A Shifting U.S. Policy Mix: Global Rewards and Risks

From The  iMFdirect Blog.

After a year marked by financial turbulence, political surprises, and unsteady growth in many parts of the world, the Fed’s decision this month to raise interest rates for just the second time in a decade is a healthy symptom that the recovery of the world’s largest economy is on track.

The Fed’s action was hardly a surprise: markets had for weeks placed a high probability on last week’s move. But market developments preceding the Fed decision did surprise many market watchers.

Especially striking were the sharp upward moves in longer-term U.S. interest rates, the dollar, and market-based measures of long-term inflation expectations soon after the U.S. presidential and congressional elections of November 8. No comparably abrupt market reactions preceded the Fed’s previous interest rate hike of December 2015 (see chart).

The dollar has risen further in the days following the Fed’s recent move.

usintrates-chartTime will tell if these market developments point to a new trend. Most likely, however, the election marks a shift in the U.S. policy regime with potentially even bigger future effects on prices and activity—abroad, as well as in the United States. Spillovers outside the United States will be felt especially strongly in emerging market economies, where for some, the advantages of enhanced competitiveness due to weaker currencies may be finely balanced against vulnerabilities.

Something has changed

From the start of 2016 and through the U.S. election, Treasury yields had been particularly low. Discussion of the global outlook, including at the IMF, stressed the risks of protracted low growth and continuing deflation pressures—even secular stagnation, with persistently low interest rates.

Longer-term nominal interest rates are, however, strongly influenced by expectations of the future path of the Fed’s policy rate, which in turn responds to U.S. inflation pressures and the economy’s underlying strength. Thus, the sharp post-election turnaround in longer-term U.S. interest rates changed the conversation: it likely reflected not the looming December rate hike alone, which was already widely anticipated, but also a shift in expectations about the future interest rate path and future demand in the U.S. economy.

Consistent with those expectations, while last week’s interest-rate hike was itself not unexpected, the future path of interest rates that Federal Open Market Committee members anticipate also steepened, and now suggests three interest rate hikes in each of the next two years.

The timing of the abrupt asset-price movements—coming within days of the U.S. election—is the key clue about what moved markets. The election of Donald Trump as president, coupled with continuing Republican control of the Congress, ended six years of divided U.S. government.

Implications for the future

Republicans in Congress have long advocated lower personal and corporate tax rates. President-elect Trump campaigned on a platform that included not only substantial tax cuts, but also increases in some categories of government spending, notably defense and infrastructure.

At this early stage, it is hard to know precisely how the shift in fiscal policy will look. One thing seems clear, however: it will turn more expansionary through some combination of more spending and lower tax rates.

In general, any increase in U.S. aggregate demand will generate some rise in real output—as new workers are hired, others work longer hours, and machinery is used more intensively—and some upward pressure on inflation. With the overall unemployment rate at 4.6 percent and other measures of labor market distress largely recovered from the financial crisis eight years ago, there could be little remaining slack in the U.S. economy. Unless labor force participation and overtime work rise significantly, there is a chance that inflation pressure therefore rises noticeably. This seems to be what the Fed has in mind when it predicts it will raise the federal funds rate more quickly.

More rapidly rising U.S. interest rates signal further dollar appreciation. Tax incentives for U.S. corporation to repatriate their past profits held abroad, which some estimate at $2.5 trillion, could also push the dollar up. Given faster demand growth, the outcome will be a widening U.S. current account deficit, that is, more borrowing from abroad. Some of it will possibly finance a growing Federal fiscal deficit, depending on the precise features of the U.S. fiscal package, the extent to which it is paid for by budget cuts elsewhere, the path of government borrowing rates, and the economy’s growth response.

U.S. growth will respond more strongly, with lower inflation, if any infrastructure spending is carefully designed to boost potential output, while tax measures encourage investment, labor supply, and inclusion.

International challenges ahead

Given the United States’ central role in the world economy, big changes in its policy mix have first-order effects beyond its borders.

