US Treasury Yield Curves (10Y-2Y, 10Y-3Mo) Back To Near Pre-Financial Crisis Lows As C&I Lending Stalls

2007 marked the last year before the financial crisis and Great Recession. Unfortunately, this is where we are in terms of the US Treasury yield curves (10Y-2Y and 10Y-3Mo).

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Commercial and Industrial (C&I) lending YoY has slowed in recent months. And is lower than before The Great Recession and financial crisis.

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But like the honey badger, the US economy keeps finding ways to escape … recession.

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Fed Leaves Rates on Hold; Forecasts Show No Change Through 2020

(Bloomberg) — The Federal Reserve left interest rates unchanged and signaled it would stay on hold through 2020, keeping it on the sidelines in an election year while also opening the possibility it might buy short-term coupon-bearing securities to ease money-market strain.

“Our economic outlook remains a favorable one despite global developments and ongoing risks,” Chairman Jerome Powell told a press conference Wednesday in Washington following the decision. “As long as incoming information about the economy remains broadly consistent with this outlook, the current stance of monetary policy likely will remain appropriate.”

The Treasury 10-year yields fell below 1.8%, the dollar declined and U.S. stocks edged higher. Powell spoke after the Federal Open Market Committee held the target range of the federal funds rate steady at 1.5% to 1.75% and its median forecast showed no rate change through next year.

“The FOMC’s monetary policy message is that the Fed is on hold and that it would take some significant change in the outlook to induce the Fed to move,” Roberto Perli, a partner at Cornerstone Macro LLC in Washington, wrote in a note. “Powell, however, made some news when talking about the problems affecting the repo market.”

Powell told reporters that the committee might consider widening reserves management-related Treasuries purchases to include short-term coupon-bearing securities, if necessary, to ease liquidity strains in money markets.

Here is the current Fed “Dots Plot” indicating a hold on rate changes through 2020, but rising after the 2020 election.

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The Fed has helped push relevant rate to around 1.576%.

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Jerome Powell should be happy that someone hasn’t painted a picture of him ala Mexican revolutionary hero Emiliano Zapata.

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Jesse?

Zoltan! Underpriced Repo Risks May Push Fed Toward QE4, Zoltan Says

Zoltan!

(Bloomberg) Funding markets are underpricing the risk of renewed turmoil at year-end and the Federal Reserve may be forced to embark on a fresh round of quantitative easing to relax constraints.

That’s the view of Credit Suisse analyst Zoltan Pozsar, who said in a note Monday that the upcoming year-end is “shaping up to be the worst in recent memory.”

The Fed has been conducting repurchase-agreement operations and Treasury-bill purchases in a bid to keep control of short-term interest rates and bolster bank reserves into the system. And while that has calmed markets since the September spike that took overnight repo rates as high as 10%, concerns about the year-end period remain and participants have been flocking to Fed term offerings that will carry them through to January.

If the Fed loses control of overnight rates in the weeks leading into year end, Pozsar said the central bank’s options could include a fourth round of QE, which would involve switching from bill buying to purchases of coupon-bearing debt. It could also encourage foreign central banks to use foreign-exchange swap lines, he said.

The repo market, which relies heavily on just four big U.S. banks for funding, was upended in part because those firms now hold more of their liquid assets in Treasuries relative to what they park at the Federal Reserve, officials at the Basel-based institution concluded in a report released Sunday. That meant “their ability to supply funding at short notice in repo markets was diminished.”

Here is CB excess reserves and all CB holdings of Treasuries and Agency Securities.

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Will The Fed force commercial banks to reduce excess reserves? 

Or let “Greenspan’s ghost” haunt the financial market?

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Thanks to Jesse of Cafe American for his great imagination!

Fed Warns Prolonged Low Interest Rates Could Spark Instability (NOW A Warning??)

You gotta love The Federal Reserve. After 11 years of interest rate repression, The Fed now admits that continuing low interest rates could spark instability.

(Bloomberg) — Continuing low interest rates could dent U.S. bank profits and push bankers into riskier behavior that might threaten the nation’s financial stability, the Federal Reserve said in a report released Friday.

The latest version of the twice-yearly report, meant to flag stability threats on the Fed’s radar, highlighted the rate squeeze facing banks and insurers, noting that it could erode lending standards.

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“If interest rates were to remain low for a prolonged period, the profitability of banks, insurers, and other financial intermediaries could come under stress and spur reach-for-yield behavior, thereby increasing the vulnerability of the financial sector to subsequent shocks,” the U.S. central bank said in the report.

Fed Chairman Jerome Powell suggested to lawmakers on Thursday that low interest rates might be a permanent part of the economic landscape.

“We’re in a world of much lower interest rates,” he told members of the House Budget Committee. “That seems to be driven by long-run structural things and there’s not a lot of reason to think that will change.’

Fed Governor Lael Brainless said in a statement Friday that the low-for-long environment “and the associated incentives to reach for yield and take on additional debt could increase financial vulnerabilities.”

