Tag: Federal Reserve

US Bank Stress Tests To Be Eased

On 9 January, Moody’s says, the Federal Reserve Board (Fed) proposed revisions to company-run stress testing requirements for Fed-regulated US banks to conform with the Economic Growth, Regulatory Relief, and Consumer Protection Act (the EGRRCPA), which became law in May 2018.

Among the revisions, which are similar to those proposed in December 2018 by the Office of the Comptroller of the Currency (OCC) and the Federal Deposit Insurance Corp. (FDIC), is a proposal that would eliminate the requirement for company-run stress tests at most bank subsidiaries with total consolidated assets of less than $250 billion. The proposed changes would be credit negative for affected US banks because they would ease the minimum requirements for stress testing at the subsidiary level.

The proposed revisions would also require company-run stress tests once every other year instead of annually at most banks with more than $250 billion in total assets that are not subsidiaries of systemically important bank holding companies. Additionally, the proposal would eliminate the hypothetical adverse scenario from all company-run stress tests and from the Fed’s own supervisory stress tests, commonly known as the Dodd-Frank Stress Test (DFAST) and the Comprehensive Capital Analysis and Review (CCAR); the baseline and severely adverse scenarios would remain.

The proposed changes aim to implement EGRRCPA. As such, we expect that they will be adopted with minimal revisions. In late December 2018, the FDIC and OCC published similar proposals governing the banks they regulate. The stress testing requirements imposed on US banks over the past decade have helped improve US banks’ risk management practices and have led banks to incorporate risk management considerations more fully into both their strategic planning and daily decision making. Without periodic stress tests, these US banks may have more flexibility to reduce their capital cushions, making them more vulnerable in an economic
downturn.

On 31 October 2018, the Fed announced a similar proposal for the company-run stress tests conducted by bank holding companies as a part of a broader proposal to tailor its enhanced supervisory framework for large bank holding companies. Positively, the Fed’s 31 October 2018 proposal would still subject bank holding companies with total assets of $100-$250 billion to supervisory stress testing at least every two years and would still require them to submit annual capital plans to the Fed, even though the latest proposal would no longer require their bank subsidiaries to conduct their own company-run stress tests. Also, supervisory stress testing for larger holding companies would continue to be conducted annually. Continued supervisory stress testing should limit any potential reduction
in capital cushions at those bank holding companies.

We believe that some midsize banks will continue to use company-run stress testing in some form, but more tailored to their own needs and assumptions. Nevertheless, this may not be the view of all banks, particularly those for which stress testing has not been integrated with risk management. Additionally, smaller banks may have resource constraints.

The reduced frequency of mandated company-run stress testing for bank subsidiaries with assets above $250 billion that are not subsidiaries of systemically important bank holding companies is also credit negative, although not to the same extent as the elimination of the requirement for the midsize banks. The longer time between bank management’s reviews of stress test results introduces a higher probability of changing economic conditions that could leave a firm with an insufficient capital cushion.

The Fed’s proposal also would eliminate the hypothetical adverse scenario from company-run stress tests and the Fed’s supervisory stress tests. The market has focused on the severely adverse scenario, which is harsher than the adverse scenario so this proposed change is unlikely to have significant consequence.

FED Announces 2018 Transfer to the US Treasury

The Federal Reserve Board announced preliminary results indicating that the Reserve Banks provided for payments of approximately $65.4 billion of their estimated 2018 net income to the U.S. Treasury. The payments include two lump-sum payments totaling approximately $3.2 billion, necessary to reduce aggregate Reserve Bank capital surplus to $6.825 billion as required by the Bipartisan Budget Act of 2018 (Budget Act) and the Economic Growth, Regulatory Relief, and Consumer Protection Act (Economic Growth Act). The 2018 audited Reserve Bank financial statements are expected to be published in March and may include adjustments to these preliminary unaudited results.

The Federal Reserve Banks’ 2018 estimated net income of $63.1 billion represents a decrease of $17.6 billion from 2017, primarily attributable to an increase of $12.6 billion in interest expense associated with reserve balances held by depository institutions. Net income for 2018 was derived primarily from $112.3 billion in interest income on securities acquired through open market operations–U.S. Treasury securities, federal agency and government-sponsored enterprise (GSE) mortgage-backed securities, and GSE debt securities. The Federal Reserve Banks had interest expense of $38.5 billion primarily associated with reserve balances held by depository institutions, and incurred interest expense of $4.6 billion on securities sold under agreement to repurchase.

Operating expenses of the Reserve Banks, net of amounts reimbursed by the U.S. Treasury and other entities for services the Reserve Banks provided as fiscal agents, totaled $4.3 billion in 2018.

