Crisis of confidence & regionalization
Artem Karida
Educator | C-suite advisor | business strategy, innovation, and marketing expert
This is Part 2 instalment of a history of the crisis involving the banking and financial system as it is now developing, with all contents based on incoming information.
Read Part I "Falling Bank Chronicles" to start the narrative from the beginning.
Read?Part 3?of the story "The Tipping Point: Systemic Deterioration in Finance"
INDEX
Don't miss the next report -?Subscribe
20.03.2023
Bond unrealized loss
According to the Fed's Z1 report, the unrealized loss on bonds issued under the dollar system is $4.8 trillion.
This is the difference between the maturity face value and the market value at the time of the cutoff. Let us know if you come across another assessment of a financial system flaw.??
The current market value is determined by the interest rate, the period of the bond, and the credit risk (the quality of the issuer and the probability of default). Bond prices decline as interest rates rise, as does the risk of default or issuer stability.
The gap in bond market valuation between Q4 2020 and Q4 2022 is about $7.6 trillion, a record negative shift in debt market history.
This paper loss, or the reduction in the value of a bond portfolio, was reported by holders of dollar bonds over two years, and the actual loss is $4.8 trillion ($5.3 trillion in Q3 2022). This is Fed data that has been extracted and collated from the Z1 report.
Only in the mid-1990s did the Fed learn to appropriately account for market value; prior to that, there was a jumble in the computation or erroneous data, so the inflationary crisis of the 1970s cannot be appraised.
The greatest contributor to the $4.8 trillion in unrealized losses:
Banks and investment funds openly manipulate their accounts and have recently moved assets from the AFS category to HTM (see the first item in the material to understand what this is about), allowing them to value the bonds in their portfolio at par, distorting the true picture.
The over $5 trillion loss is an estimate based on everything being evaluated using the AFS technique, which better reflects the extent of the financial system's hole and the motives of the Fed and the largest bankers for the ultra-rapid disposal of three banks over the past week.
Inflation and Fed's money
Last week, the Fed poured more than $300 billion into the system (twice as much as in 2008).
Will an inflationary spiral occur?
The liquidity distribution system will have no direct inflationary impact. Financial assistance in 2023 is similar to loan program adjustments in 2008.
15 years ago, the Fed's monetary injections did not produce inflation because:
This is currently occurring, as nearly half of the $300 billion was distributed through FDIC structures to support the deposit base of bankrupt banks, with the other half directed primarily to regional banks, which were severely impacted by financial contagion and large-scale redistribution of depositors and investors.
Many reasons triggered inflation in 2020-2021:
In 2023, fundamental disparities between effective demand and supply of goods and services continue.
Furthermore, government subsidies frequently overlap the income from the principal activities of low-skilled workers, causing considerable inefficiencies in the labour market, particularly in the service sector (hotels, catering, household, sports, culture and entertainment). The labour market is still unbalanced.
The Fed's loan programs aimed at repairing gaps will not have an immediate impact on inflation, but they may have an indirect influence by eroding trust.
A premature reversal of monetary policy (assuming it occurs on March 22) might gravely weaken the Fed's communication "window" with the market and economic counterparties.
In monetary policy, transparency (information transparency, accessibility and unambiguity, absence of hidden agendas and clandestine intrigues), and predictability are critical.
These three most fundamental components form the foundation of trust in monetary institutions, allowing you to construct sophisticated and long-term financial systems.
If the Fed has constantly increased its commitment to the concept of inflationary neutralization for nearly nine months, then a week later there is a sudden retreat from the desired course, then any explicit and uncompromising rhetoric cannot serve as a guide to action the next time.
All of this creates confusion, ambiguity, and volatility in the movement of cash flows. The Fed's policy has lost its clarity and legitimacy.
If they say something, they can modify their tone drastically when the input parameters change, thus trusting whatever the Fed says makes no sense. This is a disaster because the communication window has collapsed, undermining the entire transmission mechanism of the Fed's monetary policy.
Trust is eroded as a result of disorientation.
Fiat money has a shaky trust structure. Regardless of the economy's degree of growth, central banks must always demonstrate the validity of the monetary system / national currency, preventing the unrestrained/uncontrolled expansion of quasi-money and other derivative monetary instruments developed by the private sector.
The quest for an alternative and financial market bewilderment are simply pro-inflationary factors that are extremely dangerous due to the lack of tools for immediately compensating for lost confidence.
The Fed will provide $300 billion. Will the story be continued?
This program contains one very essential nuance: this meal is paid and has a very specific period of circulation, which bankers dislike.
Based on the credit program structure, the estimated average weighted rate of loans provided is around 4.7%. A considerable volume of loans passed through the discount window.
It's exorbitantly priced. There are hardly any solutions available now that allow you to cover such rates in annual terms with great dependability.
Given that rate expectations have declined dramatically, there has been a strong role of short-term rates sharply down, and the yield curve bulge is flattening (two-year treasuries changed by a record 1.2 percentage points in 6 trading days, and 10-year treasuries "only" by 0.6 percentage points).