Advanced economies with currencies that depreciate against the dollar will benefit both from higher U.S. growth and from more competitive exchange rates. For most of these economies, currently struggling with below-target inflation, any resulting inflationary pressure would (at least initially) be welcome. They may also see upward pressure on interest rates, posing a fiscal challenge for countries that are highly indebted but do not benefit enough from the positive demand spillovers that are driving their interest rates upward.

Emerging market economies can also benefit from more competitive currencies and higher U.S. demand. But although many emerging market economies have increased their policy buffers (e.g., foreign reserves), reduced currency mismatches, and improved financial oversight frameworks, some could still feel stress, especially where there are pre-existing political or economic strains.

Historically, U.S. interest rates have been one of the key drivers of net capital flows into emerging market economies. Flexible exchange rates can be helpful as a buffer against rapid outflows, as they allow international portfolios to rebalance through currency changes rather than reserve losses. A combination of rising dollar interest rates and domestic currency depreciation could reduce liquidity or worsen balance sheets, however, especially given the importance of dollar borrowing by residents and non-resident corporates in emerging market economies. Furthermore, currency depreciation might spark higher inflation. Policymakers in emerging markets therefore will remain vigilant.

If sharp exchange rate shifts and growing global imbalances follow the U.S. policy regime change, protectionist pressures become a major risk, as in past similar circumstances. Given the desire of advanced economy governments to maintain manufacturing, where emerging markets have made big inroads in recent decades, it is most likely that emerging market economies are the main targets for higher trade barriers erected by advanced economies.

Governments should therefore keep in mind that protection is likely to be counterproductive at home—even before trade partners retaliate, as they will be tempted to do. The integration of advanced economies into truly global supply chains underscores this danger. In an environment of sharply divergent policy mixes, as we may now be facing, the rules of the global trading system will be more important than ever.

Watch our recent video explaining how interest rates work:

 

Federal Reserve offers vote of confidence in US economy (so there’s no reason to panic)

From The Conversation.

No one was really surprised that the Fed raised its target interest rate by one-quarter of a percentage point. Yet some people are really upset about it and worried this will slow down a fragile economic recovery.

I would disagree with that view for several reasons.

My biggest reason is that a quarter-point is not a very big change. I recognize that the economy isn’t yet chugging along at full steam yet, but the Fed acknowledged that by making the smallest increase it could and implying that it’s unlikely to be followed by another increase in January or even in March or May. If we did get another increase that soon, it would only be in response to clear signs of strong economic growth in the U.S.

No magic wand

We should remember that monetary policy is not a magic wand.

Changes like this take time to percolate through the economy and are made with the expectation that their full impact won’t be experienced for several months. What the Fed really said today was that it fully expects that the economy will continue to strengthen over the coming three to six months.

One argument made by those against today’s rate hike (and any others the Fed might be considering) is that there’s still considerable slack in the U.S. labor market. Put another way, our recovery from the Great Recession hasn’t yet reached everyone – meaning a lot of people are still out of work or can’t get the jobs they want – and we should keep rates as low as possible to continue to encourage businesses to expand and to hire more workers.

There’s some merit to this concern. The Bureau of Labor Statistics’ broadest measure of labor underutilization is still at 9.3 percent (including discouraged workers and people who can’t find full-time work). While that certainly sounds bad, this rate was over 17 percent during the worst parts of the recent recession, so we’ve made tremendous progress.

The economy continues to create jobs at a healthy pace – adding 178,000 jobs last month and adding an average of 188,000 per month over the past year. In other words, the Fed is giving our economy a vote of confidence that this level of job creation is likely to continue.

Why a stronger dollar isn’t a concern

Another big concern is that this increase will lead to the dollar getting even stronger in international currency markets.

There are several reasons for the dollar’s rise – most of them have nothing to do with monetary policy. This means that the dollar would continue to strengthen even if the Fed did nothing. One way to look at the dollar’s recent rise is the world is saying they are confident that the U.S. economy will continue to outperform most other regions.

A rate increase is probably a good thing right now because we’ve had the lowest interest rates ever for nearly a decade, and loose monetary policy has probably done about as much as it can for now. It’s not that I think higher rates will be even more helpful, but that I think low rates aren’t likely to help the economy much anymore.

