Hope all goes well… “I have not considered or discussed anything having to do with blanket insurance or guarantees of all deposits,” answered Janet Yellen, when asked on Wednesday whether Treasury would circumvent Congress to insure all deposits. Naturally, this accelerated the bank run, as rational economic actors moved their money. “Certainly, we would be prepared to take additional actions if warranted,” said Yellen on Thursday, attempting to reverse Wednesday’s damage. And this made it more likely that additional action will become warranted. Because in times like these, markets sniff out weakness, and push prices to the point of maximum pain. Policymaker panic.
Overall: “In such an environment, our ultimate goal is clear: we must – and we will – bring down inflation to our medium-term target in a timely manner,” declared Christine Lagarde, determined, schooled in the importance of conveying confidence during times of crisis. “In current conditions, a robust strategy calls for a data-dependent approach to making policy and a clear reaction function so that the public understands the sources of information that will be important to us,” continued the ECB President. “To that end, our future policy path will be determined by three factors; (1) our assessment of the inflation outlook in light of the incoming economic and financial data, (2) the dynamics of underlying inflation, and (3) the strength of monetary policy transmission,” explained Lagarde. It all sounded great to just about everyone, except investors, and especially traders. Because (1) a central bank’s inflation outlook in times of great economic uncertainty is profoundly unreliable, (2) the dynamics of underlying inflation are wildly unstable when inflation is this high, and (3) monetary policy transmission in a highly indebted hyper-financialized global economy can appear too weak one day and precipitate a bank run the next. “At the same time, I have made clear that there is no trade-off between price stability and financial stability. We have plenty of tools to provide liquidity support to the financial system if needed and to preserve the smooth transmission of monetary policy,” said Lagarde, presumably hoping that if she said it with great certainty, we would all forget the lessons of decades of trading and a century of financial history. You see, central banks do not have the power to determine how monetary policy is transmitted. Markets decide. And there is always a trade-off that central banks must make between price stability and financial stability. To deny this is to invite markets to press our policy makers to the point where they must choose one or the other.
Week-in-Review: Mon: market digests news of CS being acquired by UBS / AT1 bond holders wiped out which initially instilled fear in market but was quickly seen as being a CS specific risk, Fed/BoC/BoE/BoJ/ECB/SNB enhance liquidity via add’l USD swap lines, Xi arrives in Moscow, AMZN to lay off add’l 9k workers, Biden veto’s GOPs anti-ESG investing bill, FRC downgraded for second time in 7 days by S&P, BOJ mins show reluctance for abrupt policy shift, China keeps 1y & 5y LPR unch as exp, French opposition party failed to pass a “no-confidence” motion against Macron’s govt – clearing the way for his unpopular retirement age reform, Germany PPI 15.8% (14.5%e), Taiwan expt orders -18.3% (-17.5%e), S&P +0.9%; Tue: Japan PM Kishida visits Ukraine, Yellen says “situation is stabilizing”, ECB’s de Cos says ECB stand ready to maintain financial stability, Lula questions the necessity of CB autonomy – again, UK public sector borrowing 16.7b (11.7b exp), Canada CPI 5.2% (5.4%e) / Core CPI - Median 4.9% (4.8%e), US existing home sales 4.58m (4.2m exp), S&P +1.3%; Wed: Fed hikes 25bp (18bp exp) / statement acknowledges recent banking crisis / median 2023 dots indicate 5.1% median yield, Yellen rejects broad increase in FDIC insurance, ECB’s Lagarde says bringing infl back to 2% is non-negotiable, ECB’s Lane mentions the banking crisis may turn out to be a nonevent, Brazil CB unch as exp, China approves first MRNA Covid vaccine, Xi’s trip to Russia concludes with little surprises, Macron says he won’t back down on reform in the face of protests, UK CPI 10.4% (9.9%e) / Core CPI 6.2% (5.7%e) / RPI 13.8% (13.3%e), UK House prices 6.3% (6.5%e), S&P -1.7%; Thu: Yellen walks back comments re FDIC insurance – says prepared for add’l deposit actions ‘if warranted’, BoE hikes 25bp (15bp exp), SNB hikes 50bp as exp, Norges bank hikes 25bp as exp and signaled more hikes to come, Taiwan CB hiked rates unexpectedly by 12.5bp (hold was exp), Turkey CB unch as exp, Philippine CB hikes 25bp as exp, Hindenburg research targets Block as new short target, UBS/CS among banks facing US Russia sanctions probe, Fed balance sheet sees consistent demand at DW/BTFP facilities / unexplained demand at FIMA repo window (foreign CB), Singapore CPI 6.3% (6.4%e) / Core CPI 5.5% (5.8%e), Taiwan IP -8.68% (-10%e), UK CPI 1.7% (2.4%e), Mexico ret sales 5.3% (3.2%e), US init claims 191k (197k exp), US Chicago Fed activity -0.19 (0.10e), US new home sales 640k (650k exp), US KC Fed activity 0 (-2e), EU cons conf -19.2 (-18.2e), S&P +0.3%; Fri: Fed’s Bullard says he raised his 2023 dot to 5.625%, Yellen convenes the FSOC to stabilize the banking crisis, US bank deposits fell $98.4b week ending 3/15, Deutsche Bank becomes market’s next suspect but not apparent “trigger”, Israel PM Netanyahu says no step back on judiciary reform will take place, BOE gov Bailey says rates will have to go up if prices keep rising, N. Korea warned of a “radioactive tsunami” from a underwater drone it tested, Japan CPI 3.3% as exp / Core CPI 3.5% (3.4%e), UK cons conf -36 as exp, Singapore IP -8.9% (-1.8%e), UK ret sales -3.5% (-4.7%e) / Core ret sales -3.3% (-4.8%e), EU mfg PMI 47.1 (49e) / serv 55.6 (52.5e) / comp 54.1 (52e), Brazil IPCA infl 5.36% (5.33%e), US durable ex transportation 0% MoM (0.2%e), US flash mfg pmi 49.3 (47e) / serv 53.8 (50.3e) / comp 53.3 (49.5e), S&P +0.6%; Sat/Sun: Putin says Russia to station tactical nuclear weapons in Belarus.