In other words, it will be difficult to park the received very expensive bank loans in order to stay in the black. In the best-case scenario, it will be zero, but given the volatility and parted spreads, it will most certainly be negative.
Given how much the deposit base now costs, banks are unlikely to begin lending against this liquidity.
As a result, it produces a wedge - it is unprofitable to lend and risky to place on the market.
As a result, do not expect this liquidity to "burst" into the market. Because it is definitely not in stock. Loans are both short-term and expensive. Trying to get out of the stock market in a month or three months without losing money is impossible.
This appears to be a temporary gimmick to normalize domestic liquidity on the trajectory of deposit base redistribution between banks and allow banks to synchronize assets and liabilities in terms of maturity and profitability, avoiding liquidity gaps. This is not for speculative purposes.
Banks, in fact, fix the loss at these rates, but they also have the chance to balance assets through a more equitable sale of the position when they fulfil their commitments to withdraw client cash.
In this case, QE is absolutely different. You can be blowing bubbles with a clean, polished injection (perpetual and free). Throughout the years between 2008 and 2020, banks NEVER used Fed loans and REPOs for market speculation.
How many more "pullouts" are going to enter the credit market?
Not many. Regional banks have concentrated deposits primarily of the poor and middle class, which are protected by FDIC guarantees of up to $250,000. There's no use in hanging on. Deposit redistribution from particularly susceptible small and medium-sized banks to large banks will be gradual, but not "epoch-making," and will occur over time.
SVB is a whole other tale. This is a fintech bank that has made venture speculative capital loans to lawyers in the fields of information technology, biotechnology, and alternative energy. The deposit base was decimated when infotech fell ill on the trajectory of growth rates, and an information attack on the flight of investors began on SVB.
The Fed's loan programs are projected to peak at 700-800 billion, which only predicts a potential hole in regional banks, and the duration is roughly 3-6 months, with a fade in the second month. This is not a QE mechanism; the rationale is entirely different.
All of this is true if no one from the big ones "falls apart" but can they? Yes, and the account will be in the trillions.
Thus far, the focus has been on the fate of the Fed's balance sheet reduction (they may discontinue the program for the monthly sale of securities worth $95 billion) and the trajectory of growth rates, because each percentage point costs the financial system trillions of dollars.
Credit Suisse is no longer in business
Credit Suisse declares bankruptcy after a forced merger with UBS. Although they deliberately avoided the term "bankruptcy" in public pronouncements, the events must be called what they are. Credit Suisse's continued operations became impossible due to a variety of factors and conditions.
The bank's 166-year history came to an end practically instantaneously. The largest bank liquidation in Swiss history, the largest bankruptcy in terms of assets since Lehman Brothers, and Europe's largest bank collapse.
Serious misrepresentation of Switzerland's model of "safe haven," meticulously developed over 100 years. What can we say about other financial systems while the "indestructible financial fortress" is crumbling?
The bank, which had the highest liquidity coverage ratio (about 50%), went bankrupt in less than a week after suffering a severe reputational hit, a flight of customers/investors, and leading financial counterparties closing restrictions on the bank.
In a deal negotiated by the government, UBS agreed to buy Credit Suisse. The deal is worth 3 billion francs (less than half the value of Credit Suisse at Friday's close and more than 40 times cheaper than at its peak in 2007) in a deal with the government that includes extensive government guarantees.
The Swiss National Bank will provide UBS with up to 100 billion francs in liquidity support, while the government will provide a 9 billion franc guarantee against potential losses from Credit Suisse's assets as part of a merger, adjustment, and business reorganization.
In truth, UBS is buying out a bank with over 530 billion francs in assets and over 120 billion in cash, backed by a 100 billion cash gap guarantee from the SNB and a 9 billion loss from the government - a fantastic deal for UBS.
In an unusually short period of time, the transaction was merged without the permission of the shareholders, with all conceivable and unthinkable infractions of official norms.
This is the quickest takeover of a bank of this size in banking history (from the point of acute issues), both in Europe and the United States.
The Swiss government has issued emergency legislation to sidestep the necessity for shareholder approval, violating the ideal of transparency and legal certainty.
Shareholders will earn 3 billion francs, while bond investors will receive 16 billion francs.
The sale will result in a "complete write-off" of the bank's additional Tier 1 bonds, according to a statement from the Swiss financial regulator FINMA.
The bond write-down was the highest loss for the European AT1 market, amounting to $275 billion, significantly exceeding the only €1.4 billion write-down of this class of securities to date in 2017, at the time of Banco Popular's bankruptcy and purchase by Banco Santander.
This is a sort of bank bond that was implemented in 2009 to improve bank capital by acting as a buffer to increase capital adequacy.
At first glance, the forced takeover of Credit Suisse appears weird and questionable.
There are currently no details on the UBS and Credit Suisse merger, and the process of coordinating organizational and legal concerns will run at least through the end of 2023, but the absorption of the entire division appears to be taking place alongside the profitable section of traditional banking.
Lately, a hitherto unforeseen innovation has emerged: ultra-fast bank bankruptcy and takeover, which further confuses and destabilizes the market.
