Tag: USA

Tweaked Volcker Rule still has teeth, which is credit positive

Last Wednesday, US regulatory agencies (namely the Federal Reserve, Office of the Comptroller of the Currency, the Federal Deposit Insurance Corporation, the Securities and Exchange Commission and the Commodity Futures Trading Commission) jointly proposed changes to simplify and clarify the Volcker Rule and tailor the compliance obligations of US banks, based on their trading activities. The changes are based on several years of regulatory experience applying the Volcker Rule says Moody’s.

For banks with the most trading activity – including Bank of America Corporation, Citigroup Inc., The Goldman Sachs Group, Inc., JPMorgan Chase & Co., Morgan Stanley and Wells Fargo & Company – the proposed changes should reduce the uncertainty about the rule’s enforcement and simplify reporting requirements, which is credit positive for the banks.

The Volcker Rule will continue to prohibit most forms of proprietary trading, which it defines as purchasing or selling financial instruments (exempting of US government securities) with the intent to profit from short-term price movements.

There are three noteworthy proposed amendments to the Volcker Rule. First, to tailor the rule based on the degree of trading risk, banks will be divided into those with gross trading assets and liabilities exceeding $10 billion, those with between $1 billion and $10 billion and those with less than $1 billion – each with varying compliance requirements. The six aforementioned banks will all remain in the category with the most stringent reporting and compliance requirements.

Second, the definition of a trading account will be modified by replacing a “short-term intent” criterion with a more objective criteria that the account be recorded at fair value under applicable accounting standards. Finally, measurement of reasonably expected near-term demand (RENTD) is being modified. Under the existing rule, to be exempt from the ban on proprietary trading a bank must demonstrate that its purchase and sale of financial instruments relating to market-making and underwriting activities does not exceed RENTD. In practice, this has been difficult to demonstrate and may have contributed to banks’ reluctance to use the underwriting and market-making exemptions. Under the proposed amendments, a bank will be presumed to have stayed within RENTD if it implements, maintains and enforces internal risk limits surrounding its market-making and underwriting activities.

For the most active trading banks, added certainty about the provisos of the Volcker Rule should make it cheaper and easier to comply with the rule and provide greater certainty about allowable market-making and underwriting activities. At the same time, it may also make it easier for regulators to enforce the rule – and maintain a regulatory guardrail that protects creditors against the risk that banks drift into proprietary trading away from their core market-making activities.

A clarified Volcker Rule that is easier to comply with and enforce, when combined with other post-crisis regulatory enhancements that still require banks to hold greater amounts capital and liquidity for less liquid and more volatile exposures (including the Basel III capital and liquidity framework, the Dodd-Frank Stress Tests, and the Fed’s Comprehensive Capital Analysis and Review), is a credit-positive development.

Dodd-Frank Easing May Be Long-Term Negative for US Banks

Congressional passage of financial reform legislation easing the Dodd-Frank Act (DFA) for smaller and custodial banks is not likely to be a near-term ratings issue but could be negative for some banks’ credit profiles over the long term, if it results in significantly reduced capital levels, Fitch Ratings says.

The congressional legislation, which is widely expected to be signed into law by the president as early as this week, eases the capital and regulatory requirements for smaller institutions and custody banks. Fitch views robust regulation and capital as supportive of bank creditworthiness.

Key attributes of the legislation raise the systemic threshold to $250 billion from $50 billion for enhanced prudential standards (EPS), reduce stress testing requirements and modify applicability of proprietary trading rules (the Volcker Rule). The legislation reduces regulations for U.S. small to mid-size banks in particular, while only providing de-minimis regulatory relief to the largest U.S. banks. The change to the systemic threshold reduces the number of banks subject to heightened regulatory oversight to 12 from 38. Regulators will still have discretion to apply EPS to banks with $100 billion-$250 billion in assets. Banks above $250 billion in assets would not see much benefit from the legislation.

