The Fed Decides (Radio Podcast): Bob Eisenbeis on Bloomberg Markets

Federal Reserve officials left their main interest rate unchanged and continued to pledge patience as they grappled with conflicting currents in the U.S. economy. Discussing the decision and Fed Chair Powell’s press conference are Bloomberg Markets Editor Joe Weisenthal, Bloomberg News Stocks Editor Dave Wilson, Former President of the Minneapolis Fed Gary Stern, Ira Jersey, Bloomberg Intelligence Chief U.S. Interest Rate Strategist, Bloomberg News Bond Reporter Alex Harris and Bob Eisenbeis, Vice Chairman and Chief Monetary Economist at Cumberland Advisers. And we Drive to the Close with Ryan Detrick, Senior Market Strategist for LPL Financial. Hosts: Carol Massar and Jason Kelly. Producer: Paul Brennan

Running time 41:10

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Cumberland Advisors on Bloomberg Radio
Radio

LISTEN HERE (or click the graphic above): Bloomberg Markets with Robert Eisenbeis Ph.D.

If you like this podcast, you may enjoy the June 22, 2018 Bloomberg Daybreak interview with  David Kotok, Chairman and Chief Investment Officer at Cumberland Advisors. He discusses the Dow’s eight day drop and possible trade war with China. He also discussed bonds and treasuries with Bloomberg.

NOTE: Links to other websites or electronic media controlled or offered by Third-Parties (non-affiliates of Cumberland Advisors) are provided only as a reference and courtesy to our users. Cumberland Advisors has no control over such websites, does not recommend or endorse any opinions, ideas, products, information, or content of such sites, and makes no warranties as to the accuracy, completeness, reliability or suitability of their content. Cumberland Advisors hereby disclaims liability for any information, materials, products or services posted or offered at any of the Third-Party websites. The Third-Party may have a privacy and/or security policy different from that of Cumberland Advisors. Therefore, please refer to the specific privacy and security policies of the Third-Party when accessing their websites.


This podcast from 2015 features David Kotok talking about his background and Camp Kotok with Barry Ritholtz. They also talk about the history of Cumberland Advisors since its founding, and delve into fundamental principles of investing and valuation.


Links here
https://itunes.apple.com/us/podcast/masters-in-business/id730188152?mt=2

And here
http://www.bloomberg.com/podcasts/masters-in-business/




A Unique Lens on Risk Management

May 1, 2019 – Jeremy Schwartz and Liqian Ren from WisdomTree Funds hosted an investment strategy discussion that covered factor investing, U.S. sector trades and the global outlook with Matt McAleer, Director of Equity Strategies at Cumberland Advisors.

Matt McAleer, Director of Equity Strategies at Cumberland Advisors

Read about or listen to their discussion here: https://www.wisdomtree.com




Market check: talking interest rates and inflation

Market check: talking interest rates and inflation

Yahoo Finance - Market Check - talking interest rates and inflation [Video]

Yahoo Finance Video

Jensen Quality Growth Fund Portfolio Manager Allen Bond talks inflation and interest rates with Yahoo Finance’s Adam Shapiro and Julie Hyman and Cumberland Advisors Chairman & Chief Investment Officer David Kotok.

Watch at Yahoo Finance or in the embedded player below.




Taxing Wealth Instead of Income?

With the desire to finance both an increasing deficit and an increase in government services, politicians are searching far and wide for funds. Increasingly, proposals are surfacing to tax wealth rather than income as the means to fund pet projects. The proposals attract followers since unequal distribution of wealth is viewed as a problem that needs to be addressed. However, we really need to think through the implications of going down this road.

Market Commentary - Cumberland Advisors - Taxing Wealth Instead of Income

First, it is important to understand the distinction between income – a flow of money from work and investments – and wealth – an accumulation of assets, things that we have. We all know that we can borrow to fund our acquisition of things, which then have to be financed out of current income. Most recent proposals therefore have actually focused on taxing net worth- reflecting the difference between what we owe and what we have.

While it is easy to refer to wealth in the abstract, it is important to recognize the wide range of assets that constitute our wealth. These include our homes, cars, financial assets, clothes, vacation homes, yachts, intellectual property rights, patents, etc. Some of these are easily valued while others are more problematic. One of the most recent wealth tax proposals would tax net worth over $10 million at 2% and net worth over $1 billion at 3%.

