Online Course Notes For Financial Markets
The bad news? The credit impulses (annual change as a percentage of GDP) for both the USA and China are negative.
The good news? The decline in China’s credit impulse is lessening.
If we throw the Eurozone into the Papusa, we see that the Eurozone has negative credit impuse growth, but is better than China or the USA.
Since 2005, China’s sovereign yield curve has actually increased will Japan’s has dropped into negative territory.
US home buyers are benefitting from European economic misery (particularly Germany and fiscal-stressed Italy). I call this the Blitzkrieg Bop.
On the other side of the interest rate barbell is China (and Japan). So while the USA is growing, Germany and Japan are not doing so well, causing their Central Banks to push rates to zero .,.. or lower. Even China’s Central Bank is buying everything in sight in fear of a recession.
Hence, US mortgage lenders and potential homebuyers benefit is terms of dropping interest rates.
You can see the downward plunge in the Treasury Volatility Curve (MOVE – TYVIX) as Central Banks become active in 2008 and 2009. The 30-year mortgage rate has been declining thanks to hyper-intrusion of global central banks, killing off bond volatility.
Allegedly, The Federal Reserve is ceasing its raising of their target rate and will stop shrinking their balance sheet in September.
Mortgage purchase applications (NSA) are in their third phase and doing quite nicely, helped along recently by the barbell slowdowns overseas.
Speculators also increased their short positions in five-year (FV), ultralong (WN) and classic 30-year (US). Speculators still remain short every Treasury futures contract.
How about gold? The net futures have actually increased since December.
(Bloomberg) — Behind the rally in global debt markets lurks a disaster just waiting to happen. At least, that’s what some long-time market watchers are warning.
While dovish comments by the Federal Reserve and other central banks have prompted investors to pile back into bonds, two troubling developments could make buyers uniquely vulnerable to deep and painful losses, they say. One is the sheer amount of ultra-low yielding debt, which means investors have almost no buffer in the event prices drop. That’s compounded by the worry liquidity will suddenly evaporate in a selloff and leave holders stuck with losses on positions they can’t get out of quickly.
Granted, nobody is actually predicting when things will turn ugly in the bond market, and history hasn’t been particularly kind to the doomsayers. Still, the risk is real, they say, and caution is more than justified. By one measure, the amount of investment-grade bonds has doubled to $52 trillion since the financial crisis. And yields have, on average, fallen to roughly 1.8 percent, less than half the level in 2007. If they were to rise by a mere half-percentage point, investors could be looking at almost $2 trillion in losses.
“This is an element of hidden leverage that is not appreciated,” says Jeffrey Snider, global head of research at Alhambra Investments. “We are eventually going to have a shock.”
The current situation is a legacy of the easy-money polices enacted by central banks following the financial crisis. With interest rates at or near zero, governments and corporations went on a historic borrowing binge — and investors gorged on debt that yielded little in return. What’s more, rules to strengthen financial firms and curb their risk-taking meant the big banks now played a much smaller role as intermediaries, transferring more of the risk of getting in and out of trades onto investors.
Using the US Treasury 10-year (yellow) and 3-year Treasury (green) yields, here is a chart of global Treasury modified duration (white).
Yes, the pounding of global interest rates downwards thanks to Central Bank “easing” has created a potential duration. wipeout.
And the short-term Central Bank rate hammer is helping to keep global rate depressed, leading to higher duration risk.
Yes, the Central Banks DID do that!
Today’s hearing in the US House of Representatives Financial Services Committee (where the committee calls Globally-Systemically Important Bank (G-SIB) CEOs to testify and ask them uncomfortable questions).
But today’s hearing should have been extended to mortgage giants Fannie Mae and Freddie Mac that unquestionably qualify as Systemically Important Financial Institutions (SIFIs), both under the statutory and FSOC definitions, and in any objective assessment of their financial importance. Are they G-SIBs? Of course.