The biggest potential change to regulatory and capital requirements is for banks under $100 billion in assets, exempting them from DFA stress test requirements. From Fitch’s perspective, stress testing has provided discipline for banks and is an important risk governance practice that is considered in its rating analysis. The elimination or meaningful reduction of stress testing would likely have negative ratings implications.

Technically, the Fed’s CCAR process is not considered EPS and therefore the lower $50 billion proposed threshold isn’t applicable to CCAR, which applies to banks over $50 billion in assets. However, exempting banks with under $100 billion in assets from stress testing requirements makes it likely the Fed would align its CCAR testing requirements with Congress’ new thresholds. Banks with over $250 billion in assets would still be required to run CCAR; however, banks between $100 billion and $250 billion in assets would be subject to periodic rather than annual stress testing requirements.

Trust and custody banks would benefit from the potential carve out of central bank deposits to their supplementary leverage ratios, allowing for increased leverage. However, the joint banking regulators’ notice of proposed rulemaking (NPR) on the enhanced supplementary leverage ratio (eSLR) noted the proposed recalibration of the eSLR was contingent on the capital rules’ current definitions of tier 1 capital and total leverage exposure, which is being significantly altered by this legislation. The NPR specifically stated: “Significant changes to either of these components would likely necessitate reconsideration of the proposed recalibration as the proposal is not intended to materially change the aggregate amount of capital in the banking system.” The regulators’ response to this definition change only for the custody banks remains unclear. Ultimately, how much custody banks increase their leverage will also dictate ratings implications.

Banks with less than $10 billion in assets would be exempt from Volcker Rule restrictions on speculative trading, and banks originating less than 500 mortgages annually would be exempt from some of the record-keeping requirements of the Home Mortgage Disclosure Act. The Volcker Rule exemption would not aid large banks that must still demonstrate compliance with the rule. The legislation would also require U.S. regulators to consider certain investment-grade municipal securities as high-quality liquid assets for liquidity coverage calculations.

Higher US Mortgage Yields Offset Lowest Jobless Rate Since 2000

The return of a 3% 10-year Treasury yield is making itself known in the housing industry. Markets have already priced in a loss of housing activity to the highest mortgage yields since 2011, according to Moody’s. They conclude that just as it is overly presumptuous to predict the nearness of a 4% 10-year Treasury yield, it is premature to declare an impending top for the benchmark Treasury yield.

Thus far in 2018, the 11% drop by the PHLX index of housing-sector share prices differs drastically from the accompanying 3% rise by the market value of U.S. common stock. In addition, the CDS spreads of housing-related issuers show a median increase of 78 bp for 2018-to-date, which is greater than the overall market’s increase of roughly 23 bp. Finally, 2018-to-date’s -1.97% return from high-yield bonds is worse than the -0.13% return from the U.S.’ overall high-yield bond market. Despite the lowest unemployment rate since 2000, the sum of new and existing home sales dipped by 0.7% year-over-year during January-April 2018. Unit home sales may not soon accelerate by enough to strengthen the case for higher Treasury yields. First-quarter 2018’s average index of pending sales of existing homes contracted by 11.5% annualized from 2017’s final quarter on a seasonally-adjusted basis, while shrinking by 3.7% year-over-year before seasonal adjustment. The recent record suggests that the 10-year Treasury yield will ultimately follow home sales.

March 2018’s 7% yearly drop by the NAR’s index of home affordability showed that the growth of after tax income was not rapid enough to overcome the combination of higher home prices and costlier mortgage yields. March incurred the 17th consecutive yearly decline by the home affordability index. The moving three-month average of home affordability now trails its current cycle high of the span-ended January 2013 by 23%.

Fewest Applications for Mortgage Refinancings since 2000

The highest effective 30-year mortgage yield in seven years has depressed applications for mortgage refinancings. For the week-ended May 18, the MBA’s effective 30-year mortgage yield reached 5.01% for its highest reading since the 5.04% of April 15, 2011. The effective 30-year mortgage yield’s latest fourweek average of 4.95% was up by 63 bp from the 4.32% of a year earlier.