It is unclear what other victims will be affected by this remarkable device.
The banking crisis is escalating
In an effort to avoid a liquidity crisis and a shortage of dollars in the system, the Fed announced on Monday night the expansion of liquidity provision through swap lines in collaboration with other Central Banks (ECB, Bank of England, Bank of Japan, SNB, and the Central Bank of Canada).
Because the majority of external debt is still denominated in dollars, any financial market tension increases demand for the main financing currency on the path of resolving obligations or producing reserves - first and foremost the dollar, then the euro, pound, yen, and Swiss franc.
A swap line is an interbank currency exchange. For example, the ECB transfers euros to the FRS at a fixed rate, and the FRS transmits dollars to the ECB at a variable rate, resulting in the establishment of a swap difference based on interest rates in dollars and euros.
This program has only run three times in contemporary history
This time, the initiative will go live on March 20 and will run daily auctions through the end of April.
Bank failures, widening money and credit market spreads, growing risk/default insurance, volatility, uncertainty, record Fed lending to banks, swap lines, and expectation repricing are all part of the financial crisis.
The global banking crisis
The global banking crisis is reaching out to a wider variety of countries, claiming fresh victims.
What began innocently enough in early March with the Silvergate crypto-bank -> two weeks later resulted in the collapse of a financial behemoth like Credit Suisse.
In 2008, the events were separated by 9-12 months; today, the count is done in days. The mechanism for putting an end to the banking crisis is well-known and time-tested: limitless credit lines on first demand secured by assets valued at face value.
When the Fed and Treasury approved the bankruptcy of SVB (and, later, Signature Bank) 10 days ago, they expected their typical monetary manipulations to function like a Swiss watch; nevertheless, even a Swiss watch fails. The SNB's allocation of 50 billion francs at the end of last week resulted in nothing - the verdict was issued.
Stopping the confidence crisis with a liquidity injection often saves, but not always. Banks and investment funds will be torn apart in such a way that it will not appear enough as long as the basic problems with the financial system are not addressed.
Now, you need to go a little deeper to understand what procedures led up to the March financial market tsunami.
The unrealized loss on USD-denominated bonds was approximately $4.8 trillion by the end of 2022 (difference between market and face value) - these losses were allocated to all holders (the financial sector concluded with a $3.5 trillion loss).
Because it is sensitive and unpleasant. This is the quickest change in bond market position valuation in history. Not only in dollars but also in euros and pounds, which incur massive losses.
Prior to the rate hike, issuers had been placed and refinanced at zero rates for about 13 years, so the interest rate shock is the most severe, and the stress on the system is incomparably bigger than in the 1970s and 1980s.
The debt burden relative to income is now three times bigger than it was 50 years ago, the extent of the financial system and the depth of development are incomparably greater, and there was almost no preparation for such a large-scale and rapid increase in interest rates this time (high rates were the norm in the 70-the 80s).
But was there anything else? The February 2023 events... These events are important because, despite a backdrop of high underlying inflation, low unemployment, and robust macroeconomic data, estimates for the Fed key rate jumped from 5.1% to 5.65% by mid-2023.
This caused the yield on two-year US government bonds to jump from 4.07% in early February to 5.1% by March 8, while the rate on 10-year notes jumped from 3.4% to 4.1%.
By early March, the unrealized loss on dollar bonds had reached $6 trillion or more, triggering a series of bank events that everyone is aware of.
The reasons for such hasty action to bankrupt three banks in the United States (two of which were substantial) were intolerable losses on a portfolio of assets (mostly dollar bonds) that had approached the redline (the main trigger).
In addition to market hazards, interest rate risk and credit risk are becoming more prevalent in the banking sector. The issue is quite challenging.
The largest bankers, the financial elite, the Treasury, and the Fed were unable to wait for macroeconomic conditions to stabilize, which have major inertia, before beginning the process of monetary policy reversal. To shift the narrative of the monetary narrative and monetary policy, it was vital to move rapidly.
As a result, estimates for supply declined from 5.6 to 3.8% (minus 1.4 percentage points) by the end of the year, two-year treasuries lost 1.3 percentage points, and 10-year treasuries lost 0.6 percentage points.
Just as Lehman Brothers' sacred sacrifice legitimized QE (they did not provide the bank $20-$40 billion to inject trillions later), so did the SVB case (they did not give $10 billion to legitimize the reversal of monetary policy ahead of the inflationary neutralizing phase).
But not everything is so straightforward. First, they have begun a financial infection in the system and are looking for weak links in the chain; second, they risk weakening the Fed's credibility and authority in the context of inflationary neutralization.
Crisis of confidence
What does the current banking crisis in Europe and the US show?
Despite the extremely soft conditions for the takeover by Credit Suisse, there was a real collapse of the banking sector in the morning trading - the third largest after September-October 2008 and March 2020.
Although the Swiss government made a practically free put option for UBS - the first 5 billion francs of losses on the side of UBS, and then 9 billion francs directly guaranteed by the government, i.e. if the accumulated losses after the integration of Credit Suisse are less than 14 billion francs, then the maximum loss of UBS is only 5 billion at a purchase price of only 3 billion.