One of the interesting points about the wealth tax is that it taxes net worth – our things – each year, whereas an income tax is based on our current year’s income. Here is an interesting thought experiment. Suppose you have $1 billion, and it is taxed 3% every year. In 10 years, assuming the principal was not invested, you would have slightly less than $750 million remaining, and in 20 years you would have about $540 million. So, in effect, the government is saying that you have too much stuff and they are going to take it. In the extreme, this is not really different from the government saying that you have too many cars or that your house is too big and therefore you must let someone use one of your cars or one or two of your rooms at your expense.

More seriously, it is interesting to look at how the composition of wealth differs over classes of different net worth. The Federal Reserve’s survey of consumer finances contains information that allows us to get a better picture of how the distribution of stuff differs across different wealth cohorts. For the lower tiers, real estate, autos, retirement funds, and liquid assets comprise the bulk of net worth. At the other extreme, for those with a net worth in excess of $1 billion, the target cohort for the net worth tax, those same assets are a minuscule portion of their net worth (See Chart, “What Assets Make Up Wealth?” at https://www.visualcapitalist.com/chart-assets-make-wealth/).

More than two thirds of the wealth of the $1-billion-dollar-net-worth cohort is composed of what is termed “business interests.” The Survey of Consumer Finances divides “business interests” into those business interests in which the owner has an active management role and those in which the owner does not play an active role and well over 90% of such business interests constitute active management. Thus those who wish to tax wealth rather than yearly income are, in fact, targeting mainly privately held business interests whose value is derived from the active entrepreneurial involvement of the principal and his or her family (1). Such assets are hard to identify, since they can include loan guarantees, intellectual property, etc. Those business interests are not frequently traded and are extremely hard to value. These are the same business interests that generate employment and benefits to many others. To implement a tax that serially requires a potential long-term expropriation of and monetization of productive businesses activities in the name of funding other social objectives requires very careful review and analysis of the costs and benefits.

The same survey also shows that one of the main determinants of wealth is education, and the returns are greatest to a college education (2). To be sure, we have recently heard about the problems of excessive student debt, and a recent Wall Street Journal article convincingly shows that students who attend but don’t finish college can be even worse off than those who don’t have a college degree (3). However, that same article also shows that unemployment rates are lower among college graduates and those with some college than for those with no college, and earnings show a similar pattern.

We need to remember that our Declaration of Independence promotes the “pursuit of happiness,” which has come to mean equal opportunity, not equal incomes or equal wealth. Given the evidence on education and wellbeing, we need to consider whether the key to dealing with the so-called problems of income and wealth inequality may be education and not government redistribution policies. Maybe we should focus on programs to raise those on the bottom while taking advantage of the often philanthropic tendencies of people with large accumulations of wealth. Perhaps we should consider policies, as just one example, that reduce inheritance taxes if a wealthy individual donated some of his or her wealth in advance of passing, provided that the gifts are to support qualified educational initiatives and keeping people in college who otherwise might be forced to drop out. This provides a carrot and opportunity for a wealthy individual to do good and avoids government expropriation with no guarantees that the funds will be used to address a social problem.

Robert Eisenbeis, PH.D.
Vice Chairman & Chief Monetary Economist
Email | Bio


Sources:

  1. “Changes in U.S. Family Finances from 2004 to 2007: “Evidence from the Survey of Consumer Finances,” Brian K. Bucks, Arthur B. Kennickell, Traci L. Mach, and Kevin B. Moore, revised 2009, Federal Reserve Bulletin, Vol. 95, 2009, https://www.federalreserve.gov/pubs/bulletin/2009/articles/scf/default.htm.
  2.   Ibid.
  3.   https://www.wsj.com/graphics/calculating-risk-of-college/

Links to other websites or electronic media controlled or offered by Third-Parties (non-affiliates of Cumberland Advisors) are provided only as a reference and courtesy to our users. Cumberland Advisors has no control over such websites, does not recommend or endorse any opinions, ideas, products, information, or content of such sites, and makes no warranties as to the accuracy, completeness, reliability or suitability of their content. Cumberland Advisors hereby disclaims liability for any information, materials, products or services posted or offered at any of the Third-Party websites. The Third-Party may have a privacy and/or security policy different from that of Cumberland Advisors. Therefore, please refer to the specific privacy and security policies of the Third-Party when accessing their websites.