The yearly increase by the effective 30-year mortgage yield’s moving four-week average last swelled by at least 63 bp during the span-ended July 12, 2013. The 10-year Treasury yield’s month-long average would climb from July 2013’s 2.56% to a December 2013 peak of 2.89%. Thereafter, a decline by unit home sales had helped to lower the 10-year Treasury yield to 2.53% by July 2014.

As of May 18, 2018, the Mortgage Bankers Association’s seasonally-adjusted weekly index of applications for mortgage refinancings sank to its lowest reading since December 29, 2000. Nevertheless, it should be noted that the MBA commenced a new sample on September 16, 2011. During the four-weeks-ended May 18, applications for mortgage refinancings sank by 19.6% year-overyear.

Moreover, the latest moving 13-week average of applications for mortgage refinancings is a very deep 77.8% under its current cycle high of October 12, 2012. By contrast, mortgage applications from prospective homebuyers are holding up much better. During the four weeks ended May 18, the MBA’s average index for homebuyer mortgage applications dipped by 0.9% from the contiguous four-weeks-ended April 20, 2018, as the year-over-year increase slowed from April 20’s 6.6% to May 18’s 3.5%.

The sum of new and existing sales of single-family homes sank annually in only nine of the calendar years since 1988. In eight of those nine years, the 10-year Treasury yield’s yearlong average fell in the following calendar year. For the nine years following a drop by single-family home sales, the median annual change for the 10-year Treasury yield’s yearlong average was -41 bp.

In summary, the longer that higher interest rates weigh on business activity and financial markets, the closer is a peak for bond yields. Nonetheless, just as it is overly presumptuous to predict the nearness of a 4% 10-year Treasury yield, it is premature to declare an impending top for the benchmark Treasury yield.

Families in Financial Distress Are More Likely to Stay in Distress

According to the  latest from The St.Louis Fed On The Economy Blog, individuals who were in financial distress five years ago were about twice as likely to be in financial distress today when compared with an average individual.

Many households have experienced financial distress at least one time in their life. In these situations, households miss payments for different reasons (unemployment, sickness, etc.) and eventually file bankruptcy to discharge those obligations.

In a recent working paper, I (Juan) and my co-authors Kartik Athreya and José Mustre-del-Río argued that financial distress is not only quite widespread but is also very persistent. Using Federal Reserve Bank of New York Consumer Credit Panel/Equifax data, we reported that individuals who were in financial distress five years ago were about twice as likely to be in financial distress today when compared with an average individual.1

Consumer Bankruptcy

In this post, we focus our attention on a very extreme form of financial distress: consumer bankruptcy. We obtained financial distress data from the Survey of Consumer Finances (SCF), conducted by the Board of Governors. The data span from 1998 to 2016 with triennial frequency, and the respondents who are younger than 25 or older than 65 have been trimmed.2

We first measured the share of households that had previously experienced an episode of financial distress by looking at people who filed for bankruptcy five or more years ago.3 The figure below shows that the share of households with past financial distress increased from approximately 6.6 percent in 1998 to 12.2 percent in 2016.

 

past distress

 

We then measured current financial distress by computing the share of households that delayed their loan payment on the year the survey was conducted.4 (We recognize that this measure is less extreme, as only a share of households that are late making payments will end up in bankruptcy.)5

The figure below shows that while there are minor fluctuations in the share of households with late payments throughout the sample period, the numbers remained around 8 percent.

current distress

 

Finally, we created a ratio to measure the persistence of financial distress. It compares the share of households with late payments among households that declared bankruptcy five or more years ago to the share of households with late payments the year the SCF was conducted.

If financial distress was not persistent at all, both shares would be equal, and the ratio would be one. Thus, a value greater than one indicates the persistence of financial distress. The figure below shows the evolution of the persistence of financial distress over the years.

distress persistance

The ratio fluctuates around 1.5, implying that the households that have encountered an episode of financial distress in the past are 1.5 times more likely to delay payment today, compared to average households.

The House of Cards

There is ever more talk of a significant financial markets correction ahead.