Weekly Close: S&P 500 +1.4% and VIX -3.77 at +21.74. Nikkei +0.2%, Shanghai +0.5%, Euro Stoxx +0.9%, Bovespa -3.1%, MSCI World +1.4%, and MSCI Emerging +2.2%. USD rose +0.8% vs Australia, +0.3% vs Turkey, and +0.1% vs Canada. USD fell -5.7% vs Bitcoin, -2.7% vs Ethereum, -2.5% vs Mexico, -2.3% vs Chile, -1.7% vs South Africa, -1.2% vs Indonesia, -0.8% vs Yen, -0.8% vs Euro, -0.6% vs Brazil, -0.6% vs Sweden, -0.5% vs Sterling, -0.3% vs China, -0.1% vs Russia, and -0.1% vs India. Gold +0.6%, Silver +3.9%, Oil +3.5%, Copper +4.7%, Iron Ore -3.7%, Corn +1.4%. 10yr Inflation Breakevens (EU +7bps at 2.27%, US +11bps at 2.21%, JP -3bps at 0.62%, and UK -1bp at 3.50%). 2yr Notes -7bps at 3.77% and 10yr Notes -5bps at 3.38%.
Year-to-Date Equities (high to low): Mexico +14.9% priced in US dollars (+8.9% priced in pesos), Taiwan +14.1% priced in US dollars (+12.6% in Taiwan dollars), Ireland +13.1% in US dollars (+12.5% in euros), NASDAQ +13%, Greece +10.3% (+9.8%), Czech Republic +9.8% (+7.4%), Italy +9.7% (+9.2%), Euro Stoxx 50 +9.4% (+8.9%), France +8.9% (+8.4%), Germany +7.9% (+7.4%), Spain +7.4% (+6.8%), Netherlands +6.7% (+6.2%), Denmark +6.6% (+6.3%), China +6.2% (+5.7%), Japan +5.2% (+4.9%), Korea +5.2% (+8%), Russia +5.2% (+11%), Chile +4.4% (-0.2%), MSCI World +3.5% in dollars, S&P 500 +3.4%, Philippines +3.2% (+0.5%), Sweden +2% (+2.2%), Indonesia +0.8% (-1.3%), UK +0.5% (-0.6%), HK +0.1% (+0.7%), Saudi Arabia -0.2% (-0.3%), Switzerland -0.6% (-0.9%), Singapore -0.7% (-1.2%), Hungary -0.8% (-4.5%), Canada -0.9% (+0.6%), New Zealand -1.5% (+0.9%), Russell -1.5%, Belgium -1.6% (-2%), Portugal -1.6% (-2.1%), Poland -2.3% (-2.5%), Austria -2.8% (-3.3%), Venezuela -3% (+38.9%), South Africa -3.1% (+3.3%), Thailand -3.4% (-4.6%), Israel -3.5% (-2%), Australia -3.7% (-1.2%), Finland -3.7% (-4.2%), India -6% (-6.4%), Argentina -6.6% (+8.5%), Malaysia -6.9% (-6.4%), UAE -6.9% (-6.9%), Brazil -9.4% (-9.9%), Turkey -10.4% (-8.7%), Norway -10.9% (-4.7%), and Colombia -11.8% (-14%).
Math: The regional bank we used, like all others, bought bonds and made loans for years at historically unprecedented interest rates. The fastest and largest rate hike cycle in decades produced massive losses for it on a marked-to-market basis. The bank run meant it would have to sell assets and realize losses. For ideological reasons, the government refused to guarantee all depositors across the system, ensuring the bank run continued. To help offset the damage that it had created, the government had the Fed offer banks 1yr loans on their underwater collateral.