The deal is not bad, given that UBS is becoming an absolute monopoly in Switzerland, absorbing the main competitor. But this promptly led to a 14-15% collapse in stocks, although positions have recovered by now, not credit risk.
Default insurance for UBS hit a new record, 5x higher since March 8 to the highest since the 2011-2012 banking crisis.
There are fears of contamination of UBS assets following the takeover of toxic assets by Credit Suisse.
The total liquidation of over $17bn of Credit Suisse debt in AT1 bonds resulted in a collapse of more than 10% for all outstanding debt of $275bn.
These are unique bonds for banks that have earned after the financial crisis of 2009, issued in order to increase bank capital of the first level. They have a higher yield than conventional bonds and act as a buffer to avoid additional share offerings and shareholder dilution.
As a result, bank shares remain under strong pressure (for European banks, the decline from March 8 is 15-25% for leading banks), bank bonds are at the bottom, and credit and cash spreads are at maximum levels since the 2011 and 2009 crisis.
The danger of a crisis of confidence in its current form is that no one knows who is next. Potentially - almost any.
The industry is very sensitive to reputation and trust, and any deviation will quickly destabilize the system. Structural problems are common to all, and the trajectory of the banking crisis is dangerous because even an initially stable and relatively healthy element of the system can collapse at once if counterparties lose confidence for a number of reasons.
As seen over the past two weeks, the loss of trust can be lightning-fast.
Financial market regionalization
Recent geopolitical, financial, and economic events have resulted in increasing fragmentation and dispersion of global monetary flows.
During the 2008 financial crisis, the world was extremely connected, which caused issues in the US and European financial systems to spread around the world, particularly harming emerging markets.
Because of high integration into the global capital market, low capacity and liquidity of national markets, any turbulence in world markets caused the national currency of developing nations, stocks, and bonds to fall to the bottom.
The level of integration was really high. In essence, the capital market was exclusively available in Western markets (dollars, euros, pounds, yen, francs, etc.).
Financing was provided primarily in dollars and euros, at all levels (business lending, placement of national issuer bonds, and direct and portfolio investments).
For the past 15 years, the globe has evolved, and the influence of national markets, as well as finance in national currencies, has grown.
Here's an oddity:
The banking crisis in the United States and Europe in 2023 has a negligible impact on developing markets, with bank shares in China, Russia, and Turkey even rising in a month (in dollar terms, taking into account changes in the national currency rate)!
According to calculations, the capitalization of all world banks available for open trading was slightly more than $10 trillion on February 20, and the current $9.1 trillion is the largest drop since March 2020:
At the same time:
That was unthinkable from 2008 to 2015, when emerging markets typically plummeted more than developed markets.
The world is evolving.
21.03.2023
Looking for a fresh victim
First Republic Bank, with $212 billion in assets (more than SVB), is collapsing, at least in terms of capitalization.
The bank's stock dropped 47% to an all-time low, the second-largest drop in the bank's history following a 62% drop last Monday (March 13). The shares have folded ten times since the beginning of March 2023! A drop of over twenty times from the November 2021 highs.
The turnover of trades reached 190 million securities, or over 3.4 billion dollars in monetary terms, which is similar to the capitalization at the end of the day, i.e. they changed the whole capitalization of the bank - amazingly - in a few hours. Vanguard Group, Blackrock, and State Street are the bank's largest shareholders, accounting for one-quarter of its capitalisation.
According to historical data, when a bank fails ten times in a short period of time, it is almost certain that bankruptcy, a merger with other financial institutions, company reorganization, or compulsory capital increase activities will occur.
In other words, the verdict has been rendered, at least according to market statistics. After much pressure, there is a slim likelihood that a financial institution can resume normal operations. There were multiple parallels in American market history when non-financial enterprises rose after a catastrophic collapse, but not banks.
Maintaining the trust of investors/shareholders/depositors, customers, and counterparties is crucial for banks. Finances are highly sensitive to market conditions and tend to flee areas of danger and uncertainty.
Credit Suisse fell despite it had one of the highest deposit coverage ratios for cash balances. Almost immediately, investors and counterparties abandoned the bank, withdrawing deposits and closing interbank market limitations. In these circumstances, a major bank cannot exist after the poisonous contamination of the bank's institutional position has begun, i.e. when trust has been destroyed.
Notwithstanding the fact that the major 11 American financial institutions invested $30 billion in First Republic Bank, the situation has not improved. Bank of America, JPMorgan, and Wells Fargo each made a $5 billion deposit. Goldman Sachs and Morgan Stanley each contributed 2.5 billion, yet this represents barely one-sixth of the deposit base.
JPMorgan's Jamie Dimon advises converting some of the proposed bailouts into shares (the form of the conversion has yet to be determined), which is unlikely to help the situation if the bank's confidence issue worsens.
Don't be surprised if First Republic Bank slides to the bottom unexpectedly (like it usually does) (forewarned is forearmed). Express bankruptcy in 2023 is both unusual and bold.