Fannie Mae and Freddie Mac are supposed to maintain capital. Congress, in enacting the Safety and Soundness Act in 1992, established minimum capital requirements for the Enterprises and those standards have been in place for the past 25+ years. That Act requires the Enterprises to maintain minimum capital that is greater than or equal to:
Well, the required capital for Fannie Mae and Freddie Mac clearly did not protect their shareholders from a catastrophic failure in 2008 due to declining home prices and a surge in mortgage delinquencies.
In fairness, Fannie and Freddie are not depository institutions. But the sheer size of their loan portolios is worrisome.
Whether you want to call Fannie and Freddie SIFIs or G-SIBs, they should have been called to testify as well.
Under the Dodd-Frank Act, all depository institutions with more than $10 billion in assets, including the U.S. G-SIBs, are supervised by the Consumer Financial Protection Bureau for compliance with consumer financial protection laws and regulations. Furthermore, the Dodd-Frank Act subjects the largest banks, including the U.S. G-SIBs, to heightened oversight and enhanced prudential standards to safeguard the U.S. financial system, which are implemented by the Federal Reserve. These requirements include enhanced capital, liquidity and leverage requirements, as well as regular stress testing to ensure banks hold enough capital to survive a future economic downturn or financial crisis. The G-SIBs are also required to submit resolution plans (also referred to as “living wills”) to ensure their firms can be resolved in an orderly way if they were to fail.
There have been several deregulatory developments and proposals in recent years. For example, S.2155, which was signed into law in May 2018 (Public Law 115-174), reduces the frequency of G-SIB stress tests, and it reduces other capital and leverage requirements. In addition, regulators have been advancing their own proposals. In April 2018, the Federal Reserve issued a set of proposals to simplify its capital rules for G-SIBs and introduced a “stress capital buffer,” or SCB, which would in part integrate the forward-looking stress test results with the Board’s non-stress capital requirements. The Federal Reserve joined the OCC in releasing a second proposal to substantially revise the current enhanced supplementary leverage ratio (eSLR) that applies to G-SIBs. After the proposal was released, former FDIC Chairman Martin Gruenberg said, “Strengthening leverage capital requirements for the largest, most systemically important banks in the United States was among the most important post crisis reforms…the amount of tier 1 capital required under the proposed eSLR standard across the lead IDI subsidiaries would be approximately $121 billion less than what is required under the current eSLR standard to be considered well-capitalized” (emphasis added). In response to a request from Committee staff for more information, the FDIC estimated the eSLR proposal would lower capital requirements for the primary federally-insured bank subsidiary of each G-SIB as follows:
● JPMorgan Chase & Co.: $34.597 billion (20.83% reduction in tier 1 capital) ● Citigroup: $26.978 billion (23.3% reduction)
● Bank of America: $22.838 billion (18.5% reduction)
● Wells Fargo: $20.406 billion (16.9% reduction)
● Bank of New York Mellon: $5.911 billion (33.65% reduction)
● State Street: $5.346 billion (37.5% reduction)
● Morgan Stanley: $2.507 billion (25% reduction)
● Goldman Sachs: $1.93 billion (9.49% reduction)
Despite proposing to reduce capital for the G-SIBs, the Federal Reserve’s own research has indicated current capital requirements are on the lower end of requirements that best balances benefits associated with mitigating systemic risk with a bank’s funding costs. Furthermore, the Federal Reserve has also been working on making stress testing more transparent to banks, potentially undermining the value of the regular exercise. Bank regulators have also proposed reducing enhanced prudential standards and liquidity requirements for banks as large as $700 billion, and there have been reports that regulators may reconsider their proposal on the Volcker Rule and propose further rollbacks of Dodd-Frank reforms.
Finally, while the Dodd-Frank Act and related reforms required additional capital and strengthened oversight of G-SIBs through the creation of the Consumer Bureau, there remain concerns regarding whether some of these institutions are adequately being held accountable for repeated consumer violations, and whether these firms may be too big to manage, as was discussed at the Committee’s hearing on March 12, 2019, with Wells Fargo’s former CEO, Tim Sloan.
