Fed Funds Rises to 1.92%; Spread to IOER Tightest Since 2010 (Large Banks Hold Most of Excess Reserves at The Fed)

Large banks hold the most excess reserves in the US. But will continued Fed rate increases lead to further withdrawal of excess reserves by these giant banks?

(Bloomberg) — The effective fed funds rate rose Wednesday to 1.92% from 1.91%, further narrowing the gap to the Fed’s interest on excess reserves (IOER) rate.

Wrightson ICAP economist Lou Crandall said in Thursday note that he expected fed funds to set higher given that “rates in the broker market continued to trend north.” Now that fed funds has set at 1.92%, the rate should remain unchanged through the end of June. Longer-run trend in fed funds is “clearly to move closer to (and eventually perhaps above) IOER. At 3bp, the fed funds/IOER spread matches the tightest level since April 2010.

Before the spread narrowed to 4bp on Tuesday, the gap between interest on excess reserves and the fed funds rate remained at 5bp, even after the Fed’s hike last week, which included the technical change of only lifting the IOER by 20bp; spread was at 8bp at beginning of year.

Two theories about the rise in fed funds rate: First is that the rise of overnight rates following the surge in T-bill supply is the culprit behind the move; second, that reserve draining is hitting a critical threshold for bank demand for funding to rise.


Here is a chart of excess reserves against the interest rate paid on excess reserves.


Its the large banks that are holding most of the excess reserves at The Fed.

et 20150811 who is holding all the excess reserves img02

This is not surprising given the consolidation of the banking industry since 1990.


U.S. Home Prices at Least Affordable Level Since Q3 2008 (Home prices rising faster than wages in 64 percent of local markets)

Yesterday, I discussed how the median price YoY on existing home sales is almost 2 times average hourly earnings growth, a sign of the growing housing affordability problem in the US.


Of course, housing affordability varies across the country. According to Attom’s Home Affordability Study, the west coast (California, Oregon and Washington) is unaffordable for many households. Florida also is losing affordability compared to historical affordability.


Annual growth in median home prices outpaced average wage growth in 275 of the 432 counties analyzed in the report (64 percent), including Los Angeles County, California; Maricopa County (Phoenix), Arizona; San Diego County, California; Orange County, California; and Miami-Dade County, Florida.

Median home prices not affordable for average wage earners in 75 percent of local markets

An average wage earner would not qualify to buy a median-priced home in 326 of the 432 counties (75 percent) analyzed in the report based on a 3 percent down payment and a maximum front-end debt-to-income ratio of 28 percent.

Counties where an average wage earner could not afford to buy a median-priced home in Q2 2018 included Los Angeles County, California; Cook County (Chicago), Illinois; Maricopa County (Phoenix), Arizona; San Diego County, California; and Orange County, California.

Rather than try to increase the supply of housing (both owner-occupied and rental), the Federal government will push to ease credit standards (now called “widening the credit b box”). While not as “wide” as the housing bubble years of 2004-2007,  each indicator has been gradually easing to meet higher home prices.





Existing Home Sales Decline 0.4% in May (Down 3% YoY), Inventory Remains Low, Highest Median Price In History (And It Is Only May!)

According to the National Association of Realtors, existing home sales fell -0.4% in May, less than the expected +1.1%. It was an improvement over the revised -2.7% in April.


Existing home sales are down 3% YoY. And the trend is not good.


The inventory of existing homes continues to be lower than normal. The increase in May is seasonal.


And we now have the highest median price for existing homes in history.


But housing is dangerously unaffordable for many households.


Simply unaffordable.



Deutsche Bank – The Ultimate TBTF Bank (or G-SIB) With Total Assets 45.3% Of Economy

Deutsche Bank is the poster child of “Too Big To Fail.” Its stock price has plummeted since before The Great Recession and never recovered. (Italian bank Unicredit is even worse!).


Both Deutsche Bank and Unicredit are G-SIBs (Global Systemically Important Banks). But Deutsche Bank has the honor (or horror) of having  the highest total asset in percent of GDP of any bank at 45.3%.


Think about that. With a fragile Eurozone, Brexit and … Italy, a Deutsche Bank failure could be disastrous for Germany. And the European banking system.

While Deutsche’s capital ratios seem fine, their net revenue growth of 2018 is projected to be -14.8%. 


And Deutsche leads global banks in Q1 trading losses in terms of Value at Risk (VaR). a 12x VaR trading blowup.

DB loss in context

In you think a big bank like Deutsche Bank can’t fail and create global shock waves, remember that the Germans thought the WWII battleship Bismarck was unsinkable too. 


Despite 5% Growth in 1-Unit Starts, There Is Too Little Housing Being Built and Its Too Expensive! (Bad “Attainable” Housing Policy)

Affordable housing policy in the US is a mess.  As I mentioned at the American Action Forum meeting on the future of the GSEs yesterday, the housing market today reminds me of the housing market from the 2000s … where home price growth was over twice that of earnings growth for most households. The credit market composition is different (e.g., fewer low-doc loans), but the ratio of home price growth to earnings growth is the same.