Regional banks in the United States
What is the position of regional banks in the United States, what are the hazards, and is there a possibility of a chain reaction?
First and foremost, the global concerns of the entire financial system must be distinguished from the local problems of regional banks in the United States.
The first thing to notice is the financial system's significant fragmentation of liquidity.
There is an inverse relationship: the smaller the bank in terms of assets, the higher the cost of attracting a financing resource (mostly deposits) and the lower the short-term liquidity (cash, equivalents, and liquid market assets) in the accounts.
For example, small and medium-sized banks (which are below the top 25 largest US banks in terms of assets) have only 6% of cash in their asset structure, compared to 10% for the top 25 and around 25% for large banks.
When it comes to bank excess reserves ($3.5 trillion deposits retained in FRS accounts, as well as REPO procedures for $2.4 trillion), it is assumed that we are primarily talking about a group of principal dealers.
This is not the entire list, but rather the most important banks. The aforementioned financial organizations have over $3 trillion in cash on hand, which is substantial.
It is incorrect to speak of a surplus of cash in the banking system; rather, it is more accurate to state that the excess currency is concentrated in financial structures that can be counted on two fingers. Since 2008, there has been significant fragmentation, which has increased year by year and will reach a peak in 2020-2023.
领英推荐
We can unequivocally state that the liquidity imbalance has never been greater than in 2023, and the situation has deteriorated since March. The recent incidents involving banks will undoubtedly result in additional liquidity distortions in the financial system.
Now that everything is obvious, what comes next?
The liquidity issue, which evolves into a crisis of trust in regional banks, exacerbates fragmentation, and in order to close cash gaps, small and medium-sized banks will be obliged to seek super-expensive lending from the Fed at rates around 5% and boost deposit rates.
The rivalry for finance is increasing, and there is no longer a low-cost basis, owing to both the rise in the Fed rate and the lack of trust in banks outside the top ten. The only viable option is to raise deposit rates.
The interest rate risk is realized here when the funding base grows in value and overtakes the bank's assets (loans and securities), increasing the asset-liability imbalance in terms of maturity and profitability.
Securities are under pressure, and raising rates will be essential to balance assets through loans, which will already contribute to credit risk in the future (growth of delinquencies and write-offs, the risk of non-payments and defaults of borrowers).
Credit risk follows as a natural way to compensate for interest rate risk, because large banks will take over the most solvent and high-quality customers, while regional banks will obtain "scum," toxic, and trash clients willing to borrow at high rates with the danger of nonpayment.
The liquidity problem can be stopped, but not the losses on bank operating activities and the asset-liability imbalance.
What will occur?
Loss-making banks will cause breaks, increasing flight and locking the system back into the first phase in a more severe form.
Will a prolonged period of regional bank deterioration, however, have an impact on the overall financial system?
Questions that no one can answer
The history of banking crises in the United States demonstrates that these processes cannot end abruptly
these are processes that, on average, last years and have a distinct profile, specifics, measure, and depth of impact on the economy and financial system, as well as a distinct trajectory of event development.
What is happening today is critical, both from an opportunistic and historical standpoint, since history is being written right now.
It is critical to thoroughly investigate what is going on.
In the hierarchy of priorities, this is currently the most essential and relevant topic, pushing most everyday occurrences and macroeconomic statistics to the sidelines. At least for the duration of the event.
Throughout the last century, the United States has had three banking crises:
The fourth crisis has arrived.
Important concerns:
At least one big bank is now directly threatened. The list of vulnerable banks is lengthy. Read more details in "Falling Bank Chronicles, Major blow for local banks"
It took almost 1.5 years from the beginning of the primary impact of the crisis to the top, and we are just in the third week of the acute phase. There will be many events in the future.
So far, it appears improbable because it is difficult to swing JPM, which has about $1 trillion in cash on its balance sheet.
No, they will be averted by the typical manoeuvres of unrestricted liquidity injection from all directions (Central banks, major banks and funds).
Each financial crisis that has happened in the last 100 years has resulted in significant changes in legislation, regulation, and the proportions of key actors in the arena.
As a complex choice between financial stability and inflationary neutralization, we expect this to have an effect. The Fed will be compelled to make a decision in favour of financial stability, which may prove to be a disastrous error given the current risk factor composition.
There will be no internal financial movement, but external money outside of US-controlled countries is available; nonetheless, there will be fragmentation into neutral and US-friendly countries, i.e. created ecosystems (dollar-euro-yen-pound-franc-Canadian and Australian dollar against the currencies of neutral countries). At the same time, developing countries reliance on developed countries will decline dramatically.
International usage is likely to fall, but it will remain constant within the US-created environment of major US allies.
Absolutely. Growth of credit spreads, the rising cost of risk insurance, rising volatility, and reduction in through funding across rival structures as a result of a confidence crisis.
Yes.
All of the preceding were not responses to questions, and the list of questions is not exhaustive. The essential point is that no one in any country currently responds to them, which raises the question of the wisdom of preserving the current political class.
23.03.2023
The Fed raised the interest rate by 0.25 percentage points.