I’d like to see rates return to a slightly higher level so that we have the flexibility to decrease them if needed. In the past, we’ve relied almost exclusively on monetary policy to moderate the ups and downs in the economy and that flexibility isn’t available to us right now.

Some risks

The Fed has certainly heard President-elect Donald Trump talk about his ideas for significant tax cuts and infrastructure investments. Congress has expressed mixed feelings about these proposals, so it’s not certain that they will actually happen. If they do, each of these would boost the economy some, although not right away.

Another reason to raise rates earlier rather than later stems from the beliefs of some economists that loose monetary policy has been a causal factor in several past recessions.

I’m not a strong proponent of this view, but I agree that this potential exists. I’m a more worried about the potential for inflation when banks decide to start using the US$2 trillion they have saved up and deposited at the Fed, but that’s a conversation for another time.

Looking ahead to 2017, a lot will depend on how well the new administration does and how successful they are at getting their proposals through Congress. Assuming the economy continues to plod along, I’d expect another quarter-point increase in mid- to late 2017.

Author: Robert Rebelein, Associate Professor of Economics, Vassar College

US Mortgage Rates Quickly Approaching 4.5%

From Mortgage News Daily.

Don’t believe anything you read about mortgage rates today… well, except this. In fact, you’re welcome to believe anything you read as long as it acknowledges the fact that rates have risen nearly a quarter of a point from last week, pushing them well into the highest levels in more than 2 years.  The average top tier conventional 30yr fixed rate is quickly approaching 4.5%.  Nearly every lender that was at 4.125% last week is now at 4.375%.  Lenders who were at 4.25% last week are mostly up to 4.5%.

The overall spike in rates since the election is now on par with the 2013 taper tantrum.  You’ll hear time and again “don’t worry… rates are historically low…” and my personal favorite “for every .125% in rate, the payment only rises $7 per $100k borrowed.”  All of that is true, except perhaps for the “don’t worry” part.  Some borrowers may need to worry about no longer qualifying due to debt-to-income guidelines.

Rates haven’t risen a mere .125%, after all.  That’s just today’s increase.  Added to recent losses, the damage is between .75 and 1.0% now.  Let’s take a more average loan amount of $250k and see what happens when the rate goes up 0.75.  The increase is over a hundred dollars a month.

Many of the people interviewed by financial journalists have a hard time relating to most of the people that will end up being exposed to their opinions.  $100/month may not sound like the end of the world to the CEO of some financial firm, but it is more than enough to tip the scales for prospective homebuyers.  They’ll have to adjust their price range at least $20k to get back to the same payment.  If that’s not an option for the area, then they’re no longer a prospective homebuyer, or they’ll be forced to move out of the area.  This dynamic is not congruent with “not worrying.”

Oh, and you’ll also need to worry if rates will continue to move higher.  That’s possible, although for technical reasons, the higher rates go, the more challenging it will be to continue higher.  It’s also possible that markets are riding on a cloud of optimistic euphoria and that the cloud will dissipate as the new year begins.  It’s possible this rise in rates is a necessary ingredient in longer term trends.  In other words, rates have to rise so they can fall again.  Last but not least, it’s possible I don’t know everything and rates will go much higher than they are currently, but if that happens, it will increasingly have consequences for the economy.

Yellen’s Fed faces a tricky rates dilemma in 2017 that may end up tripping up Trump

From The Conversation.

Editor’s note: The Federal Reserve’s policy-setting committee raised its target interest rate a quarter-point to a range of 0.5 percent to 0.75 percent, only the second such move in eight years. In the widely anticipated decision, the Fed signaled it anticipates raising rates another 0.75 percentage point in 2017 – likely in three quarter-point hikes – a faster pace of tightening than previously expected. We asked two experts to analyze what this will mean for the not too distant future.

Between a rate hike and a hard place

Steven Pressman, Colorado State University

As almost everyone expected, the Fed raised interest rates, and banks will now pass their higher costs on to companies and consumers, leading to higher borrowing rates throughout the economy.