We review the signs of growing stress on financial markets which indicate that the risks are rising.

Economics and Markets
Economics and Markets
The House of Cards
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Equity markets a ‘house of cards’: FIIG

With US 10-year bond yields at a seven-year high, a relatively minor shock could be enough to trigger forced selling on equity markets, says FIIG via InvestorDaily.

The yield on 10-year US treasuries closed at 3.11 per cent overnight on Friday, a seven-year high that prompted speculation about a shift out of equities.

Speaking to InvestorDaily, FIIG NSW state manager Jon Sheridan said that if the 10-year holds at this level it will have broken the long-term secular downtrend in yields.

While he did not profess to be a “massive believer” in technical analysis, he said it is important to realise that many of the people trading in markets do.

And with high levels of margin debt and stretched valuations on the S&P 500 index, equity markets are looking like a “bit of a house of cards at the moment”, Mr Sheridan said.

“A strong gust, whatever that might be – it might be a geopolitical thing, or Facebook getting regulated, or Tesla raising capital – could break the fragile confidence,” he said.

“And then it all comes tumbling down and then you’ve got algorithmic selling, and margin debt being called and forced selling – all the waterfall effects that you don’t want to see if you’re an equity investor.”

There are three indicators that have Mr Sheridan worried about the future trajectory of the current US equity bull run.

First, the three-month US treasury bill is now above the yield on the S&P 500. In other words, he said, investors can get a higher (and risk-free) yield on three-month treasuries than they can get from the dividend yield of the stocks on the S&P 500.

Second, the 10-year treasury yield, at 3.11 per cent, is above the terminal US Federal Reserve funds rate of 2.75-3 per cent – something that has never happened before (at least “sustainably”).

“What that means is that if you think history will play out again, you should actually be a buyer of longer-dated bonds, because the chances are that yields aren’t going any higher from here. And in fact may even go lower,” Mr Sheridan said.

Finally, the spread between the US 10-year and 2-year yields has fallen to 51 basis points (down from 1 per cent a year ago, and from 2.62 per cent in December 2013).

When the spread goes negative (i.e, ‘inverts’) it means 2-year yields are higher than their 10-year counterparts.

“Every time since World War Two there has been a recession within 1 to 3 years from that inversion,” Mr Sheridan said.

“That’s the main signalling influence that the yield curve has in terms of the general economic outlook, and of course recession is terrible for stocks and property, because they’re risk-on assets,” he said.

US Production Numbers Strong In April

US Industrial production rose 0.7 percent in April for its third consecutive monthly increase according to data from the Federal Reserve.

The rates of change for industrial production for previous months were revised downward, on net; for the first quarter, output is now reported to have advanced 2.3 percent at an annual rate. After being unchanged in March, manufacturing output rose 0.5 percent in April. The indexes for mining and utilities moved up 1.1 percent and 1.9 percent, respectively. At 107.3 percent of its 2012 average, total industrial production in April was 3.5 percent higher than it was a year earlier. Capacity utilization for the industrial sector climbed 0.4 percentage point in April to 78.0 percent, a rate that is 1.8 percentage points below its long-run (1972–2017) average.

Market Groups

The rise in industrial production in April was supported by increases for every major market group. Consumer goods, business equipment, and defense and space equipment posted gains of nearly 1 percent or more, while construction supplies, business supplies, and materials recorded smaller increases.

Within consumer goods, the output of nondurables rose nearly 1 1/2 percent in April, as both consumer energy products and non-energy nondurable consumer goods posted increases. The output of durable consumer goods declined about 1/2 percent, mostly because of a sizable drop in automotive products. The advance in business equipment resulted from gains for information processing equipment and for industrial and other equipment, while the rise in materials was led by an increase for energy materials.