The Fed increased the interest rate by 0.25 percentage points to 5%, the highest level since December 2007 and the fastest increase in 42 years. The monthly balance sheet reduction program has been continued at 95 billion.
What is important here is the projection of intentions, not the actual decision, which fits into the specifics of the Fed's work and is compatible with the concept of preserving trust in monetary policy.
The occurrences are remarkable, thus it is quite intriguing how the Fed looks into the future and how Powell remarked on the happenings. Let's note right away that the market and the financial media missed the most important thing in the speech, and I'll tell you about it in detail.
Very succinctly the most basic intentions of Powell's 45-minute speech: "Events in the banking system will lead to a tightening of credit conditions, which is likely to affect economic results, but it is too early to determine the extent of the impact of financial consequences on the economy and early to say about how the Fed's monetary policy should respond.
As a result, we are NO longer claiming that the next interest rate hike will be suitable to restrain inflation.
At the same time, we now assume that some additional Fed monetary policy may be appropriate in assessing the current and expected impact of the credit tightening.
Tightening financial conditions is the equivalent of rising interest rates, but the Fed has no data or insight into the medium-term forecast of financial conditions.
The tightening of credit conditions in some sense replaces the rate hike.
The monetary policy should be tight enough to drive inflation down to 2%, but it doesn't have to be tied to higher interest rates.
If it becomes necessary to raise the rate even further, we will do so, but financial conditions must be considered."
This is quite an important transformation of rhetoric and tone. Given how carefully the Fed chooses its language and is conservative in its declarations of intent, the preceding is unambiguously interpreted as the emergence of a "new" determinant of the Fed's monetary policy - financial conditions.
Powell was visibly nervous, and after each rate outlook announcement, he made reservations about uncertainty and financial conditions, which serve as a substitute for the Fed's monetary policy tools, offsetting the rate hike.
In other words, the stress in the banking system and any instability in financial markets is clearly and unequivocally a deterrent to further tightening, despite the fact that the pain threshold and breakdown points were not presented, as is typical of the Fed.
How should the Fed's statement be interpreted??
There are no plans at all. As long as inflationary pressures and strong economic data prevail, the Fed has a window of opportunity to hold the rate, but any economic and/or financial disturbance will rapidly adjust monetary policy to present conditions.
"Participants will not see rate cuts this year... the rate path is uncertain, and policy will reflect what is actually happening, adjusting to market conditions," according to the speech.
Powell's nervousness is indicative of the fact that he blew off a couple of questions about the regulation of the banking sector, was reluctant to answer uncomfortable questions, asked more often than usual and looked at the cheat sheet more.
But most importantly, Powell said much more often than usual that "no one should doubt that the Fed is on track to bring inflation down to 2%," as if it wasn't clear in the context.
Nervousness, uncertainty, and fear of breaking the delicate equilibrium, when, with unsolved problems with inflation, the financial sector is destabilized.
In principle, the direction of the monetary policy is shown quite clearly. Stop tightening at the first sign of trouble, as the signal is given for the first time in a year.
Briefly about recent events
Concerning the most recent developments in the banking system, as well as the unprecedented 300 billion from the Fed last week.
How does last week's $300 billion increase in the Fed's balance sheet connect with quantitative tightening (QT) policies, i.e. a $95 billion balance sheet cut?
"The goal and impact of bank rescues are very different from QE, which affects demand channels well understood by the Fed" (through financial easing). To address financial gaps, temporary lending to banks was adopted."
About the SVB collapse?
Powell: “SVB does not reflect the intricacies of the difficulties in the overall banking sector. This is a unique bank with a low proportion of insured deposits, a high concentration of assets in long-term securities, and considerable deposit mobility as a result of venture financing schemes (a run of investors)."
True in the context of the SVB case, but bank failures directly reflect the specifics of financial system problems. Powell, in other words, lied without hesitation ??
What about the banking system's stability?
"Problems in individual banks, if not resolved, can weaken trust in healthy banks and imperil the financial system's operation." The Fed has taken decisive action, in collaboration with the US Treasury and the FDIC, to restore trust in the banking system and protect depositors' savings.
Banks with dependable and liquid assets can pledge them to the Fed at face value if necessary, acquiring liquidity that, when combined with other Fed programs, will fully cover the needs for emergency funding. Our banking system is strong and stable, with adequate capital and liquidity.
We will keep an eye on the state of the banking system and employ all of our resources and capacities as needed. Furthermore, we hope to learn from what happened and avoid similar incidents in the future."
This section of the speech can be interpreted as a clear intention to use any funding channels on an unlimited scale as problems are identified, as they have been in the last two weeks.
What about the economics section of the speech?
"Inflation is high, the labour market is tense, we are dedicated to lowering inflation down to the 2% objective, housing activity is sluggish, which reflects higher mortgage lending rates." Fixed investment is also subdued.
Salaries are increasing rapidly, albeit at a declining rate. The labour market imbalance persists (low unemployment, high labour demand), but the Fed believes in the adjustment of labour market circumstances.
Expectations for long-term inflation remain consistent and sustained."
There is nothing new. Interestingly, it was stated that "deposit flows have stabilized over the past week," so let's take a look at bank reports.