In addition, the Reserve Banks were assessed $849 million for the costs related to producing, issuing, and retiring currency, $838 million for Board expenditures, and $337 million to fund the operations of the Consumer Financial Protection Bureau. Additional earnings were derived from income from services of $444 million. Statutory dividends totaled $1 billion in 2018.

Fed Lifts As Expected

As expected the FED lifted the targets rate today. No real indication of future changes, suggesting a pause perhaps? Here is their statement:

Information received since the Federal Open Market Committee met in November indicates that the labor market has continued to strengthen and that economic activity has been rising at a strong rate. Job gains have been strong, on average, in recent months, and the unemployment rate has remained low. Household spending has continued to grow strongly, while growth of business fixed investment has moderated from its rapid pace earlier in the year. On a 12-month basis, both overall inflation and inflation for items other than food and energy remain near 2 percent. Indicators of longer-term inflation expectations are little changed, on balance.

Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The Committee judges that some further gradual increases in the target range for the federal funds rate will be consistent with sustained expansion of economic activity, strong labor market conditions, and inflation near the Committee’s symmetric 2 percent objective over the medium term. The Committee judges that risks to the economic outlook are roughly balanced, but will continue to monitor global economic and financial developments and assess their implications for the economic outlook.

In view of realized and expected labor market conditions and inflation, the Committee decided to raise the target range for the federal funds rate to 2-1/4 to 2‑1/2 percent.

In determining the timing and size of future adjustments to the target range for the federal funds rate, the Committee will assess realized and expected economic conditions relative to its maximum employment objective and its symmetric 2 percent inflation objective. 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 and international developments.

The Dow is currently down significantly, having been higher in the day.

How Persistent Is Financial Distress?

From The St. Louis Fed.

Interesting research from the US, which shows that households who get into financial difficulty may make up a minority of all households, but they tend to stay in this state for an extended period. This is exacerbated by high default fees and charges, and an impatience to consume.

When households lose income unexpectedly, they may skip debt payments (such as credit card payments) rather than lower their consumption. Given that most everyone will experience unanticipated income changes at some point, one may expect that a majority of households fell (at least temporarily) into financial distress sometime between 1999 and 2016. The findings in this post challenge that view: The data show financial distress to be highly concentrated in a relatively small share of the population.

Measuring Financial Distress

We used data from the New York Federal Reserve Consumer Credit Panel/Equifax to show the concentration of debt delinquency across a nationwide sample of people with credit reports. “Total delinquency” refers to the total number of quarters in which people in our sample had debt payments that were 120 days delinquent or more.

The graph below orders the population from least financial distress to most and presents the portion of total delinquency accounted for by every population centile. This is done in two separate lines for credit card debt and for any kind of debt.1

debt delinquency

Debt Delinquency Concentration

The first major fact to emerge is that debt delinquency was highly concentrated over the period 1996-2016. About 60 percent of people never have debt payments 120 days late. On the other extreme, 20 percent of people accounted for 80 percent of financial distress, and around 10 percent of people accounted for 50 percent.

This points to the fact that delinquency is frequent among those who experience it. In fact, more than 30 percent of people who had debt 120 days delinquent at any point in our sample spent at least a quarter of their time in that state.

Effect of Credit Card Delinquency

A second major fact to emerge is that much of the trend in financial distress concentration was driven by credit card delinquency. This makes sense given that credit cards are a widely used debt instrument.

Addressing Financial Distress

In light of the remarkable concentration and persistence of financial distress, it is important for policymakers to be able to disentangle the causes. What factors drive some people to be in financial distress for so long and others to never experience it?

In a working paper titled “The Persistence of Financial Distress,” Fed economists Juan M. Sánchez, José Mustre-del-Río and Kartik Athreya examined this question.2 Specifically, they showed that while traditional economic models of defaultable debt cannot account for the observed concentration and persistence of financial distress, a model which also accounts for high penalty rates on delinquent debt and individuals’ heterogeneity in impatience to consume can do so with a high degree of accuracy.

FED Holds In November (But Expect A Rise In December)

Information received since the Federal Open Market Committee met in September indicates that the labor market has continued to strengthen and that economic activity has been rising at a strong rate. Job gains have been strong, on average, in recent months, and the unemployment rate has declined. Household spending has continued to grow strongly, while growth of business fixed investment has moderated from its rapid pace earlier in the year. On a 12-month basis, both overall inflation and inflation for items other than food and energy remain near 2 percent. Indicators of longer-term inflation expectations are little changed, on balance.

There was no mention of the deterioration in data with policymakers describing household spending growth as strong even though core retail sales stagnated in September. This unambiguously positive outlook is a signal of the central bank’s commitment to raising interest rates. There’s no doubt that the Fed will hike in December, especially if stocks maintain their current recovery.