Industry Groups

Manufacturing output moved up 0.5 percent in April; for the first quarter, the index registered a downwardly revised increase of 1.4 percent at an annual rate. In April, the indexes for durables and nondurables each gained about 1/2 percent, while the production of other manufacturing industries (publishing and logging) rose nearly 1 percent. Among durables, advances of more than 1 percent were posted by machinery; computer and electronic products; electrical equipment, appliances, and components; and aerospace and miscellaneous transportation equipment. The largest losses, slightly more than 1 percent, were recorded by motor vehicles and parts and by wood products. The increase in nondurables reflected widespread gains among its industries.

The output of mining rose 1.1 percent in April and was 10.6 percent above its year-earlier level. The increase in the mining index for April reflected further gains in the oil and gas sector but was tempered by a drop in coal mining.

In April, the index for utilities advanced 1.9 percent. The output of electric utilities was little changed, but the output of gas utilities jumped more than 10 percent as a result of strong demand for heating due to below-normal temperatures.

Capacity utilization for manufacturing rose to 75.8 percent in April, a rate that is 2.5 percentage points below its long-run average. Increases were observed in all three main categories of manufacturing. The operating rates for durables and nondurables each moved up about 1/4 percentage point, and the rate for other manufacturing rose about 3/4 percentage point. Utilization for mining rose about 1/2 percentage point and remained above its long-run average; the rate for utilities jumped more than 1 percentage point.

U.S. 10-Year Treasury Yield Hits Highest Level Since 2011

U.S. government 10-year bond yields rose to their highest level since 2011 on Tuesday and the two-year yield hit its highest since 2008 as traders continued to price in a faster pace of rate hikes by the Federal Reserve this year.

The yield on 10-year U.S. Treasury notes rose as high as 3.095, the highest level since August 2011. Bond yields move inversely to prices. Two-year Treasury yields rose as high as 2.56%, their highest since 2008. The yield on the 30-year Treasury note was also higher at 3.191%.

Mortgage rates in the US also moved higher.Yields were boosted after a report on U.S. retail sales for April indicated that consumer spending is on track to rebound after a soft patch in the first quarter.

The Commerce Department reported that retail sales rose 0.3% in April, while the prior months figure was revised up to 0.8% from a previously reported 0.6%.

Yields have climbing higher since the Fed said on at its May meeting that inflation is moving closer to its 2% target.

The Fed raised rates in March and projected two more rate hikes this year, although many investors see three hikes as possible.

US Unemployment Down To 3.9%

Total nonfarm payroll employment increased by 164,000 in April, and the unemployment rate edged down to 3.9 percent, the U.S. Bureau of Labor Statistics reported. This is the lowest number since 2000! Job gains occurred in professional and business services, manufacturing, health care, and mining.

The market reacted positively, with the lower number sitting in the “Goldilocks” zone meaning the FED’s programme of rate rises can continue as planned.  Wages growth remains constrained, so inflation is controlled.

Household Survey Data

In April, the unemployment rate edged down to 3.9 percent, following 6 months at 4.1 percent. The number of unemployed persons, at 6.3 million, also edged down over the month.  Among the major worker groups, the unemployment rate for adult women decreased to 3.5 percent in April. The jobless rates for adult men (3.7 percent), teenagers (12.9 percent), Whites (3.6 percent), Blacks (6.6 percent), Asians (2.8 percent), and Hispanics (4.8 percent) showed little or no change over the month.

Among the unemployed, the number of job losers and persons who completed temporary jobs declined by 188,000 in April to 3.0 million.

The number of long-term unemployed (those jobless for 27 weeks or more) was little changed at 1.3 million in April and accounted for 20.0 percent of the unemployed. Over the year, the number of long-term unemployed was down by 340,000.

Both the labor force participation rate, at 62.8 percent, and the employment-population ratio, at 60.3 percent, changed little in April.

The number of persons employed part time for economic reasons (sometimes referred to as involuntary part-time workers) was essentially unchanged at 5.0 million in April. These individuals, who would have preferred full-time employment, were working part time because their hours had been reduced or because they were unable
to find full-time jobs.