The bigger issue, however, concerns likely increases in 2017. Here the message was somewhat ambiguous. While indicating that three 0.25 percentage point increases were possible in 2017, compared with the previous guidance that only two rate hikes were likely next year, Janet Yellen stressed in her press conference that any changes would be small and remain highly uncertain. She continually noted that the Federal Reserve would have to adjust its thinking in 2017 based on actual economic circumstances.

The Federal Open Market Committee press release was likewise rather ambiguous. It indicated that monetary policy “remains accommodative” and that future adjustments will depend on the “economic outlook” and “incoming data.”

The important takeaway from all this is that it is really not clear what the Fed will do next year. The reason for this is that the Fed is damned if they raise interest rates considerably in 2017 and damned if they don’t.

On the one hand, debt remains a Damocles sword hanging over the U.S. economy, and a rise in rates could cut the thread. Household debt is approaching levels reached before the 2008 financial crisis, which suggests that households may be approaching the point at which they cannot repay their loans – something that can bring down banks and the U.S. economy. And real median household income remains US$1,000 below pre-Great Recession levels and $1,500 below its all-time peak in the 1990s. U.S. households, responsible for 70 percent of all spending in our economy, face a double squeeze that cannot continue.

Worse still, many households remain underwater on their mortgages. Others are slightly above water, unable to come up with the realtor commissions and moving expenses that would let them sell their home and find a more affordable place to live. Higher interest rates will worsen this problem by reducing home affordability and prices.

On the other hand, at some point, perhaps soon, the U.S. economy will enter another recession. If the tax cuts and spending increases proposed by President-elect Trump get enacted, a ballooning budget deficit (made worse by the onset of a recession) will hinder the ability of fiscal policy to create jobs. Interest rate cuts then become our only viable policy tool.

So with rates already near zero, central banks cannot lower them very much. For this reason, they want to load up on ammunition, and push them up some. At the same, time they fear the consequences of doing this. Today’s Fed guidance was ambiguous for a good reason – they are caught on the horns of a nasty dilemma.

How higher rates will hurt Mexico and tie up Trump

Wesley Widmaier, Griffith University

Donald Trump has promised to build a wall and make Mexico pay. But the Fed’s decision to continue raising rates higher – known as tighter monetary policy – may push Trump to send money abroad, even to Mexico, a common target of his scorn on the campaign trail.

History shows that monetary policy decisions can have complex effects.

With a U.S. recovery continuing, the Fed’s tightening is raising fears of a reaction similar to the 1994 Mexican peso crisis. If this happens, the Trump administration may face hard choices.

Just like today, early 1994 saw then-Fed Chair Alan Greenspan move from an easy money stance and resume raising rates. Greenspan argued that the stock market was flirting with a bubble, bank earnings were low and inflation might revive. Raising interest rates was seen as the solution to ease the market bubble, pull money back from emerging markets and tamp down on a return of inflation.

However, the Fed’s moves back then had unexpected effects. Like many middle-income countries today, Mexico had issued dollar-denominated tesobonos to insure against exchange rate risk. But as the Fed raised rates over 1994, Mexico found it harder to make payments on the bonds, prompting a run on the peso.

The U.S. responded with a $50 billion rescue. Dollars had to flow south – or a Mexican collapse might send immigrants north.

Of course, this is not a dynamic unique to Mexico. As Fed moves raise the cost of servicing dollar-denominated debts, increased debt-servicing costs could have global repercussions.

However, Mexico’s economy has been a subject of some recent concern. If Fed restraint heightens those concerns, Trump may need to forget the wall – and pay Mexico instead.

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.

Fed Lifts Rate As Expected

The Fed has lifted its target rate by 0.25%, the second move up in 10 years. They signalled only gradual increases in the federal funds rate which is likely to remain, for some time, below levels that are expected to prevail in the longer run.