The T10 Bond Rate went higher.

Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The Committee expects that further gradual increases in the target range for the federal funds rate will be consistent with sustained expansion of economic activity, strong labor market conditions, and inflation near the Committee’s symmetric 2 percent objective over the medium term. Risks to the economic outlook appear roughly balanced.

In view of realized and expected labor market conditions and inflation, the Committee decided to maintain the target range for the federal funds rate at 2 to 2-1/4 percent.

In determining the timing and size of future adjustments to the target range for the federal funds rate, the Committee will assess realized and expected economic conditions relative to its maximum employment objective and its symmetric 2 percent inflation objective. 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 and international developments.

US Bank Capital Requirements Eased

Moody’s says that relaxed regulatory oversight for the largest US regional banks would be credit negative.

On 31 October, the US Federal Reserve (Fed) proposed revisions to the prudential standards for the supervision of large US bank holding companies to implement the Economic Growth, Regulatory Relief, and Consumer Protection Act (the Act) that became law in May of this year. The proposal would apply less rigorous capital and liquidity standards to most large regional bank holding companies with less than $700 billion of consolidated assets or less than $75 billion of cross-jurisdictional activity, a credit-negative.

In particular, the Fed proposals would relax current supervisory requirements for banks with assets of more than $250 billion, which goes beyond the Act’s primary focus on banks below that threshold. However, the proposal is still consistent with the Act’s emphasis on regulation that increases in stringency with a firm’s risk profile, defining four categories of banks as described and named in Exhibit 1 (other firms are no longer subject to the Fed’s enhanced prudential standards under the Act).

The 11 firms in Category IV would be subject to significantly reduced regulatory requirements under the proposal, including public supervisory stress testing every two years instead of annually. These firms would also be permitted to exclude accumulated other comprehensive income (AOCI) from capital and would no longer be subject to the liquidity coverage ratio (LCR) or proposed net stable funding ratio (NFSR) rules. Internal liquidity stress-testing would be required quarterly rather than monthly.

The four firms in Category III would be subject to modestly reduced regulatory requirements under the proposal. They would no longer have to apply the advanced approaches (internal models-based) risk-based capital requirements but would remain subject to the standardized approach requirements. Like Category IV firms, they could elect to exclude AOCI from capital. However, they would still be subject to the annual public supervisory stress tests. Their LCR and NFSR requirements would be reduced to between 70% and 85% of full requirements.

The changes in capital and liquidity requirements for Category III and IV firms are likely to reduce their capital and liquidity buffers, a credit negative. Moreover, the reduced frequency of capital and liquidity stress testing could lead to more relaxed oversight and afford banks greater leeway in managing their capital and liquidity, as well as reduce transparency and comparability, since fewer firms will participate in the public supervisory stress test.

Category I and II firms would not see any changes to their capital or liquidity requirements. The proposals do not address the US operations of foreign banking organizations, but a proposal on their supervision will likely be forthcoming.

Fed Minutes Underscores Higher Rates Ahead

The Federal Reserve released the minutes relating to the 26th September decision to lift rates.  The impression from the more detailed disclosures is that more hikes are likely, and perhaps quicker than originally expected.  Members agreed to remove the sentence indicating that “the stance of monetary policy remains accommodative.”

US Mortgage Rates continue higher.

This is what the FED said:

In their discussion of monetary policy for the period ahead, members judged that information received since the Committee met in August indicated that the labor market had continued to strengthen and that economic activity had been rising at a strong rate. Job gains had been strong, on average, in recent months, and the unemployment rate had stayed low. Household spending and business fixed investment had grown strongly. On a 12-month basis, both overall inflation and inflation for
items other than food and energy remained near 2 percent.

Indicators of longer-term inflation expectations were little changed on balance.

Members viewed the recent data as consistent with an economy that was evolving about as they had expected. Consequently, members expected that further gradual increases in the target range for the federal funds rate would be consistent with sustained expansion of economic activity, strong labor market conditions, and inflation near the Committee’s symmetric 2 percent objective over the medium term. Members continued to judge that the risks to the economic outlook remained roughly balanced.

After assessing current conditions and the outlook for economic activity, the labor market, and inflation, members voted to raise the target range for the federal funds rate to 2 to 2¼ percent. Members agreed that the timing
and size of future adjustments to the target range for the federal funds rate would depend on their assessment of realized and expected economic conditions relative to the Committee’s maximum-employment objective and symmetric 2 percent inflation objective. They reiterated that this assessment would 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 and international developments.