Fannie Mae and Freddie Mac’s regulator is proposing that the mortgage-finance giants have a combined capital buffer of as much as $180.9 billion should the companies be released from government control.
I would really like to hear what new-minted FHFA Director Mark Calabria has to say on capital requirements and administrative reform. And turning Fannie and Freddie loose again in the financial system.
Hopefully Calabria will be fixing the holes in the mortgage system.
According to the Mortgage Bankers Association, residential mortgage refinancings shot up 38.50% from the previous week.
Here is the chart of mortgage refinancing applications with the mortgage rate drop to 4.06%.
Mortgage purchase applications were more modest at +4.06% WoW despite the rapid decline in mortgage rates.
30-year mortgage rates have been falling thanks to deterorating conditions in the EU.
Is this a refi inferno? Or is it just a slight increase? Call it a relative inferno!
Investors in mortgage-backed securities are cooling on swaps used to hedge against falling interest rates, signaling confidence that yields may have found their bottom.
The 10-year swap spread has backed off from the tightest level since October 2017, reached last week. The U.S. Treasury 10-year yield had touched a 15-month low of 2.37 percent on March 27.
A U.S. homeowner may prepay their mortgage at will, and the duration of a mortgage-backed security can drop dramatically during periods of falling yields due to the potential for faster prepayments. This means MBS investors need to add duration, referred to as “convexity hedging,” as interest rates drop.
A popular method to add duration is by using swaps and “the 10-year is still the most liquid swap for mortgage hedgers,” said Walt Schmidt, head of mortgage strategies at FTN Financial. Now that the 10-year yield has risen again to the 2.50 percent area, swap spreads are back close to where they lay previous to the rally and “the wave of convexity hedging is likely over for now,” he said.
| Duration: the weighted average maturity of the security’s cash flows, where the present values of the cash flow serve as the weights. The greater the duration of a security, the greater its percentage price volatility. |
The Overnight Indexed Swap (OIS) looks like an ARCTANGENT function.
Slippin’ Jimmy took this photo of Fed Chair Jerome Powell’s chair.
When the US housing bubble was in full steam, I was working with a major insurance company on a way to hedge home price risk in major metropolitan areas. Their risk committee thought housing was too risky (hence the reason for trying to hedge the risk). But to no avail.
The problem with housing futures is … there is very thin volume in trading. Exactly one contract trade on March 12, 2019 at. 261.2.
Aggregate open interest is a minuscule 20.
This contracts with the SOFR futures with substantially larger open interest.
Based on thin depth of trading, the trend line for San Francisco futures is downward sloping. And LAGGING the Case-Shiller home price index.
If we look at the CFTC CBOE, CME futures activity, home price indices are so thin that don’t show up.
Home price futures are thinner than other futures contracts, hence one must be careful.
The 30-year mortgage rate is dropping fast and the housing data is low riding on the rate decline.
And with the drop, both new home sales and existing home sales are enjoying a revival.
The Core PCE and Core PCE deflator YoY (aka, core inflation) are both declining. The deflator is actually down to 1.4% YoY.
The US housing market is slowing and The Federal Reserve is likely to CUT interest rates in 2019 (at least the market is betting on it).
(Bloomberg) — Contract signings to purchase previously owned U.S. homes fell more than estimated in February, suggesting that the prior month’s surge resulted from pent-up demand and that a sustainable recovery may take more time.
The index of pending home sales fell 1 percent from the prior month, after a downwardly revised 4.3 percent increase in January, according to data released Thursday from the National Association of Realtors in Washington. The gauge fell 5 percent from a year earlier following a 3.3 percent annual decline.
And pending home sales fell 5% YoY in February,
Not only are pending home sales YoY slowing, but so is home price growth.
Existing home sales inventory is down considerably from 2007.
At least interest rates are likely to be cut by The Fed in 2019.
