Tag: FED

There’s Never Been a Tougher Time to be a Central Banker

From The Conversation.

The two central banks that matter most for Australians – the Reserve Bank of Australia (RBA) and the US Federal Reserve (the Fed) – released minutes from their latest meetings this week. And although there were not a lot of surprises, there was a fair bit of detail about what we can expect on interest rates going forward.

The Federal Open Market Committee’s (FOMC) main message was unmistakable -expect interest rate rises, and expect them sooner rather than later:

Many participants expressed the view that it might be appropriate to raise the federal funds rate again fairly soon if incoming information on the labor market and inflation was in line with or stronger than their current expectations or if the risks of overshooting the committee’s maximum-employment and inflation objectives increased.

and that they:

continued to see only a modest risk of a scenario in which the unemployment rate would substantially undershoot its longer-run normal level and inflation pressures would increase significantly.

This is exactly what markets have been expecting, and it seems clear that the balance of risks is no longer that the labour market is too weak or inflation too low, but that the Fed might wait too long to continue its path of rate rises.

The really big unknown is how the Fed goes about unwinding a good chunk of its balance sheet, which involves US$2.64 trillion (with a “T”) of treasury bonds that were purchased as part of its effort to stimulate the economy in the wake of the financial crisis. The Fed also holds around US$1.75 trillion of mortgage-backed securities (“MBSs”).

The natural way to unwind this is by not reinvesting those funds when the securities mature. The Fed gets its money back and doesn’t purchase new treasuries or MBSs.

But it’s more complicated than that. New post-crisis capital rules require commercial banks to keep a large amount of reserves sitting at the Fed. This is now around US$2 trillion. The Fed has to match this liability with assets, like treasuries.

Nobody knows, but my guess is that the Fed shifts MBSs to treasuries over time, but has to keep a large asset side of the balance sheet. This suggests that maybe the whole balance sheet unwinding problem may not be as significant an issue as first thought. But this is genuinely unchartered territory.

At home, the RBA minutes confirmed the ongoing dilemma governor Philip Lowe faces. Like his predecessor, Glenn Stevens, Lowe is trying to manage: unemployment, the Aussie dollar exchange rate, business investment, overall growth, inflation and housing price stability all at the same time, but with only one instrument: the cash rate.

To see this, just look at the opening sentences of the long section of the RBA minutes titled “Considerations for Monetary Policy”. They read as follows:

In considering the stance of monetary policy, members viewed the near-term prospects for global growth as being more positive, although recognised the risks from policy uncertainty in the medium term… Domestically, the economy was continuing its transition following the end of the mining investment boom… Non-mining business investment was also expected to gain some momentum…

Conditions in housing markets varied considerably across the country… Inflation outcomes for the December quarter were much as had been expected and there had been very little change to the forecast for inflation…Labour cost pressures were expected to build gradually from their current low levels…

Wow. That’s a whole lot of targets to try and hit with a single (non-magic, non-silver) bullet. No wonder Dr Lowe has now taken to giving speeches that essentially plead businesses to invest.

It hasn’t quite gotten to “there’s never been a better time to be a business in Australia”. But close. It may, however, be that it’s never been a tougher time to be a governor of the RBA.

Author: Richard Holden , Professor of Economics and PLuS Alliance Fellow, UNSW

FED Sets Up Parameters For 2017 Dodd-Frank Stress Tests

The Federal Reserve Board on Friday released the scenarios to be used by banks and supervisors for the 2017 Comprehensive Capital Analysis and Review (CCAR) and Dodd-Frank Act stress test exercises and also issued instructions to firms participating in CCAR.

CCAR evaluates the capital planning processes and capital adequacy of the largest U.S.-based bank holding companies, including the firms’ planned capital actions such as dividend payments and share buybacks and issuances. The Dodd-Frank Act stress tests are a forward-looking assessment to help assess whether firms have sufficient capital. Stress tests help make sure that banks will be able to lend to households and businesses even in a serious recession by ensuring that they have adequate capital to absorb losses they may sustain.

This year, 13 of the largest and most complex bank holding companies will be subject to both a quantitative evaluation of their capital adequacy and a qualitative evaluation of their capital planning capabilities. As announced earlier this week by the Board, 21 firms with less complex operations will no longer be subject to the qualitative portion of CCAR, relieving them of significant burden.