Sign up for our FREE Cumberland Market Commentaries

Cumberland Advisors Market Commentaries offer insights and analysis on upcoming, important economic issues that potentially impact global financial markets. Our team shares their thinking on global economic developments, market news and other factors that often influence investment opportunities and strategies.




Bloomberg TV – Cumberland ‘s Eisenbeis Says Importance of Fed’s Balance Sheet ‘Overemphasized’

LISTEN HERE (or click the embedded player above): Importance of Fed’s Balance Sheet ‘Overemphasized’

Another podcast you may enjoy is the June 22, 2018 Bloomberg Daybreak interview with  David Kotok, Chairman and Chief Investment Officer at Cumberland Advisors. He discusses the Dow’s eight day drop and possible trade war with China. He also discussed bonds and treasuries with Bloomberg.

NOTE: Links to other websites or electronic media controlled or offered by Third-Parties (non-affiliates of Cumberland Advisors) are provided only as a reference and courtesy to our users. Cumberland Advisors has no control over such websites, does not recommend or endorse any opinions, ideas, products, information, or content of such sites, and makes no warranties as to the accuracy, completeness, reliability or suitability of their content. Cumberland Advisors hereby disclaims liability for any information, materials, products or services posted or offered at any of the Third-Party websites. The Third-Party may have a privacy and/or security policy different from that of Cumberland Advisors. Therefore, please refer to the specific privacy and security policies of the Third-Party when accessing their websites.


If you like podcasts, check out this one from 2015 featuring David Kotok talking about his background and Camp Kotok with Barry Ritholtz. They also talk about the history of Cumberland Advisors since its founding, and delve into fundamental principles of investing and valuation.


Links here
https://itunes.apple.com/us/podcast/masters-in-business/id730188152?mt=2

And here
http://www.bloomberg.com/podcasts/masters-in-business/




Tax the Rich

As the political season begins to heat up for 2020, we have seen an increasing number of proposals to provide free education, free healthcare, a universal guarantee of a living wage, etc. With an historic level of public debt topping $21 trillion and a deficit of nearly $1 trillion and projected to climb even more in 2019, the logical question is how will the advocates for all those free programs pay for their suggestions, some of which have been priced out in the neighborhood of $30 trillion? The almost universal response is to raise tax rates on the wealthy so that they can “pay their fair share.” Let’s look at some facts.

Market Commentary - Cumberland Advisors - Tax the Rich

First, who is paying what? The following table is from the most recently available data from the IRS for 2015, showing federal individual shares of adjusted gross income, share of taxes paid, and average tax rates by income class. The top 1% had 20.65% of AGI and paid nearly 40% of the taxes.


Federal individual shares of adjusted gross income, share of taxes paid, and average tax rates by income class

Similarly, the top 25% earned just under 70% of the income and paid 86% of the taxes. By comparison, the bottom 50% of the income distribution earned only 11% of the income and paid 2.8% of the taxes. Data reflecting tax structure changes taking effect for 2018 is, of course, not yet available.

The argument is that it is necessary to raise the marginal tax rates on the higher-income groups so that they can pay their “fair share.” But what is a “fair share” and who gets to decide what is “fair?” Clearly, those already bearing the bulk of the tax burden are going to argue that they already are paying more than their “fair share,” while those with pet projects they want to fund will argue to increase the tax burden on the rich.

Further, would raising the marginal tax rate on the wealthy actually generate the river of additional revenue the “70 percenters” envision? Just how realistic are the proposals to raise the highest marginal tax rates to 70% or more? Historical evidence suggests that such proposals are, at best, naïve, and will not succeed. Proponents simply assume, without any understanding of history or how taxes affect behavior, that their proposals will be the magic solution. It turns out that the US has a rich history and multiple experiments with widely varying marginal tax rates, dating back to the Great Depression.

The highest marginal personal tax rate at one time was 94% in 1944, was about 91% from 1954–1963, dropped to about 70% from 1964–1980 before declining to its present rate in 1993. The highest marginal corporate tax rate was 52% in 1952 through 1963, and was only a bit higher at 54% between 1968 and 1969. (It will be 21% for 2018.) The following chart details that history, but more importantly shows the impact the variation in the highest marginal tax rates has had on tax revenues collected.