What about financial regulation? (where did the Fed look and why are banks falling so rapidly?)
These questions irritated him the most. He indicated that a special commission was working, that he did not know the results, and that if he did, he would not reveal them.
If we count the tone of the speech, Powell was scared and excited, and there was a general lack of confidence because all forces were thrown to maintain confidence in the Fed's policy in the context of inflationary neutralization: "The Fed is determined to reduce inflation to the target and is unshakable."
There were numerous mutually exclusive hypotheses. On the one hand, he stated several times that "lowering interest rates is not part of our baseline assumption." Simultaneously, by adjusting "tighter financial conditions might have a large macroeconomic impact, reversing the Fed's monetary policy direction."
The Fed is in a strategic clinch, a dead end. How can I get out? They have no idea, but they are aware of the dangers and attempt to jump off. They profess the war against inflation, displaying declaratory rigour, but they are ready to abandon this road at any time. Q.E.D.
Macroeconomic Forecast from the Fed
The Fed pretended that nothing was happening in its macroeconomic forecast.
To be sure, this is typical Fed conduct, as the Fed's significant reluctance in responding to trends is its defining feature.
All Fed acknowledgement of concerns occurs after the fact, normally six months later, but recently with a year lag.
For example, they only began to officially address the problem of inflation in January 2022 (almost a year after it arose), when the inflation rate exceeded 7%, and the Fed beat QE on the markets with rates of 0.25% in Q1 2022.
Another intriguing finding is that in December 2021, when inflationary difficulties were obvious "in full development," the Fed expected a rate of 0.9% (in fact 4.4%), GDP growth of 4% (in fact - + 0.5%), and PCE inflation of 2.6% (in fact 5.7% on average per year) in its economic estimate for 2022.
In this sense, when the Fed states at every meeting that it "understands nothing and cannot predict the future," it is stating the "ultimate truth."
In terms of macroeconomic and financial forecasting, the Fed is unique in that it has never predicted a crisis or even a tipping point in its existence.
This time, the Fed forecasted 3.3% inflation, no recession, 0.4% GDP growth, 4.5% unemployment, and no rate drop from 5.1% by the end of the year.
What's the point of it all?
The key to easing will be changes in the financial markets and the financial system. We're keeping an eye on it!
Debt crisis & Non-financial organizations
From the point of view of the stability of the system, the reproductive debt mechanism is very significant, i.e. the ability of the non-financial sector to efficiently and easily refinance current loans and create new ones.
This is such an important process that it directly raises the issue of the system's medium-term sustainability, including the formation of the economy's investment potential.
All of the conditions for a collapse appeared to be in place in 2022, but the American financial system withstood and even showed fragmentary signs of growth.
This is not fully logical in the context of susceptible links in the chain that have high leverage, and low profitability - typical corporate zombies that have puffed up in 13 years of cheap capital in unlimited volumes. They are not visible at the top of the S&P 500, because. The toxic business is primarily concentrated in companies with revenues of less than $1.5 billion. They are not backbone companies, but they are extremely sensitive on a macro level.
Hence, a direct head-on assessment of the S&P 500 index can shift the emphasis of perception, establishing assumptions about the surplus margin of the business. Huge business, especially in infotech? Yes, but in the US economy, there are quite a lot of companies that have losses or near-zero profits, with an aggressive corporate strategy.
These are the initial "write-off" possibilities. In theory, this segment can be categorized as junk debt, where placements have reached zero. But not just junk bonds.
Taking inflation into account, the non-financial sector's debt market is dropping at a record rate in history, while lending, which is expanding in step with inflation, functions as a stabilizing mechanism.
This is what rescues the system, at least in 2022. And now? Financial circumstances are tightening throughout the banking sector, and competition for depositors is intensifying in medium and small banks, raising deposit and loan rates.
This reduces demand for loans, which, combined with an unrecovered method for refinancing debts through bonds, can generate liquidity shortages for non-financial enterprises, precipitating an economic debt crisis.
24.03.2023
Pumping money into the banking system
The Fed is still aggressively pumping money into the banking system, albeit the pace has slowed dramatically.
If more than $300 billion was issued in the first week following the bankruptcy of American banks, a record pace in history, and another $95 billion was released in the second week, then the funding structure is shifting.
As a result, the current volume of loans on the balance as of March 22 is about $414 billion, up from $318 billion the previous week.
As a result, the two-week change in money from the Fed to the banking sector is $400 billion,
the most significant credit impulse in the Fed's history, though the disparity has shrunk.
As the graphs show, there have only been three emergency lending programs in the last 20 years: the 2008 crisis, with a total volume of about $1.15 trillion by the end of December 2008 (credit programs + REPO), and $460 billion by March 25, 2020.
Last week's impulse was over 1.5 times the size of the worst incident of 2008 ($275 billion on March 18, 2020, versus $272 billion by October 1, 2008).
It is vital to notice that lending shrinkage has ALWAYS followed the path of simultaneous printing presses via asset buyouts from 2009 and 2020. (QEs). Because of the inflation, it will be harder to employ QE this time.