Financial institutions are required to use the scenarios in both the stress tests conducted as part of CCAR and those required by the Dodd-Frank Act. The outcomes are measured under three scenarios: severely adverse, adverse, and baseline.

For the 2017 cycle, the severely adverse scenario is characterized by a severe global recession in which the U.S. unemployment rate rises by about 5.25 percentage points to 10 percent, accompanied by a period of heightened stress in corporate loan markets and commercial real estate markets. The adverse scenario features a moderate recession in the United States, as well as weakening economic activity across all countries included in the scenario. The adverse and severely adverse scenarios describe hypothetical sets of events designed to assess the strength of banking organizations and their resilience. They are not forecasts. The baseline scenario is in line with average projections from surveys of economic forecasters. It does not represent the forecast of the Federal Reserve.

Each scenario includes 28 variables–such as gross domestic product, unemployment rate, stock market prices, and interest rates–encompassing domestic and international economic activity. Along with the variables, the Board is publishing a narrative that describes the general economic conditions in the scenarios and changes in the scenarios from the previous year.

As in prior years, six bank holding companies with large trading operations will be required to factor in a global market shock as part of their scenarios. Additionally, eight bank holding companies with substantial trading or processing operations will be required to incorporate a counterparty default scenario.

The Board is also releasing several letters with additional information on its stress testing program. One letter describes the reduced data required from the 21 firms that have been removed from the qualitative portion of CCAR; a second details enhancements and changes made to certain supervisory loss models; and a third provides an overview of the stress testing program and its expectations for foreign firms that are beginning the stress testing program this year, but are not yet required to publicly report their results under the Board’s rules.

Bank holding companies participating in CCAR are required to submit their capital plans and stress testing results to the Federal Reserve on or before April 5, 2017. The Federal Reserve will announce the results of its supervisory stress tests by June 30, 2017, with the exact date to be announced later.

Firm Removed from qualitative portion of CCAR New to CCAR 2017 Subject to global market shock Subject to counterparty default
Ally Financial Inc. X
American Express Company X
BancWest Corporation X
Bank of America Corporation X X
The Bank of New York Mellon Corporation X
BB Corporation X
BBVA Compass Bancshares, Inc. X
BMO Financial Corp. X
Capital One Financial Corporation
CIT Group Inc. X X
Citigroup Inc. X X
Citizens Financial Group, Inc. X
Comerica Incorporated X
Deutsche Bank Trust Corporation X
Discover Financial Services X
Fifth Third Bancorp X
The Goldman Sachs Group, Inc. X X
HSBC North America Holdings Inc.
Huntington Bancshares Incorporated X
JPMorgan Chase & Co. X X
KeyCorp X
M Bank Corporation X
Morgan Stanley X X
MUFG Americas Holdings Corporation X
Northern Trust Corporation X
The PNC Financial Services Group, Inc.
Regions Financial Corporation X
Santander Holdings USA, Inc. X
State Street Corporation X
SunTrust Banks, Inc. X
TD Group US Holdings LLC
U.S. Bancorp
Wells Fargo & Company X X
Zions Bancorporation X

Rates Plough Higher

Following the FED’s decision today, the benchmark T30 US Bond yield continues to move higher. A strong indicator that capital markets rates will continue to rise.  The FED is signalling more hikes next year, so yields will continue to climb. This has global significance.

The knock on effect for Australia is significant. Banks will have to pay more for their capital markets funding. International money market investors will switch money from Australia in favour of US markets, putting downward pressure on the AU$. This makes an RBA rate cut in 2017 even more remote (though some economists are still talking about 2 cuts!).

Mortgage rates here will continue to rise. Our outlook on the Property Market for 2017 took these rate movements into account.

Further evidence the world changed last month.

 

 

 

US Federal Reserve Rate Hike Is Credit Positive for Housing Finance Agencies

Moody’s says following the US Federal Reserve raise of its short-term interest rate by 25 basis points, the first time the Fed has increased the rate since December 2015, when it was raised to 0.25% from 0%, where it had been for seven years. Although the increase is small, the Fed’s decision is credit positive for housing finance agencies (HFAs) in aggregate because higher interest rates boost their investment earnings, drive profit margins and present opportunities to grow loan portfolios and rebuild balance sheets.