Variation in the highest marginal tax rates on tax revenues collected

Over the entire post-war history from 1944 to the present, revenues collected from all sources (including person and corporate income taxes, social insurance taxes, excise taxes and other taxes) have ranged between 14.4% and 19.6% of GDP, with an average of 17.1% and a standard deviation of about 1 percentage point. Thus, variations in the marginal tax rates have no perceptible impact on the volume of taxes collected relative to GDP. The graph of revenues collected is essentially a flat line when compared to the changes in the higher marginal tax rates and changes in the corporate tax rate. It is such a chart that in the past has led many to argue for a flat tax rather than a graduated progressive tax.

This history does not bode well for the “70 percenters” and reflects their basic lack of understanding of how individuals and markets respond when taxes begin to bite: Those impacted seek ways to avoid paying the tax by seeking tax shelters and tax-exempt returns like those on municipal securities, and by shifting income to tax havens abroad. Before any of us take the “70 percenters” seriously, they have got to explain the pattern shown in the chart, how “this time will be different,” and what criteria they are using to claim that their tax proposals are “fair.”

Robert Eisenbeis, PH.D.
Vice Chairman & Chief Monetary Economist
Email | Bio

 


Links to other websites or electronic media controlled or offered by Third-Parties (non-affiliates of Cumberland Advisors) are provided only as a reference and courtesy to our users. Cumberland Advisors has no control over such websites, does not recommend or endorse any opinions, ideas, products, information, or content of such sites, and makes no warranties as to the accuracy, completeness, reliability or suitability of their content. Cumberland Advisors hereby disclaims liability for any information, materials, products or services posted or offered at any of the Third-Party websites. The Third-Party may have a privacy and/or security policy different from that of Cumberland Advisors. Therefore, please refer to the specific privacy and security policies of the Third-Party when accessing their websites.

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Can the President Fire the Chairman of the Federal Reserve?

The question has arisen, does the president have the ability to fire the chairman of the Federal Reserve. The short answer appears to be no. But few understand the structure of the Federal Reserve and how, by design, that structure both compartmentalizes and is designed to insulate policy making from attempts by outsiders to influence policy.

Cumberland Advisors' Bob Eisenbeis

The Federal Reserve is not a single entity but rather a system composed of two different types of legal entities: The Board of Governors of the Federal Reserve System and the Federal Open Market Committee are both federal agencies and are part of the Executive Branch of the government. Technically, they are among some 61 disparate, independent institutions such as the Commodity Futures Trading Commission, Tennessee Valley Authority, EPA, Federal Election Commission, and General Services Administration, just to name a few.[1] Unlike some of these agencies whose directors serve at the pleasure of the president, as is the case with the CIA and the Office of the Director of National Intelligence, the Board of Governors and FOMC are truly independent. These entities do not report to the president, and governors (and the presidents of the 12 regional Federal Reserve banks) do not serve at the pleasure of the president. Board members are appointed for staggered 14-year terms, so every two years a term expires, the intent being to limit the number of governors that a sitting president could appoint.[2] The Fed is not subject to appropriations, nor does the president have any authority over its policies or decisions. Section 242 of the Federal Reserve Act provides that a governor can be removed by the president only “for cause,” which is usually meant to mean incompetence, neglect of duty, or malfeasance in office. No chairman has been removed for cause, but on several occasions a sitting chairman’s appointment to a four year as chair has not been renewed and has left voluntarily vacating an unfinished term as governor, including Burns, Volcker, and most recently Yellen. Finally, by law, what oversight exists is provided by Congress in the sense that the Fed chairman is required to report to Congress twice a year on progress towards the Fed’s responsibilities and monetary policy objectives, which are “maximum employment, stable prices, and moderate long-term interest rates.”[3]