In April, 1.4 million persons were marginally attached to the labor force, down by 172,000 from a year earlier. (The data are not seasonally adjusted.) These individuals were not in the labor force, wanted and were available for work, and had looked for a job sometime in the prior 12 months. They were not counted as unemployed because they had not searched for work in the 4 weeks preceding the survey.

Among the marginally attached, there were 408,000 discouraged workers in April, little changed from a year earlier. (The data are not seasonally adjusted.) Discouraged workers are persons not currently looking for work because they believe no jobs are available for them. The remaining 1.0 million persons marginally attached to the labor force in April had not searched for work for reasons such as school attendance or family responsibilities.

Establishment Survey Data

Total nonfarm payroll employment increased by 164,000 in April, compared with an average monthly gain of 191,000 over the prior 12 months. In April, job gains occurred in professional and business services, manufacturing, health care, and mining.

In April, employment in professional and business services increased by 54,000. Over the past 12 months, the industry has added 518,000 jobs.

Employment in manufacturing increased by 24,000 in April. Most of the gain was in the durable goods component, with machinery adding 8,000 jobs and employment in fabricated metal products continuing to trend up (+4,000). Manufacturing employment has risen by 245,000 over the year, with about three-fourths of the growth in durable goods industries.

Health care added 24,000 jobs in April and 305,000 jobs over the year. In April, employment rose in ambulatory health care services (+17,000) and hospitals (+8,000).

In April, employment in mining increased by 8,000, with most of the gain occurring in support activities for mining (+7,000). Since a recent low in October 2016, employment in mining has risen by 86,000.

Employment changed little over the month in other major industries, including construction, wholesale trade, retail trade, transportation and warehousing, information, financial activities, leisure and hospitality, and government.

The average workweek for all employees on private nonfarm payrolls was unchanged at 34.5 hours in April. In manufacturing, the workweek increased by 0.2 hour to 41.1 hours, while overtime edged up by 0.1 hour to 3.7 hours. The average workweek for production and nonsupervisory employees on private nonfarm payrolls increased by 0.1 hour to 33.8 hours.

In April, average hourly earnings for all employees on private nonfarm payrolls rose by 4 cents to $26.84. Over the year, average hourly earnings have increased by 67 cents, or 2.6 percent. Average hourly earnings of private-sector production and nonsupervisory employees increased by 5 cents to $22.51 in April.

The change in total nonfarm payroll employment for February was revised down from +326,000 to +324,000, and the change for March was revised up from +103,000 to +135,000. With these revisions, employment gains in February and March combined were 30,000 more than previously reported. (Monthly revisions result from additional reports received from businesses and government agencies since the last published estimates and from the recalculation of seasonal factors.) After revisions, job gains have averaged 208,000 over the last 3 months.

FED Held US Cash Rate This Month

The Fed held this month, but is still talking about more adjustments later in the year.

The Dow closed lower as the market digested the inflation commentary.

Information received since the Federal Open Market Committee met in March indicates that the labor market has continued to strengthen and that economic activity has been rising at a moderate rate. Job gains have been strong, on average, in recent months, and the unemployment rate has stayed low. Recent data suggest that growth of household spending moderated from its strong fourth-quarter pace, while business fixed investment continued to grow strongly. On a 12-month basis, both overall inflation and inflation for items other than food and energy have moved close to 2 percent. Market-based measures of inflation compensation remain low; survey-based measures 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, with further gradual adjustments in the stance of monetary policy, economic activity will expand at a moderate pace in the medium term and labor market conditions will remain strong. Inflation on a 12-month basis is expected to run 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 1-1/2 to 1-3/4 percent. The stance of monetary policy remains accommodative, thereby supporting strong labor market conditions and a sustained return to 2 percent inflation.

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 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 and international developments. The Committee will carefully monitor actual and expected inflation developments relative to its symmetric inflation goal. The Committee expects that economic conditions will evolve in a manner that will warrant further gradual increases in the federal funds rate; the federal funds rate is likely to remain, for some time, below levels that are expected to prevail in the longer run. However, the actual path of the federal funds rate will depend on the economic outlook as informed by incoming data.