Asset Reduction Plan
The Fed's balance-sheet asset reduction program (QT) has been halted. Securities worth $12 billion have been sold in the last three weeks, the slowest pace since August.
The regular rate of sales over three weeks is $60 billion, in keeping with the Fed's real open market operations, eliminating the factor of uneven redemption of securities, because sales are volatile and average values for 20 trading days are required.
The discrepancy between sales objective and actual sales volume has widened to $245 billion, the largest since the start of the balance sheet reduction program in June 2022. The disparity is growing to 2.6 monthly sales volumes. In reality, the Fed was absent for about three months.
From December 2022 to February 2023, the deficit was steady at $185 billion, indicating that they actually met the sales objective of $95 billion per month, and sales have since ceased.
As per MBS, the total deviation from the plan has climbed by 65%, implying that only 35% have sold (three times less than necessary), while Treasuries have an execution rate of 89% (96% at the beginning of March).
In general, the beginning of QT's work was a disaster; they began to swing only in October, when they reached plus or minus appropriate sales rates, and accomplished absolutely nothing for the first month.
Halt or sharp slowing of sales occurred three times (till March 2023) in response to the market shock, agony, and volatility (in June and September, when the markets fell and in November, when there was an interest rate shock due to the inflation of interest rates on bonds).
The Fed discontinues QT as soon as financial system stress occurs.
The dollar swap lines, which the central banks began on March 19, had not been activated by March 22.
Therefore, in 9 months, the Fed sold $542 billion in securities and injected $400 billion into the economy through lending, offsetting about 34 per cent of the whole QT, which is, to put it gently, disastrous.
Direct proof of the hypothesis of zero faith in the financial authorities' words, promises, and forecasts.
There is no trust in words or acts
Do not place too much emphasis on the current actions of the world's central banks and monetary authorities' statements. Trends must be evaluated, and context must be considered.
Despite the fact that the financial system is in disarray, the actions and pronouncements of monetarists are taking place in the midst of the highest inflationary pressures in 40 years. Inflation is reducing due to the base effect countering the negative effect of volatile components (mostly the energy component), and headline inflation may fall to 4.5%, while core inflation is three times greater than average.
They simply do not have an option but to disclose their plans to combat inflation, or else the confidence of the monetarists will be shattered, with disastrous ramifications for the financial system.
Official forecasts, virtually always, deviate from reality at the tipping point, when the system collapses into crisis processes. Official forecasts have never been and cannot be the primary decision-making tool in system transformation, since they are one of the tools of the Central Bank's switching channel with the market, forming potential economic actors' intentions.
As a result, official projections will never indicate the potential implementation of crisis processes, because the Central Bank's identification of system imbalances may have a self-fulfilling effect. For example, the Central Bank creates estimates in which it expects a crisis in three months, which automatically guides the activities of economic agents that rely on official monetarists' projections, estimates, and comments.
The amount to which market players support the Central Bank's verbal interventions is determined by trust in the Central Bank. The more trust, the greater monetarists' capacity to influence the market through comments rather than deploying monetary policy instruments. For example, the Fed has stated that it will do all possible to limit inflation and is confident in the effectiveness of its monetary policy and the tools it employs. This statement is intended to have a disinflationary effect, normalizing inflation expectations, and assuming faith in the Central Bank.
Even if there is internal agreement on the onset of a crisis, public statements will never, ever clearly express this.
Trust is essential to the functioning of the financial system, and trust in the Central Bank determines the success of monetary policy transmission to the financial system and, ultimately, to the economy.
Transparency, consistency, and predictability are critical for maintaining trust. Deformation or loss of confidence leads to disorientation, confusion, and flight from the national currency, with the inevitable search for surrogates, and alternative places of capital investment, resulting in a highly pro-inflationary scenario that is on the verge of becoming hyperinflationary.
Monetary policy inertia is caused by the need to retain trust in central banks and save face. Even if they have a short-term benefit, quick reversals (out of sequence) are like death.
As a result, the ECB lifted its rate by 0.5 percentage points, the Fed by 0.25 percentage points, the Bank of England by 0.25 percentage points, and the SNB by 0.5 percentage points in the last week.
Long-term confidence in monetary institutions is incomparably more important in the hierarchy of objectives than the short-term shock of market cash disparities. The liquidity crisis is halted by Central Bank liquidity, but the crisis of confidence in the Central Bank is unaffected. As a result, the motivations driving the monetarists' pronouncements in the recent week.
At the same time, a distinction must be made between a proclamation of purpose (for example, the Fed's pronouncement that rates would not be cut in 2023) and actual acts, which can be disguised and not public.
Regardless of what the monetarists say, the real action is that financial stability comes first.
Any standstill is in a tailspin, as Central Bank assistance arrives in real-time in a limitless amount.
Read?Part 3?of the story "The Tipping Point: Systemic Deterioration in Finance"
THE END OF THE REPORT
Stay tuned.?
Regards, Negorbis.
Don't miss the next report -?Subscribe
We don't make recommendations; instead, we highlight critical patterns that will help you fail less.