Although the FOMC is a separate legal body, it has no office or staff except that provided each year by the Board and reserve banks. Its members include the seven members of the Board of Governors, the president of the Federal Reserve Bank of New York, and four other reserve bank presidents whose rotation on and off the committee is defined in the statute.[4] At the Committee’s first meeting each year, the initial item of business is to elect a chairman and vice chairman, to appoint official staff from among the staff of the Board of Governors and the respective federal reserve banks whose presidents are voting that year, and to select the reserve bank to execute transactions for the Open Market Account and the manager of the System Open Market Account. By custom, but not always, the vice chairman of the Board of Governors nominates the Board chair as chairman of the FOMC, the president of the Federal Reserve Bank of New York as vice chairman, and the Federal Reserve Bank of New York as the location for the Open Market Account. There have never been competing or additional nominations, but it is important to note that there is nothing in the law preventing another voting member from being either chairman or vice chairman of the FOMC or preventing the Open Market Desk from being located at another reserve bank besides the Federal Reserve Bank of New York.[5] The importance of this is that removal of the chairman of the Board of Governors does not control who serves as chairman of the FOMC, should any jurisdictional dispute arise between the president and the Fed. That election is specified in the statute and is the prerogative of the voting members. The president has no say in the matter.

In contrast to the Board and FOMC, the 12 Federal Reserve Banks are quasi-public- private entities whose stock is owned by the member banks headquartered in their respective Federal Reserve Districts.[6] Their officers and employees are not federal employees; the bank presidents and first vice presidents are appointed by their respective reserve bank boards of directors, (who also control their budgets) and both appointments and budgets are subject to approval by the Board of Governors.[7] Bank presidents are not appointed by the president, nor are they subject to congressional approval.[8]

The Federal Reserve Act, which lays out the structure and duties of the System, has been modified by Congress many times, and relative roles of the respective legal entities have also evolved. For example, in the original structure, the heads of the reserve banks were called governors, and the board in DC had few responsibilities. It was called the Federal Reserve Board, whose members included the Comptroller of the Currency and the Secretary of the Treasury, who also served as chairman. The Banking Act of 1933 created the Federal Open Market Committee as an independent agency, and the Banking Act of 1935 changed the name of the Federal Reserve Board to “Board of Governors of the Federal Reserve System,” and the Board’s members were called governors.[9] The number of governors was increased from six to seven, and the Secretary of the Treasury and Comptroller of the Currency were removed from the Board. The Board of Governors moved its offices out of Treasury into its own building, further distancing itself from the Executive Branch. At the same time, titles of reserve bank governors were changed to presidents, thus completing the shift in control of the system and policy from the reserve banks to the Board of Governors in DC.

Just as the organizational structure is Byzantine, so are the structure and responsibilities for the key tools of monetary policy, and those complexities can also frustrate the ability of outside forces to influence policy, since different groups of Federal Reserve officials control different policy levers. There are four principal tools employed in the FOMC’s current floor and sub-floor system: the interest rate on reserves (IOER), the federal funds rate target range, the interest rate on overnight repurchase agreements (ON RRP), and the discount rate. The Board of Governors is empowered to set both the discount rate and IOER, whereas the FOMC sets the federal funds rate and ON RRP.[10] The interest rate on reserves (IOER) was envisioned to be a floor for the federal funds rate; but as has been explained in previous commentaries, the effective federal funds rate has often been below the floor because the GSEs and Home Loan Banks were not able to receive interest on their reserve deposits held at the Fed and thus were lending them in the overnight market at rates below IOER.[11] To counter this, the Open Market Desk employs the ON RRP rate, borrowing from reserve suppliers at a rate that is presently 2.25% (the sub-floor) or 15 bp below the IOER’s 2.40 percent (the floor).[12] Note that IOER is 10 bp below the upper target range for the federal funds rate of 2.25–2.5%.[13]

In the present policy regime, the discount rate – the rate that the Fed charges banks for borrowing – has become largely unimportant. [14] Historically, however, it was the first policy tool the system employed. It was initially was used to accommodate the cyclical demand for credit during the crop cycle, given the agricultural nature of the economy during the Fed’s early years. The discount rate then evolved prior to the financial crisis and passage of permission for the Fed to pay interest on reserves, as the cap or ceiling rate on the FOMC’s funds rate target. It remains the responsibility of each reserve bank’s board of directors to make recommended changes in the discount rate to the Board of Governors every two weeks. Recommendations are staggered so that there is always a fresh recommendation available to the Board. The Board cannot change the discount rate without a recommendation from at least one reserve bank to make a change.

Presently, the discount rate is the same across each Federal Reserve district, but this is true only after each bank’s board of directors makes a change request that is submitted and approved, and this is why there is always a separate announcement of the Board’s approval of discount window changes. The process can sometimes take a few days, but eventually the rates are equalized. Most recently, the Board approved requests from six Federal Reserve banks to increase the discount rate for primary credit to 3% effective December 20, 2019.