As of fiscal year-end 2015, roughly 7.2% of HFAs’ assets were held in cash and cash equivalents, which will immediately benefit from the rate increase and boost investment earnings. Historically, HFA profitability has closely tracked investment earnings. Between 2007 and 2009, the steep drop in interest rates led to a decline in HFA profitability. Since then, low interest rates have curtailed profits, although HFA earnings have recovered owing to selling mortgage-backed securities in the secondary market and savings from bond refundings. Now, profit margins should expand with the higher interest rates boosting investment earnings. We project that HFA sector-wide profit margins will increase by 5% if investment income doubles from 2015 levels and by 9% if investment income triples (see Exhibit 1). Actual results will vary among the HFAs.

As interest rates rise, HFAs will be challenged by higher interest expense on both their hedged and unhedged variable-rate debt. However, increased investment earnings on cash held by HFAs combined with the interest rate swaps on the hedged variable rate debt will alleviate the effect of the higher interest costs. HFAs can also use cash to redeem unhedged variable-rate bonds if interest rates become too high. As Exhibit 2 shows, the cash and cash equivalents that HFAs had at fiscal year-end 2015 were equal to 2.7x the amount of unhedged variable-rate debt. Higher interest rates also mean HFAs’ swap termination costs will decline, allowing HFAs to terminate swaps more economically.

An increase in mortgage rates (close to 6% or higher) would also allow HFAs to grow their loan portfolios. Although mortgage rates are not immediately affected by short-term interest rates, changes affect long-term mortgage rates. Demand for HFA mortgages is driven by the attractiveness of rates on HFA loans relative to those on conventional mortgages. With rates on conventional mortgages so low, HFAs have found it difficult to originate loans over the past seven years. With an increase in interest rates, fewer borrowers could obtain a mortgage from a conventional lender at a lower rate than from an HFA. Higher loan originations, coupled with issuance of tax-exempt bonds, would rebuild HFA balance sheets. In the past few years, HFAs have financed loans primarily through selling mortgage-backed securities in the secondary market rather than bond financing.

U.S. economy adds fewer jobs than expected; Fed rate move in doubt

As reported in the Globe and Mail, U.S. employment growth slowed more than expected in August after two straight months of robust gains and wage gains moderated, which could effectively rule out an interest rate increase from the Federal Reserve this month.

USA-Economy-Pic

Nonfarm payrolls rose by 151,000 jobs last month after an upwardly revised 275,000 increase in July, with hiring in manufacturing and construction sectors declining, the Labor Department said on Friday. The unemployment rate was unchanged at 4.9 per cent as more people entered the labour market.

“This mixed jobs report puts the Fed in a tricky situation. It’s not all around strong enough to assure a September interest rate hike. But it’s solid enough to engender a heated policy discussion,” said Mohamed el-Erian, chief economic adviser at Allianz, in Newport Beach, California.

Economists polled by Reuters had forecast payrolls rising 180,000 last month and the unemployment rate slipping one-tenth of a percentage point to 4.8 per cent.

Last month’s jobs gains, however, could still be sufficient to push the Fed to raise interest rates in December. The rise in payrolls reinforces views that the economy has regained speed after almost stalling in the first half of the year.

The report comes more than two weeks before the U.S. central bank’s Sept. 20-21 policy meeting. Rate hike probabilities for both the September and December meetings rose after remarks last Friday by Fed Chair Janet Yellen that the case for raising rates had strengthened in recent months.

Following the report, financial markets were pricing in a 27 per cent chance of a rate hike this month and a 57.7 per cent probability in December, according to the CME Fedwatch tool.

The Fed lifted its benchmark overnight interest rate at the end of last year for the first time in nearly a decade, but has held it steady since amid concerns over low inflation.

The dollar fell against a basket of currencies after the report, while prices for U.S. government bonds rose. U.S. stock futures rose.