With local zoning and construction restrictions, it is difficult to provide “affordable” housing. The typical reaction from the Federal government and its agencies/enterprises is to expand the credit box (lower credit standards) to make housing “more affordable.” In reality, it only makes housing “more attainable” while at the same time making housing more costly.


By making home ownership more attainable in a restricted supply area (like Los Angeles), that only serves to make entry-level housing even MORE unattainable.

But enough of that (Washington DC is filled with rent seekers and is not likely to change).

For May, 1-unit starts grew 5% (good, but not good enough). But permits fell by 5% too.




Treasury Curve 10Y-2Y Continues Flattening To Below 35 BPS (Inversion Alert!)

The US Treasury yield curve (10Y-2Y) slope just broke through 35 basis points and is now at 34.41 BPS. And as The Fed continues to tighten, the curve is headed towards inversion.


The 1 month US OIS forward spread has already inverted.

JPM 3y2y

And the BBB corporate bond less prime spread has inverted too.

corp yield curve

I wish I had an inversion …  table.


Don’t Forget About the GSEs (Fannie Mae and Freddie Mac) And Their Government Guarantee

I am speaking today at an American Action Forum event in Washington DC at noon entitled “The Future Of Housing Finance Reform.” Also speaking will be affordable housing guru Laurie Goodman from The Urban Institute with Politico’s Lorraine Woellert moderating.

Meghan Milloy of the American Action Forum penned a nice editorial in advance of the event entitled “Don’t Forget About the GSEs.” Here is a taste:

“It’s been ten years since Fannie Mae and Freddie Mac (the government-sponsored enterprises, or GSEs) went into government conservatorship following the height of the financial crisis. After that much time and a number of new policy challenges in the interim, it might be easy to forget about the GSEs and the financial risks they still pose. This would be a mistake. Fannie and Freddie remain actively dangerous systemically important financial institutions (SIFIs), and their policies have started to slip back to where they were before the crisis.”

The problem stems from the government guarantee, whether explicit or implicit. All the proposals flying around Washington DC all carry a government guarantee in one form or another. And with FHFA Director Mel Watt’s term ending in January, it is time to do something.

In short, I will be recommending returning Fannie and Freddie into the market in a privatized form (releasing them from conservatorship). But without a government guarantee or affordable housing goals. And with a twist.

Ed DeMarco, the previous FHFA Director, attempted to move Fannie and Freddie towards privatization (or shut down) by introducing credit risk sharing notes where mortgage default risk is transferred from Fannie and Freddie to private market investors. But that has been slow moving.

Here is my suggestion.

We adopt the Options Clearing Corp (OCC) model. The OCC clears all listed US equity and index options and is owned by the options exchanges. But the OCC is capitalized by the clearing members (banks and broker/dealers), who also post risk-based margin on behalf of their customers. Default risk is mutualized among the members. While a few large firms dominate the risk (e.g., BAML, Goldman, Morgan Stanley), these same large members are posting the largest amount of risk-based margin and default-fund capital. Mutualizing the risk of the GSEs is the key, just as is mutualizing the risk of the members of a central counterparty. I think the OCC model could work well for the GSEs and the lenders. No guarantee and no affordable housing goals.

Wasn’t that simple?


Treasury 10Y-2Y Slope Flattens To 35.5 BPS, Eurodollar 3M Futures Spread Falls To Lowest Level Since 2000 (Europe’s Troubles In One Chart)

The US Treasury 10Y-2Y slope keeps falling … as The Fed keeps raising their target rate. It has flattened to 35.5 basis points.


Meanwhile, the 3 month Eurodollar spread to  the lowest level since 2000.


You can see Europe’s troubles (which are legion) in this chart.


It looks like even Europe will be drinking Pabst Blue Ribbon if things don’t improve.



Treasury 10Y-2Y Slope Flattens Again, UST-German Bund 10Y Spread Nears Multi-year High

Like the Limbo Rock, the US Treasury 10Y-2Y slope continues to see how low it will go.  It has flattened to 37.61 basis points.


How low will it go?


The US Treasury 10Y spread over the 10Y German Bund is near its multi-year high.


Not now Jay, we’re doing the limbo!


Fed Raises Target Rate To 2%, 10Y-2Y Treasury Slope Flattens To Below 40 BPS (Flattest Since 2007)

As expected, The Federal Reserve raised their target rate (upper bound) to 2%.


However, the interest on excess reserves is now 1.95% (not 1.75% according to Bloomberg).


At the same time, the US Treasury 10Y-2Y slope flattened to below 40 basis points, the lowest since 2007.


Now for the Fed Dots Plot.