The bulk of the work on the report was done before September’s repo market tumult, which prompted the Fed to pump reserves into the banking system to boost money market liquidity. Still, the report does briefly address problems with the short-term repurchase agreements.

“Pressures in the repo market spilled over to other markets, including the federal funds market,” the report said. “The Federal Reserve took a number of steps beginning in mid-September to maintain the federal funds rate within its target range and to ensure an ample supply of reserves. Pressures in short-term funding markets subsequently abated.”

The central bank appeared to take a more relaxed view of the rising stock market than it did in its last report in May.

While equity prices remain high relative to corporate earnings, they are consistent with the low level of interest rates, the Fed said.

“Over the past couple of years, equity prices have been high relative to forecasts of corporate earnings,” according to the report. “However, other measures of investors’ risk appetite in domestic equity markets are in the middle of their historical ranges.”

You mean like the Shiller CAPE (Cyclically Adjusted Price Earnings) ratio … that is near the level seen on Black Tuesday of 1929.

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And then we have former Fed Chairs Ben Bernanke and Janet Yellen who kept The Fed Funds Target Rate (Upper Bound) at near zero from late 2007 to late 2015 (and then FINALLY raised the target rate in Dec ’15).  As Meryl Streep uttered in Death Becomes Her, “NOW a warning?”

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And then we had the joint rate-repression regimes of Bernanke and Yellen. Note the decline in the 10-year Treasury yield from over 4% in 2008 to under 2% today.

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Yes, The Fed has suddenly come to the realization (after 11 years of low-rate policies) that low rates can spark instability.

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The Big Short In One Chart! The Case of Phoenix AZ (The Fed’s And Federal Government’s Forgotten Role In The Mortgage Crisis)

I don’t mean to be a Debbie Downer, but it is important to understand what happened to the US economy and housing market in the US back in 2000s that culminated in such destruction to American households.

The book/movie “The Big Short” laid the blame on subprime adjustable-rate mortgages (ARMs) which is partially true. It also blamed Collateralized Debt Obligations (CDOs). But “The Big Short” ignored the Federal government and Federal Reserve’s role in the financial disaster.

It all started in 1995 under President Bill Clinton when HUD issued its now infamous National Homeowership Strategy  in order to increase homeownership rates, particularly among minorities. The NHS included Action 44: Flexible Mortgage Underwriting Criteria. Flexible? Like ALT-A (no or limited documentation) loans? Yes, the mortgage product that had less that 5% serious delinquencies (60+ days) as of late 2007, but exploded after 2007.

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Using Phoenix AZ was an example, notice that Phoenix’s home price index soared post-1995 as mortgage underwriting became looser coupled with The Fed lowering its target rate as a result of the 2001 recession. But The Fed overdid it, resulting in a massive house price bubble that exploded. The Fed then lowered their target rate to near zero percent but the damage had been done.

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At the national level, adjustable-rate mortgages (ARMs) were higher than post crisis.

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As housing construction collapsed, unemployment skyrocketed as did subprime mortgage delinquencies.

Phoenix was rocked by unemployment in the wake (not John Wake) of the construction boom and collapse. Pre-foreclosure filing rose with the unemployment rate, then subsided.

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So, The Big Short failed to mention the role of the Federal government and The Federal Reserve in the crisis, a dance that was a fantasy with a bad ending.

That is, The Fed and the Federal government were hoping for Heineken but got Pabst Blue Ribbon instead.

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US Average Hourly Earnings (3 Mo Avg) Highest Since President GWBush, Home Price Growth Lowest Since 2012 (Housing Bubble Redux?)

Unlike the housing bubble and “The Big Short” years of 2005-2007, when home price growth was greater than average hourly earnings growth, we are now in the opposite situation: slowing 2% YoY home price growth and the highest average hourly earnings growth rate since 2008 and President George W. Bush.

Home price growth is slowing …

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As average hourly earnings growth rises to its highest level since 2008 and George “Dubya” Bush.

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Using a different home price growth index (FHFA Purchase Only) and an average hourly earnings for the majority of Americans, you can see where home price growth exceeds average hourly earnings growth starting in 1998 and ending in 2006 (the “Big Short” bubble) and the QE3-induced home price bubble starting in 2012 to today.

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Between HUD’s National Homeownership Strategy of 1995 and The Fed’s quantitative easing (particularly QE3). the US Federal government is doing the “housing bubble dance.”

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Perry Omo? Fed Will Likely Restart QE In November (SOFR, Repo Rates Stabilize To Near Normal)

Is Fed Chair Jerome Powell really Perry Como? Or Perry OMO?

To the disappointment of many, Powell did not lower the target rate by 50 points and did not announce a resumption of QE.  Instead, the FOMC realigned both interest on excess reserves (IOER) and the reverse repo (RRP) rate lower by 5bp. Powell noted during his press conference that the Fed would use temporary open market operations (OMOs) “for the foreseeable future” to address pressures in funding markets.