Math II: This new Fed lending facility replaced the risk of an immediate bank collapse with a virtual guarantee that the bank would incur medium- to longer-term chronic losses. The interest rate on the 1yr loan was higher than the yield on the bank’s investment portfolio. With no blanket guarantee on depositors, those losses will grow as depositors leave and the bank borrows more money from the Fed at higher rates than its portfolio yields. It’s generally not a great idea to be doing business with firms that are losing money, especially leveraged ones like banks.
Math III: So when I thought about this dynamic that is now the essence of our banking system, a few possibilities emerged: (1) The bank run will continue and the economic damage will accelerate until the government offers a blanket guarantee to all depositors, (2) the gov’t will devise a way to subsize the banks or make them whole on their losses, or (3) the Fed will be slash interest rates to 1-2% so that the 1yr loan rate is below the yields on their bond and loan portfolios. In the end, if the bank run continues, which seems likely, it could be all three.
Math IV: Policymakers bide time with a common voice: “All depositors’ savings in the banking system are safe,” said Powell. The American Bankers Association reported “safe & sound” on the latest data. Yellen testified “that our banking system remains sound.” It’s local and global. The State of Maine’s top regulator said that state banks “continue to operate in a safe and sound manner”. Even the Philippines central bank saw “safe and sound” banking conditions. But of course, markets aren’t persuaded by words alone. They move on fear, greed, and math.
Biggie: “We get guaranteed bank deposits when there’s a bank run,” Barked Biggie Too. “We get energy rebates when there’s a war,” continued the Chief Global Strategist for one of Wall Street’s Too-Big-To-Fail affairs. “And we got stimmy checks when we had Covid,” bellowed Biggie. “What are we gonna get when unemployment starts heading higher?” And of course, you never interrupt Biggie when he’s on a roll, so I just nodded. “Bank activity, commercial real estate, it’s all contracting. Why couldn’t we have a big, nasty recession in the 2nd half?” asked Biggie.
Biggie II: “If investors start losing faith in US gov’t credibility over the debt ceiling and the poor handling of this banking crisis, and we get the progressives screaming for stimmy checks at the first hint of rising unemployment, then we got a real problem,” said Biggie. “They start talking about UBI and it’s over,” he said, dropping to a whisper. “And let me tell you what Armageddon is. It’s a -200k non-farm payrolls report that leads to a 50bp rise in long-term bond yields. And that’s where the people running policy are leading us. To be an emerging market.”
Anecdote: In my early years, captivated by Ayn Rand, I thought often of John Galt’s engine. It converted ambient atmospheric energy into electricity. Atlas Shrugged is fiction, and Galt’s engine is a metaphor of course. But I came to see that our highest purpose is in converting static electricity into motive energy. I think about that often. In a world filled with noise, distraction, waste, those who can convert chaos into things of value lift humanity to the benefit of all. They are our builders and are to be exalted. For me, that message is Rand’s lasting gift. But so much of her writing was political. This naturally reflected her life experience, which was that of a Russian Jew, raised in the dark shadow of Lenin. Her father’s business was seized, she faced periodic starvation, terrible deprivation. Rand fled to America at age 21. Her body of work is a warning of the perils of collectivism, statism, and like most alarms it is louder and shriller than necessary. But it was all to make a point, by painting black and white pictures, stark choices, to help us see through the static. America’s libertarians worship her work. I did too, but came to recognize the world as ever evolving, and unsuited to any lasting ideology. I saw politics as a never-ending war to determine the division of economic spoils between capital and labor, with the battle lines periodically shifting to either side of stalemate. Throughout my career, the political forces that favored capital were ascendant. This moved us so far from equilibrium that the system came to be governed mainly by capital. Labor wilted. Our politicians dithered. But that time has passed. The process is reversing. The political fight ahead will be vicious, as the competing interests of labor and capital battle for position. The political push toward greater statism, collectivism, is also on the rise. Such things are inextricably linked. And through the coming struggle we must strive to convert static electricity into motive energy. Build.
Good luck out there,
Chief Investment Officer
One River Asset Management
Disclaimer: All characters and events contained herein are entirely fictional. Even those things that appear based on real people and actual events are products of the author’s imagination. Any similarity is merely coincidental. The numbers are unreliable. The statistics too. Consequently, this message does not contain any investment recommendation, advice, or solicitation of any sort for any product, fund or service. The views expressed are strictly those of the author, even if often times they are not actually views held by the author, or directly contradict those views genuinely held by the author. And the views may certainly differ from those of any firm or person that the author may advise, converse with, or otherwise be associated with. Lastly, any inappropriate language, innuendo or dark humor contained herein is not specifically intended to offend the reader. And besides, nothing could possibly be more offensive than the real-life actions of the inept policy makers, corrupt elected leaders and short, paranoid dictators who infest our little planet. Yet we suffer their indignities every day. Oh yeah, past performance is not indicative of future returns.