“As far as the Fed is concerned, I don’t think it’s a number that is a major setback for what they ultimately want to achieve, which is a slow and gradual pace for a rate normalization,” said Jason Celente, senior fixed income portfolio manager at Insight Investment in New York.

Fed Minutes Point To Rate Rise … Sometime…

The last FED meeting suggests it could well be time to raise short-term interest rates at the December policy meeting after keeping them at near zero levels for more than seven years, according to released minutes.  Whilst they voted to change the wording of their policy statement leaving the option to lift in December; it is not a sure bet.

From the Fed minutes for October.

After assessing the outlook for economic activity, the labor market, and inflation and weighing the uncertainties associated with the outlook, all but one member agreed to leave the target range for the federal funds rate unchanged at this meeting. Members generally agreed that, in light of some weaker-than-expected readings on measures of labor market conditions and in the absence of greater confidence about the inflation outlook, it would be prudent to wait for additional information bearing on the medium-term outlook before initiating the process of policy normalization. One member, however, preferred to raise the target range for the federal funds rate by 25 basis points at this meeting.

In its postmeeting statement, rather than framing its near-term policy path in terms of how long to maintain the current target range, the Committee decided to indicate that, in determining whether it would be appropriate to raise the target range at its next meeting, it would assess both realized and expected progress toward its objectives of maximum employment and 2 percent inflation. Members emphasized that this change was intended to convey the sense that, while no decision had been made, it may well become appropriate to initiate the normalization process at the next meeting, provided that unanticipated shocks do not adversely affect the economic outlook and that incoming data support the expectation that labor market conditions will continue to improve and that inflation will return to the Committee’s 2 percent objective over the medium term. Members saw the updated language as leaving policy options open for the next meeting. However, a couple of members expressed concern that this wording change could be misinterpreted as signaling too strongly the expectation that the target range for the federal funds rate would be increased at the Committee’s next meeting. While members differed in their assessment of the likelihood that incoming information will warrant an increase in the target range for the federal funds rate when the Committee meets in December, they agreed that, in making the decision, the Committee will evaluate progress toward its objectives, taking into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial and international developments. It was noted that the expected path of the federal funds rate, rather than the exact timing of the initial increase, was most important in influencing financial conditions and thus in affecting the outlook for the economy and inflation. The Committee reiterated its expectation that, even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the Committee views as normal in the longer run.

The Committee also maintained its policy of reinvesting principal payments from its agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction. This policy, by keeping the Committee’s holdings of longer-term securities at sizable levels, should help maintain accommodative financial conditions.

US Banking Supervision, More To Do

Fed Chair Janet L. Yellen addressed the Committee on Financial Services, U.S. House of Representatives on Banking Sector Supervision. She said that before the crisis, their primary goal was to ensure the safety and soundness of individual financial institutions. A key shortcoming of that approach was that they did not focus sufficiently on shared vulnerabilities across firms or the systemic consequences of the distress or failure of the largest, most complex firms. Although changes have been made, substantial compliance and risk-management issues remain.

There has since been a significant shift in focus has led to a comprehensive change in the regulation and supervision of large financial institutions. These reforms are designed to reduce the probability that large financial institutions will fail by requiring those institutions to make themselves more resilient to stress. However, recognising that the possibility of a large financial institution’s failing cannot be eliminated, a second aim of the post-crisis reforms has been to limit the systemic damage that would result if a large financial institution does fail. This effort has involved taking steps to help ensure that authorities would have the ability to resolve a failed firm in an orderly manner while its critical operations continue to function.

They created the Large Institution Supervision Coordinating Committee (LISCC). The LISCC is charged with the supervision of the firms that pose elevated risk to U.S. financial stability. Those firms include the eight U.S. banking organizations that have been identified as GSIBs, four foreign banking organizations with large and complex U.S. operations, and the four nonbank financial institutions that have been designated as systemically important by the Financial Stability Oversight Council (FSOC).

With regard to capital adequacy, the Federal Reserve’s Comprehensive Capital Analysis and Review (CCAR) is designed to ensure that large U.S. bank holding companies, including the LISCC firms, have rigorous, forward-looking capital planning processes and have sufficient levels of capital to operate through times of stress, as defined by the Federal Reserve’s supervisory stress scenario. The program enables regulators to make a quantitative and qualitative assessment of the resilience and capital planning abilities of the largest banking firms on an annual basis and to limit capital distributions for firms that exhibit weaknesses.