However, and the reason why stocks shot up just before 3pm ET, is that that’s when Powell added that “it’s possible that we’ll need to resume the organic growth of the balance sheet, earlier than we thought. … We’ll be looking at this carefully in coming days and taking it up at the next meeting” in late October. Said otherwise, the Fed may not have announcer QE4 yesterday, but it will likely announce it in the very near future.

Sure enough, as Goldman wrote in its FOMC post-mortem, “we took this as a fairly strong hint and now expect the Fed to resume trend growth of its balance sheet in November with permanent OMOs. It is possible that the FOMC will take that opportunity to also reach a final decision on possibly shortening the maturity composition of its purchases, which it discussed at its May meeting.”

With all the OMO (or Perrys), the Fed’s Secured Overnight Finance Rate (SOFR) stabilized to normal levels.

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And the repo rate returned to near normal with the massive intervention with OMO.

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Fed Chair Jerome Powell (aka, Perry Omo).  Hot diggity dog. …

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On a side note, I tripped on a weight at the gym and fell against a weight machine. Fractured rib, badly swollen knee and dislocated perhaps broken finger(s). I call for a ban on power lifters dropping their weights and having them bounce in front of me!

The Big Squeeze! GC Repo Rate Crashes To 0% Amid Liquidity Squeeze And The Fed’s $53.2 Billion Flood Of Liquidity

Panic?

(Bloomberg) — The Federal Reserve took action to calm money markets on Tuesday, injecting billions in cash to quell a surge in short-term rates that was pushing up its policy benchmark rate and threatening to drive up borrowing costs for companies and consumers.

While the spike wasn’t evidence of any sort of imminent financial crisis, it highlighted how the Fed was losing control over short-term lending, one of its key tools for implementing monetary policy. It also indicated Wall Street is struggling to absorb record sales of Treasury debt to fund a swelling U.S. budget deficit. What’s more, many dealers have curtailed trading because of safeguards implemented after the 2008 crisis, making these markets more prone to volatility.

Money markets saw funding shortages Monday and Tuesday, driving the rate on one-day loans backed by Treasury bonds — known as repurchase agreements, or repos — as high as 10%, about four times greater than last week’s levels, according to ICAP data.

More importantly, the turmoil in the repo market caused a key benchmark for policy makers — known as the effective fed funds rate — to jump to 2.25%, an increase that, if left unchecked, could have started impacting broader borrowing costs in the economy. Because that’s at the top of the range where Fed officials want the rate to be, they are likely to make yet another tweak to a key part of their policy tool set to try to get things back on track when they meet Wednesday to set benchmark rates.

But the central bank didn’t wait until then to do something, resorting to a money-market operation it hasn’t deployed in a decade. The New York Fed bought $53.2 billion of securities on Tuesday, hoping to quell the liquidity squeeze. It appeared to help. For instance, the cost to borrow dollars for one week while lending euros retreated after almost doubling Monday.

For repo traders, hedge funds and others that rely on that market for financing, this intervention came none too soon.

A bit of an overshoot?

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And something that went unnoticed by many …

The New York Fed bought $3.001b of T-bills in the secondary market Tuesday as part of its planned reinvestment purchases.

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Yes, it is The Big Squeeze (not to confused with The Big Short).

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What up with that?

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The Big Short: Part Deux? US Home Prices Slow As Wage Growth Highest Since Early 2009 (Tiny Bubble OR BIG Bubble?)

No matter which US home price index you choose, US home prices have risen above the peak of the housing bubble in April 2007 (as highlighted in the book and film “The Big Short”).

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Thanks to relaxed credit standards, including the infamous NINJA (no income, no job) loans, the US saw a steady and increasing growth in mortgage credit and a corresponding growth in home price growth … until 2005. Then the bottom fell out out the housing market.

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Today, we are witnessing a slowing of home price growth even as earnings growth is at its highest level since early 2009.  The last time we saw home price growth and earnings growth so in alignment was back in the 1995-1998 period following the enactment of HUD’s National Homeownership Strategy. 

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The big difference between the 2000s housing bubble and today’s housing bubble is that the 2000s housing bubble was driven by subprime and ALT-A credit. But today’s housing bubble is in part driven by foreign investors on both the west and east coasts, not to mention the Federal Reserves low interest-rate policies. And we are seeing a softening of credit standards from Fannie Mae and Freddie Mac.

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And Fannie and Freddie’s debt-to-income (DTI) is rising to 2008 (financial crisis levels).

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So does the US have a tiny bubble? Or a big bubble?

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US Treasury 2Y Auction Sees 1.516% High Yield (Down From 1.825% At Previous Auction), Yield And Swap Curves Remain Cratered

The US Treasury just auctioned $40 billion of 2-year Treasury Notes at a high yield of 1.516%, down from the prior auction of high yield rate of 1.825%.

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As a result, the cratered yield and dollar swap curve remain … cratered.

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Sadly, the US Treasury yield and swaps curves remind me of the Lochnagar mine in France.

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