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. (…)

Empire State Manufacturing

Manufacturing activity continued to decline in New York State, according to the March survey. The general business conditions index fell nineteen points to -24.6, continuing the see-saw pattern of ups and downs within negative territory seen in recent months.

The new orders index fell fourteen points to -21.7, indicating that orders declined substantially, and the shipments index fell fourteen points to -13.4,
pointing to a decline in shipments.

The unfilled orders index came in at -6.7, a sign that unfilled orders continued to decline.

The index for number of employees fell four points to -10.1, its second consecutive negative reading.

The average workweek index fell six points to -18.5, its lowest level since early in the pandemic, indicating that hours worked shrank for a fourth consecutive month.

Input prices and selling prices increased at a somewhat slower pace than last month: the prices paid index fell three points to 41.9, and the prices received index moved down six points to 22.9.

  

Yellen Says US Will Intervene If Needed to Protect Smaller Banks

Banking crisis spillover (Axios)

In polling conducted March 10-13 — amid the FDIC seizure of Silicon Valley Bank and myriad headlines about the health of the regional banking system — nearly 19% of adults polled by Morning Consult said they’re worried about losing their job in the next month.

• That’s up materially from 11% a month earlier — and is the highest in more than two years.
• Among high-income respondents (those making more than $100,000 per year) job loss fears were the strongest — at 24%, from just 9% in February.

Data: Morning Consult/Axios Inequality Index; Chart: Axios Visuals

Home Prices Fell in February for First Time in 11 Years The median existing-home price fell 0.2% in February from a year earlier to $363,000. That’s down 12% from June. The price drop and a dip in mortgage rates helped snap a yearlong streak of declining monthly home sales.

Sales of previously owned homes, which make up most of the housing market, rose 14.5% in February from the prior month, but were down 22.6% from a year earlier, the National Association of Realtors said Tuesday. Sales had decreased for 12 consecutive months through January. (…)

Homes typically go under contract a month or two before the contract closes, so the February sales data largely reflect purchase decisions made in January and December. (…)

Real-estate brokerage Redfin Corp. said that about 45% of offers written by its agents faced competing bids in February, down from 66% of offers in February 2022. (…)

There were 980,000 homes for sale or under contract at the end of February, unchanged from January and up 15.3% from February 2022, the NAR said. At the current sales pace, there was a 2.6-month supply of homes on the market at the end of February. (…)

(CalculatedRisk)

Redfin:

Pending home sales have now hovered around the same level since November. They rose 0.3% in February from the month before on a seasonally-adjusted basis, and were down 26% from a year earlier—an improvement from the 35.5% record annual drop in the fall.

New listings in February were at the lowest level on record aside from the start of the pandemic. They fell 23.3% year over year on a seasonally-adjusted basis and were down 3.5% from the prior month.

One in seven (14.2%) homes for sale had a price cut in February. While that’s down from a peak of 22% in the fall, it’s still more than double the 5.7% rate of a year earlier.

24% of homes sold above their final list price, down from 45% a year earlier.

It’s worth noting that the housing market shifted in March following the collapse of Silicon Valley Bank. Ongoing turmoil in the banking sector lowered the likelihood of the Federal Reserve hiking interest rates much more this year. That caused mortgage rates to drop, which brought more homebuyers back to the market. The average 30-year-fixed mortgage rate was 6.54% as of Thursday morning, down from nearly 7% at the end of February. The decline comes after rates jumped by almost a whole percentage point during the month of February.

The monthly mortgage payment on the median-asking-price home was $2556 at a 6.6% mortgage rate, the current weekly average. Monthly mortgage payments are up 24% ($499) from a year ago.

The median downpayment is now 10% of the purchase price of the house, off its peak of 17.5%, (which amounted to $65,000), in May 2022.

Nearly one-third home purchases were paid for in cash, the highest share in nine years.

CANADA: Softer Headline But Sequential Core Inflation Edges Up

• CPI +5.2% YoY in February, +5.9% in January. MoM: +0.1% after +0.3%.
• Core CPI +4.8% in February, vs +4.9%. MoM: +0.3% vs +0.1%.
• CPI-Trim +4.8% in February, vs +5.1%.
• CPI-Median +4.9% in February, vs +5.0%.

NBF:

(…) over the past three months, the average of the two measures has moved at an annualized rate of 3.5%, still above the Bank of Canada’s target range but the weakest pace in 16 months. Another core inflation indicator that we like to follow at the moment is the CPI excluding food, energy and mortgage interest costs (driven up by the central bank). Over the past three months, it has been running at a rate of 2.1%, which is at the midpoint of the Bank of Canada’s target range.

Looking ahead, annual inflation is expected to continue to decline rapidly as base effects remain favorable. We are confident that inflation will fall below 3.0% this summer, supported by a continued moderation in the goods component. The current financial turmoil has put pressure on commodity prices. In particular, oil and natural gas prices are at their lowest levels since 2021, meaning that a significant source of inflation in 2022 has been dramatically reversed.

In addition, higher inventories, much lower transportation costs, price cuts by Chinese producers, and weaker global demand all point to a lull in merchandise prices. In the second half of 2022, we have seen a significant easing of demand pressure on prices compared to previous quarters.

Tight monetary policy is likely to continue to weigh on demand in the coming months, as will inflationary pressures from the tight labour market. In our view, the decline in corporate profits and investment over the past two quarters suggests that the current strength in the labour market will prove transitory and that wage pressures will ease as the economy weakens.

  

China: The World Economics SMI report showed a further acceleration in China’s business activity this month. (The Daily Shot)

Source: World Economics

Pessimism running high

Sentiment is close to lowest we have seen over the past 2 decades. Hartnett’s logic stays intact: “…positioning/policy panic says SPX 3.8k floor holds, fade rally run to >4.1-4.2k.” (The Market Ear)

BofA