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 expanding at a moderate pace since mid-year. Job gains have been solid in recent months and the unemployment rate has declined. Household spending has been rising moderately but business fixed investment has remained soft. Inflation has increased since earlier this year but is still below the Committee’s 2 percent longer-run objective, partly reflecting earlier declines in energy prices and in prices of non-energy imports. Market-based measures of inflation compensation have moved up considerably but still are low; most survey-based measures of longer-term inflation expectations are little changed, on balance, in recent months.

Consistent with its statutory mandate, the Committee seeks to foster maximum employment and price stability. The Committee expects that, with gradual adjustments in the stance of monetary policy, economic activity will expand at a moderate pace and labor market conditions will strengthen somewhat further. Inflation is expected to rise to 2 percent over the medium term as the transitory effects of past declines in energy and import prices dissipate and the labor market strengthens further. Near-term risks to the economic outlook appear roughly balanced. The Committee continues to closely monitor inflation indicators and global economic and financial developments.

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 1/2 to 3/4 percent. The stance of monetary policy remains accommodative, thereby supporting some further strengthening in labor market conditions and a 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. In light of the current shortfall of inflation from 2 percent, the Committee will carefully monitor actual and expected progress toward its inflation goal. The Committee expects that economic conditions will evolve in a manner that will warrant only 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.

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, and it anticipates doing so until normalization of the level of the federal funds rate is well under way. This policy, by keeping the Committee’s holdings of longer-term securities at sizable levels, should help maintain accommodative financial conditions.

US Regulators Say Wells Fargo Has More To Do

The Federal Deposit Insurance Corporation (FDIC) and the Federal Reserve Board on Tuesday announced that Bank of America, Bank of New York Mellon, JP Morgan Chase, and State Street adequately remediated deficiencies in their 2015 resolution plans. The agencies also announced that Wells Fargo did not adequately remedy all of its deficiencies and will be subject to restrictions on certain activities until the deficiencies are remedied.

Resolution plans, required by the Dodd-Frank Act and commonly known as living wills, must describe the company’s strategy for rapid and orderly resolution under bankruptcy in the event of material financial distress or failure of the company.

In April 2016, the agencies jointly determined that each of the 2015 resolution plans of the five institutions was not credible or would not facilitate an orderly resolution under the U.S. Bankruptcy Code, the statutory standard established in the Dodd-Frank Act. The agencies issued joint notices of deficiencies to the five firms detailing the deficiencies in their plans and the actions the firms must take to address them. Each firm was required to remedy its deficiencies by October 1, 2016, or risk being subject to more stringent prudential requirements or to restrictions on activities, growth, or operations. The review and the findings announced today relate only to the joint deficiencies identified in April 2016.

The agencies jointly determined that Wells Fargo did not adequately remedy two of the firm’s three deficiencies, specifically in the categories of “legal entity rationalization” and “shared services.” The agencies also jointly determined that the firm did adequately remedy its deficiency in the “governance” category. In light of the nature of the deficiencies and the resolvability risks posed by Wells Fargo’s failure to remedy them, the agencies have jointly determined to impose restrictions on the growth of international and non-bank activities of Wells Fargo and its subsidiaries. In particular, Wells Fargo is prohibited from establishing international bank entities or acquiring any non-bank subsidiary.

The firm is expected to file a revised submission addressing the remaining deficiencies by March 31, 2017. If after reviewing the March submission the agencies jointly determine that the deficiencies have not been adequately remedied, the agencies will limit the size of the firm’s non-bank and broker-dealer assets to levels in place on September 30, 2016. If Wells Fargo has not adequately remedied the deficiencies within two years, the statute provides that the agencies, in consultation with the Financial Stability Oversight Council, may jointly require the firm to divest certain assets or operations to facilitate an orderly resolution of the firm in bankruptcy.

The Federal Reserve Board is releasing the feedback letters issued to each of the five firms. The letters describe the steps the firms have taken to address the deficiencies outlined in the April 2016 letters. The feedback letter issued to Wells Fargo discusses the steps the firm has taken to address its deficiencies and those needed to adequately remedy the two remaining deficiencies.

The determinations made by the agencies today pertain solely to the 2015 plans and not to the 2017 or any other future resolution plans. In addition to requiring that the firms address their deficiencies, in April the agencies also identified institution-specific shortcomings, which are weaknesses identified by both agencies, but are not considered deficiencies.