The financial condition of the firms in the LISCC portfolio has strengthened considerably since the crisis. Common equity capital at the eight U.S. GSIBs alone has more than doubled since 2008, representing an increase of almost $500 billion. Moreover, these firms generally have much more stable funding positions. The amount of high-quality liquid assets held by the eight U.S. GSIBs has increased by roughly two-thirds since 2012, and their reliance on short-term wholesale funding has dropped considerably. The new regulatory and supervisory approaches are aimed at helping ensure these firms remain strong. Requiring these firms to plan for an orderly resolution has forced them to think more carefully about the sustainability of their business models and corporate structures.

Nevertheless, while they have seen some evidence of improved risk management, internal controls, and governance at the LISCC firms, they continue to have substantial compliance and risk-management issues. Compliance breakdowns in recent years have undermined confidence in the LISCC firms’ risk management and controls and could have implications for financial stability, given the firms’ size, complexity, and interconnectedness. The LISCC firms must address these issues directly and comprehensively.

Their examinations have found large and regional banks to be well capitalized. Both large and regional banking organizations experienced dramatic improvements in profitability since the financial crisis, although these banks have also faced challenges in recent years due to weak growth in interest and noninterest income. Both large and regional institutions have seen robust growth in commercial and industrial lending.

Finally, community banks are significantly healthier. More than 95 percent are now profitable, and capital lost during the crisis has been largely replenished. Loan growth is picking up, and problem loans are now at levels last seen early in the financial crisis.

FED Announces Further Capital Uplifts For GSIB’s

The Federal Reserve Board approved a final rule requiring the largest, most systemically important U.S. bank holding companies to further strengthen their capital positions. Under the rule, a firm that is identified as a global systemically important bank holding company, or GSIB, will have to hold additional capital ranging from 1.0 to 4.5 percent of each firm’s total risk-weighted assets to increase its resiliency in light of the greater threat it poses to the financial stability of the United States.

The final rule establishes the criteria for identifying a GSIB and the methods that those firms will use to calculate a risk-based capital surcharge, which is calibrated to each firm’s overall systemic risk. Eight U.S. firms are currently expected to be identified as GSIBs under the final rule: Bank of America Corporation; The Bank of New York Mellon Corporation; Citigroup, Inc.; The Goldman Sachs Group, Inc.; JPMorgan Chase & Co.; Morgan Stanley; State Street Corporation; and Wells Fargo & Company.

“A key purpose of the capital surcharge is to require the firms themselves to bear the costs that their failure would impose on others,” Chair Janet L. Yellen said. “In practice, this final rule will confront these firms with a choice: they must either hold substantially more capital, reducing the likelihood that they will fail, or else they must shrink their systemic footprint, reducing the harm that their failure would do to our financial system. Either outcome would enhance financial stability.”

Like the proposal issued in December 2014, the final rule requires GSIBs to calculate their surcharges under two methods and use the higher of the two surcharges. The first method is based on the framework agreed to by the Basel Committee on Banking Supervision and considers a GSIB’s size, interconnectedness, cross-jurisdictional activity, substitutability, and complexity.

The second method uses similar inputs, but is calibrated to result in significantly higher surcharges and replaces substitutability with a measure of the firm’s reliance on short-term wholesale funding. As seen during the crisis, reliance on this type of funding left firms vulnerable to runs and fire sales, which may impose additional costs on the broader financial system and economy.

Under the final rule and using the most recent available data, estimated surcharges for the eight GSIBs range from 1.0 to 4.5 percent of each firm’s total risk-weighted assets. Because the final rule relies on individual GSIB data that will change over time, the currently estimated surcharges may not reflect the surcharges that would apply to a GSIB when the rule becomes effective.

“A set of graduated capital surcharges for the nation’s most systemically important financial institutions will be an especially important part of the strengthened regulatory framework we have constructed since the financial crisis,” Governor Daniel K. Tarullo said. “Like the higher leverage ratio requirements we will apply to these firms, they reflect the relatively new, but very significant, principle that the stringency of prudential standards should vary with the systemic importance of regulated firms.”