The complex organizational structure combined with split authority for the policy tools has led the Board and FOMC to hold joint meetings in which policy is set.[15] This arrangement was an organizational response by Chairman Bernanke to create a more collegial and cooperative environment for policy setting with all participants present and participating in the decision process. But all this could be undone by another chairman or by a split within the system concerning the relative roles of the Board and FOMC. For example, a return to a low volume of excess reserves and a resurgence of a specific federal funds rate target rate instead of a range would change the relative importance of Board and reserve bank presidents in the policy-setting process. At the same time, the Committee’s flexibility to change how policy is formulated and implemented provides additional potential insulation from outside pressures to affect or influence the setting of policy.

Robert Eisenbeis, PH.D.
Vice Chairman & Chief Monetary Economist
Email | Bio


[2] This intent has been frustrated by resignations, enabling a president to make appointments to fill unexpired terms. President Trump has been able to make four appointments in just the first two years of his tenure. Recently appointed Governor Bowman’s term expires in 2020 and Governor Clarida’s term expires in 2022. Presently unconfirmed appointments of Professor Goodfriend and former Fed staffer Nelly Liang are for terms expiring in 2024 and 2030. People filling unexpired terms may be appointed to a full term.
[3] Section 225a. of the Federal Reserve Act
[4] Presidents rotate membership each year as follows: one from the Federal Reserve Banks of Boston, Philadelphia, and Richmond; one from the Federal Reserve Banks of Chicago and Cleveland; one from the Federal Reserve Banks of Atlanta, Dallas, and St. Louis; and one from the Federal Reserve Banks of Minneapolis, Kansas City, and San Francisco.
[5] The events of 9/11 exposed the risks of having the Open Market Desk in New York. Subsequently, the System introduced a back-up structure for both the Desk and the discount window administration for all the reserve banks. There are now designated banks to pick up discount window functions and Desk operations in the event that any of the banks are unable to operate for any reason.
[6] Although member banks own stock in their reserve bank, the stock is nonvoting and carries a fixed dividend.
[7] Traditionally, three nominees are sent to the Board for approval, although recently only one recommendation has been sent for approval. There have been cases in the distant past when a reserve bank’s favored candidate has been rejected by the Board.
[8] Board of Governor’s email addresses end in @FRB.gov while reserve bank addresses end in @xxx.FRB.org, where the bank’s city initials are substituted for xxx. Recent proposals have been made to subject the appointment of the president of the Federal Reserve Bank of New York to congressional approval so as to control and limit the influence of Wall Street on monetary policy decisions. However, requiring rotation of the vice chairman position among the voting presidents would ensure even broader regional representation on the Committee
[9] Until a change in the Banking Act of 1935, Federal Reserve Board members were not voting members of the FOMC.
[10] Prior to the financial crisis, the principal tool was the federal funds rate, but under the present regime the Board of Governors controls the floor and lower bands of the policy corridor whereas the FOMC sets only the target range within the corridor.
[11] See “TNB and the Regulatory Dialectic,” December 13, 2018: http://www.cumber.com/tnb-and-the-regulatory-dialectic/ .
[12] For the rationale for setting the ON RRP rate slightly below the IOER, see Steven Williamson, “Monetary Policy Normalization in the United States,” FRB St. Louis Review, second quarter 2015, 97(2).
[13] See FOMC Statement and Implementation Notes, December 19, 2018, https://www.federalreserve.gov/newsevents/pressreleases/monetary20181219a1.htm.
[14] There are three main categories of discount lending, and these have varied over time.
[15] The proposed change was the subject of “Conference Call of the Federal Open Market Committee on January 16, 2009, https://www.federalreserve.gov/monetarypolicy/files/FOMC20090116confcall.pdf.


Links to other websites or electronic media controlled or offered by Third-Parties (non-affiliates of Cumberland Advisors) are provided only as a reference and courtesy to our users. Cumberland Advisors has no control over such websites, does not recommend or endorse any opinions, ideas, products, information, or content of such sites, and makes no warranties as to the accuracy, completeness, reliability or suitability of their content. Cumberland Advisors hereby disclaims liability for any information, materials, products or services posted or offered at any of the Third-Party websites. The Third-Party may have a privacy and/or security policy different from that of Cumberland Advisors. Therefore, please refer to the specific privacy and security policies of the Third-Party when accessing their websites.

