strong correlation between lending standards the economy.

  

It is estimated that some $1.1 trillion of cash recently moved out of smaller banks. There should be a direct, immediate impact on CRE operators, adding to the already underway policy lags:

• CRE facts (The Market Ear)

Morgan Stanley with the stats: “CRE market is $11tn in size with ~$4.5tn of debt outstanding. Banks have ~38% share of debt outstanding followed by GSEs (~21%), life insurers (+15%), CMBS (+14%) and REITs (+4%)”.

MS

This might go smoothly , but my bet goes with the BOC’s view: slower demand, slower inflation, lower rates. Hopefully, not too slow and not too low.

Chinese property stocks fall after Evergrande reveals restructuring plan The company still had $276bn of liabilities as of end of 2021 vs $300bn earlier that year. It said in the event of a liquidation, offshore creditors would see an estimated recovery rate of about 2 to 9 per cent.

SEC Plans Lawsuit Against Coinbase, According to Exchange The regulator believes the largest U.S. crypto exchange violated investor-protection laws in several aspects of its business, including its staking and wallet service.

(…) An SEC lawsuit against a crypto exchange carries potentially existential consequences since regulators can seek injunctions that would block the company from activities the SEC argues violate the law. Despite a yearslong crackdown on crypto sales and trading, the SEC has sued only a few crypto exchanges. (…)

The SEC’s enforcement process gives companies the right to respond to the SEC’s Wells notice and argue why regulators are wrong. Regulators have six months to decide whether to proceed with a lawsuit after delivering a Wells notice, although that deadline can be extended. (…)

Alleging that Coinbase listed assets that should have been regulated as securities is “the next logical step for the SEC to look at,” Mr. Fagel said. But bringing a lawsuit alleging those claims “is a more complicated case because for each token, the SEC has the burden of showing it is a security,” he added. (…)