The agencies in April also provided guidance to be incorporated into the next full plan submission due by July 1, 2017, to the five firms, as well as Goldman Sachs, Morgan Stanley, and Citigroup, and will review those plans under the statutory standard. If the agencies jointly decide that the shortcomings or the guidance are not satisfactorily addressed in a firm’s 2017 plan, the agencies may determine jointly that the plan is not credible or would not facilitate an orderly resolution under the U.S. Bankruptcy Code.

The decisions announced today received unanimous support from the FDIC and Federal Reserve boards.

Feedback letters:
Bank of America (PDF)
Bank of New York Mellon (PDF)
JP Morgan Chase (PDF)
State Street (PDF)
Wells Fargo (PDF)

Big banks in US could see fat payday under Trump

After eight years of unrelenting scrutiny and billions of dollars in legal settlements, the banking industry suddenly is facing a more hospitable political climate in Washington next year, says AFP.

Prior to November 8, Wall Street had been girding for a potential Democratic victory that would have empowered progressive firebrands like Massachusetts Democrat Elizabeth Warren, who has pushed to break up large banks and jail banking executives in the wake of the finanical crisis.

Instead, the Republican sweep of Congress and President-elect Donald Trump’s election in one fell swoop bolstered the chances for pro-growth measures, tax cuts and loosening of a whole swath of regulations, including the 2010 Dodd-Frank banking law passed in response to the crisis.

“You’re going to have a very substantial reversal in regulations of all types,” Blackstone Group chief executive Stephen Schwarzman told the Goldman Sachs banking conference Tuesday.

Schwarzman, a major Republican donor tapped by Trump to chair a advisory council of prominent business leaders, gushed that the election would usher in the biggest regulatory revolution in his 45 years in finance.

Trump’s cabinet appointments have furthered the sense that his presidency will be good for big finance.

And he tapped Goldman Sachs President Gary Cohn to lead the National Economic Council, according to reports Friday, his third major personnel pick from the prestigious New York investment bank following selections of Steven Mnuchin as Treasury secretary and Steve Bannon as chief strategist.

Critics have accused the president-elect of hypocrisy after he railed against Wall Street on the campaign and then brought many financial market insiders onto his team.

“We’re intensely worried,” said Bart Naylor, financial policy advisor at Public Citizen, a consumers advocacy organization.

“What we do have on our side is a public that knows the banks screwed them to get into the financial crisis.”

Wall Street itself is literally cashing in on the fat expectations.

The S&P banks index has surged more than 25 percent since November 8, lifting the entire sector, including Goldman Sachs, the midsized Capital One and regional banks like KeyCorp in Cleveland.

Yet Erik Oja, a banking analyst at CFRA, rejected the suggestion that big banks will win major rollbacks under the Trump administration. Smaller banks may win concessions, but big banks are still under fire.

“I don’t think there’s any political will at all to do any rollback for the largest banks,” Oja said, who added that there was still a remote chance large banks could face calls to break them up.

Oja attributed the rise in bank share prices primarily to rosier outlooks about the economy due to the anticipated pro-growth policies and the expectation the Federal Reserve will accelerate interest rate increases.

– Tear up Dodd-Frank? –

During the presidential campaign, Trump vowed to dismantle the Dodd-Frank law, whose main provisions include tougher capital requirements on banks, the creation of the Consumer Financial Protection Board and Volcker rule, which restricts the ability of big banks to make highly lucrative investments that do not benefit their customers.

Smaller regional banks in particular have complained about the burden of regulations meant to rein in excesses of the large banks that could take down the whole system.

Mnuchin took aim at the 2010 law last week, shortly after he was picked for the Treasury post.

“The number one problem with the Volcker rule is it is too complicated and people don’t know how to interpret it,” Mnuchin said. “So we’re going to look at what to do with it, as we are with all of Dodd Frank with the number one priority that banks lend.”

At the Goldman Sachs conference, large banks offered guarded optimism on regulatory relief they expect from Washington.