With regard to the postmeeting statement, members agreed to remove the sentence indicating that “the stance of monetary policy remains accommodative.” Members made various points regarding the removal of the sentence from the statement. These points included that the characterization of the stance of policy as “accommodative” had provided useful forward guidance in the early stages of the policy normalization process, that this characterization was no longer providing meaningful information in light of uncertainty surrounding the level of the neutral policy rate, that it was appropriate to remove the characterization of the stance from the Committee’s statement before the target range for the federal funds rate moved closer to the range of estimates of the neutral policy rate, and that the Committee’s earlier communications had helped prepare the public for this change.

In choppy trading in the US on Wednesday, it appears the markets are coming to accept higher rates ahead. The Dow Jones Industrial Average fell 91.74 points, or 0.36 percent, to 25,706.68.

The Fear Index eased a little to 17.40, down 1.25%, but volatility still stalks the halls.

The S&P 500 lost 0.71 points, or 0.03 percent, to 2,809.21.

The Nasdaq Composite dropped 2.79 points, or 0.04 percent, to 7,642.70.

The 10-Year Bond rate continued higher ending at 3.207, up 0.88%.

The FED Lifts, More Ahead And What Are The Consequences?

We discuss the implications of the FED move, plus a final look at the 60 Minutes segments on home prices.

Please consider supporting our work via Patreon ;

Please share this post to help to spread the word about the state of things….

Economics and Markets
Economics and Markets
The FED Lifts, More Ahead And What Are The Consequences?



Loading





/

Fed Hikes As Expected – More To Come…

The Fed moved as expected, and continues to highlight more upward movements in the months ahead – in fact their language is arguably more bullish now.  The target range for the federal funds rate is now 2 to 2-1/4 percent.

In their projection release, they see GDP sliding from 2019….

… while inflation is expected to rise:

Information received since the Federal Open Market Committee met in August indicates that the labor market has continued to strengthen and that economic activity has been rising at a strong rate. Job gains have been strong, on average, in recent months, and the unemployment rate has stayed low. Household spending and business fixed investment have grown strongly. On a 12-month basis, both overall inflation and inflation for items other than food and energy remain near 2 percent. Indicators of longer-term inflation expectations are little changed, on balance.

Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The Committee expects that further gradual increases in the target range for the federal funds rate will be consistent with sustained expansion of economic activity, strong labor market conditions, and inflation near the Committee’s symmetric 2 percent objective over the medium term. Risks to the economic outlook appear roughly balanced.

In view of realized and expected labor market conditions and inflation, the Committee decided to raise the target range for the federal funds rate to 2 to 2-1/4 percent.

In determining the timing and size of future adjustments to the target range for the federal funds rate, the Committee will assess realized and expected economic conditions relative to its maximum employment objective and its symmetric 2 percent inflation objective. 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 and international developments.

Voting for the FOMC monetary policy action were: Jerome H. Powell, Chairman; John C. Williams, Vice Chairman; Thomas I. Barkin; Raphael W. Bostic; Lael Brainard; Richard H. Clarida; Esther L. George; Loretta J. Mester; and Randal K. Quarles.

Does A Yield Curve Inversion Lead To A Recession?

Today we consider whether the shape of the yield curve is a good indicator of a future recession in the US.

To answer that question, let’s look at the longer term trends, using data from one of our favourite data sources FRED.  FRED is the St. Louis Fed datasets, which contains a wide range of useful indices.

Here is plot of the 10 year rates since 1980. The shaded areas are US recessions, when the economy shrank (generally seen as a negative indicator), certainly unemployment rose as is clearly evident as a direct result of the recession.

But now let’s look at the 10-year rate from the 1980’s, and overlay the 3-month rate also. In the video we follow the inflection points, and here is the thing. Prior to each of the last three US recessions, the short-term rate overtook the long term rate in a classic inversion of the yield curve. And we see recessions follow.

The logic behind the inverted yield curve as a recession indicator is simple: if long-term yields are lower than short-term yields, the market’s view is that growth will slow in the coming years. More often than not, that view has been right.

From this, we can say there is clear evidence that once the yield curve does reverse, a recession will likely follow. But what does that tell us about the current situation? Well currently short term rates have been rising sharply, more so than long term rates, as the Fed draws in their QE horns. If that trend continues, the yield curve will go negative, and in that case a US recession is highly likely. And on current trajectory that could happen within a couple of years.

However, beware, because there were cases when the US yield curve inverted but a recession did not follow. For example, in the late 1980s, the yield curve inverted and then steepened again, before inverting again later on before a recession hit. The curve also inverted very briefly in the late 1990s, too, and again in 2005-2006. However, the trends to my mind do signal a recession, but the timing does vary. Sometimes it happens in just a few months, in other cases it’s taken a year or two. But it does look like a yield inversion is an important signal to watch for, worth bearing in mind when people are taking about all the reasons why the stock market in the US should go higher still.