In response to comments, the Board modified several aspects of the proposal’s second method to more accurately reflect a GSIB’s systemic importance. Additionally, the Board released a white paper on Monday describing how the surcharges were calibrated. The paper details the methodology used to set a GSIB’s surcharge at a level that would reduce the impact of its failure to near the impact of the failure of a large bank holding company that is not a GSIB.

The surcharges will be phased in beginning on January 1, 2016, becoming fully effective on January 1, 2019.

FED Ends Bond By-Back Programme

Just released. Sufficient signs of recovery mean the FED will end QE this month. Interest rates will remain low for now.  One of the biggest economic experiments in history moves to a new phase.

Information received since the Federal Open Market Committee met in September suggests that economic activity is expanding at a moderate pace. Labor market conditions improved somewhat further, with solid job gains and a lower unemployment rate. On balance, a range of labor market indicators suggests that underutilization of labor resources is gradually diminishing. Household spending is rising moderately and business fixed investment is advancing, while the recovery in the housing sector remains slow. Inflation has continued to run below the Committee’s longer-run objective. Market-based measures of inflation compensation have declined somewhat; survey-based measures of longer-term inflation expectations have remained stable.

Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The Committee expects that, with appropriate policy accommodation, economic activity will expand at a moderate pace, with labor market indicators and inflation moving toward levels the Committee judges consistent with its dual mandate. The Committee sees the risks to the outlook for economic activity and the labor market as nearly balanced. Although inflation in the near term will likely be held down by lower energy prices and other factors, the Committee judges that the likelihood of inflation running persistently below 2 percent has diminished somewhat since early this year.

The Committee judges that there has been a substantial improvement in the outlook for the labor market since the inception of its current asset purchase program. Moreover, the Committee continues to see sufficient underlying strength in the broader economy to support ongoing progress toward maximum employment in a context of price stability. Accordingly, the Committee decided to conclude its asset purchase program this month. The Committee is maintaining its existing policy of reinvesting principal payments from its holdings of agency debt and agency mortgage-backed securities in agency mortgage-backed securities and of rolling over maturing Treasury securities at auction. This policy, by keeping the Committee’s holdings of longer-term securities at sizable levels, should help maintain accommodative financial conditions.

To support continued progress toward maximum employment and price stability, the Committee today reaffirmed its view that the current 0 to 1/4 percent target range for the federal funds rate remains appropriate. In determining how long to maintain this target range, the Committee will assess progress–both realized and expected–toward its objectives of maximum employment and 2 percent inflation. This assessment will take into account a wide range of information, including measures of labor market conditions, indicators of inflation pressures and inflation expectations, and readings on financial developments. The Committee anticipates, based on its current assessment, that it likely will be appropriate to maintain the 0 to 1/4 percent target range for the federal funds rate for a considerable time following the end of its asset purchase program this month, especially if projected inflation continues to run below the Committee’s 2 percent longer-run goal, and provided that longer-term inflation expectations remain well anchored. However, if incoming information indicates faster progress toward the Committee’s employment and inflation objectives than the Committee now expects, then increases in the target range for the federal funds rate are likely to occur sooner than currently anticipated. Conversely, if progress proves slower than expected, then increases in the target range are likely to occur later than currently anticipated.

When the Committee decides to begin to remove policy accommodation, it will take a balanced approach consistent with its longer-run goals of maximum employment and inflation of 2 percent. The Committee currently anticipates that, even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the Committee views as normal in the longer run.

Voting for the FOMC monetary policy action were: Janet L. Yellen, Chair; William C. Dudley, Vice Chairman; Lael Brainard; Stanley Fischer; Richard W. Fisher; Loretta J. Mester; Charles I. Plosser; Jerome H. Powell; and Daniel K. Tarullo. Voting against the action was Narayana Kocherlakota, who believed that, in light of continued sluggishness in the inflation outlook and the recent slide in market-based measures of longer-term inflation expectations, the Committee should commit to keeping the current target range for the federal funds rate at least until the one-to-two-year ahead inflation outlook has returned to 2 percent and should continue the asset purchase program at its current level.