“The first thing I would ask for is nothing new, no new rules,” said Citigroup chief financial officer John Gerspach, who said unnecessarily high liquidity requirements crimp lending.

Bank of America Chief Executive Brian Moynihan estimated his bank was holding about $15 billion in “excess” capital due to overlapping regulatory requirements that could be returned to shareholders.

“At the end of the day, we are overcapitalized,” he said.

But Marty Mosby, banking analyst at Vining Sparks, said the changes have broadly succeeded since 2008 in safeguarding the financial system, even if there have been some regulatory excesses.

Overregulating and overcapitalizing big banks is preferable to the alternative “because you can’t have those banks failing,” he said.

US Mortgage Rates Continue To Move Higher

According to MortgageNewsDaily, US mortgage rates rose further, continuing their upward trajectory since the US election. As we discussed yesterday, this will have a flow-on effect here.

Mortgage rates rose meaningfully today, with most lenders coming close to the highest levels in more than 2 years (on December 1st).  Keep in mind though, that my daily assessment puts rate movement under a microscope, so “rose meaningfully” is a relative term.  In fact, many lenders are quoting the exact same contract rates today compared to yesterday, with the only deterioration being seen in the form of higher upfront costs (or lower lender credit, depending on the scenario).  Even so, there was enough movement to shift the average lender’s top tier conventional 30yr fixed quote up to 4.25% although 4.125% is nearly as prevalent.

Today’s market movement had to do with investor anxiety heading into a few challenging days at the beginning of next week.  In addition to the Fed announcement on Wednesday, Treasury auctions (Where the government sells bonds to investors directly, typically a Tue/Wed/Thu affair) are packed into the first 2 days of the week.  Bond market movement (which drives interest rates) is all about supply and demand.  When supply is more challenging, it puts upward pressure on rates.  Moving the bond market’s key source of “supply” ahead in the calendar and condensing 3 days of supply into 2 definitely makes supply more challenging.

The bottom line is that bond markets are anxious, and that anxiety is being managed by selling bonds.  It could absolutely still be the case that bond traders are interested in keeping rates from moving above recent highs, but we won’t have a great sense of that until the middle of next week.  The blanket advice for any new loans is to lock in this environment.  That said, risk-takers might consider the fact that 10yr Treasury yields (a good proxy for momentum in longer-term rates, like mortgages) have yet to break above 2.50%, despite facing maximum anxiety this afternoon.  2.50% could be used as line in the sand that lets risk-takers know it’s time to lock.

Trump is changing the rules for American business

From The Economist.

His inauguration is still six weeks away but Donald Trump has already sent shock waves through American business. Chief executives—and their companies’ shareholders—are giddy at the president-elect’s promises to slash burdensome regulation, cut taxes and boost the economy with infrastructure spending. Blue-collar workers are cock-a-hoop at his willingness to bully firms into saving their jobs.

In the past few weeks, Mr Trump has lambasted Apple for not producing more bits of its iPhone in America; harangued Ford about plans to move production of its Lincoln sports-utility vehicles; and lashed out at Boeing, not long after the firm’s chief executive had mused publicly about the risks of a protectionist trade policy. Most dramatically, Mr Trump bribed and cajoled Carrier, a maker of air-conditioning units in Indiana, to change its plans and keep 800 jobs in the state rather than move them to Mexico. One poll suggests that six out of ten Americans view Mr Trump more favourably after the Carrier deal. This muscularity is proving popular.

Popular but problematic. The emerging Trump strategy towards business has some promising elements, but others that are deeply worrying. The promise lies in Mr Trump’s enthusiasm for corporate-tax reform, his embrace of infrastructure investment and in some parts of his deregulatory agenda. The dangers stem, first, from the muddled mercantilism that lies behind his attitude to business, and, second, in the tactics—buying off and attacking individual companies—that he uses to achieve his goals. American capitalism has flourished thanks to the predictable application of rules. If, at the margin, that rules-based system is superseded by an ad hoc approach in which businessmen must take heed and pay homage to the whim of King Donald, the long-term damage to America’s economy will be grave.