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Market Backlash

The Treasury market had priced in a 25-basis-point increase in the FOMC’s target range for federal funds prior to the FOMC’s December 18–19 meeting. The Committee was faced with essentially three policy options: Pause, deliver on the 25-basis-point increase and signal a pause, or deliver on the 25-basis-point increase and signal the willingness to continue raising rates.

Cumberland Advisors' Bob Eisenbeis

The decision was a 25-basis-point increase in the target range and a signal that the most likely path for 2019 included two more rate moves. Until the announcement and subsequent press conference, the Dow was up 300 points, but it plunged into negative territory when the FOMC delivered on what turned out to be a modified version of the third option. That market funk continued the next day. Markets clearly wanted a strong signal that the FOMC would pause in 2019, and traders weren’t mollified by the generally moderate tone struck by Chairman Powell in his press conference.

Different people took different messages away from the press conference. First, when asked what role recent market turmoil played in the FOMCs decision, Powell said – consistent with long-standing Fed policy – that market turmoil was not a defining consideration, a view that was received negatively by the market, despite the fact that Powell went on to elaborate that the FOMC looks at many considerations, including global issues, concerns about tariffs, the declining impact of the tax cut and financial market conditions more broadly. That clarification apparently fell on deaf ears.

Second, when questioned about the impact of the president’s recent tweets, Powell did not state that the president, like other citizens, has a right to his personal opinions. Rather, he issued the emphatic statement that the Fed was independent and would do what it felt needed to be done, free from political considerations. Clearly, the president’s tweets were not well received by the FOMC.

Third, Powell noted that the policy rate was at the low range of what the Committee viewed as neutral and that financial conditions continued to be accommodative in the context of a growing economy, strong labor markets, and an inflation outlook near the Committee’s target. He went on to try to dispel the view that two rate hikes were a given for 2019. He emphasized that the Committee would be driven totally by incoming data. Again, markets didn’t hear him.

What is the Committee expecting as far as those data are concerned? The SEP forecasts clearly showed that median growth had been marked down for both 2018 and 2019; and the central tendencies for both 2018 and 2019 were also marked down. There was virtually no change in the unemployment forecasts; and PCE headline inflation forecasts had softened somewhat, while PCE core forecasts were essentially unchanged for 2019, at the target rate of 2%.

If those forecasts are realized, there will likely be, at most, two policy moves in 2019. Moreover, the chairman’s message was clear: The Committee will not do anything stupid. Chairman Powell emphasized that the Committee could be patient and is not wedded to any particular path.

The keys to both timing and amount will be incoming data on growth and inflation. Given that, when might we expect the next rate hike, if it is deemed justified? Monthly data will be available on PCE, but only quarterly data will be available on growth. More importantly, the FOMC will not receive data on Q4 2018 until January 30, but that is likely to be stale news given what is already known about economic performance in 2018. More relevant is that Q1 2019 GDP will not be available until the Committee’s April meeting, and Q2 GDP will not be available until its July meeting. This timeline suggests that the most likely time for the first rate hike, if it is to occur, would be at the Committee’s April meeting. Having said that, a patient FOMC could reasonably wait to make its first rate move in 2019 until its July meeting, where it would have readings on several months of employment and inflation data and readings on growth for the first half of 2019. It is worth repeating, the Committee is clear that it will not do anything stupid.

Robert Eisenbeis, PH.D.
Vice Chairman & Chief Monetary Economist
Email | Bio



Links to other websites or electronic media controlled or offered by Third-Parties (non-affiliates of Cumberland Advisors) are provided only as a reference and courtesy to our users. Cumberland Advisors has no control over such websites, does not recommend or endorse any opinions, ideas, products, information, or content of such sites, and makes no warranties as to the accuracy, completeness, reliability or suitability of their content. Cumberland Advisors hereby disclaims liability for any information, materials, products or services posted or offered at any of the Third-Party websites. The Third-Party may have a privacy and/or security policy different from that of Cumberland Advisors. Therefore, please refer to the specific privacy and security policies of the Third-Party when accessing their websites.

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Cumberland Advisors Market Commentaries offer insights and analysis on upcoming, important economic issues that potentially impact global financial markets. Our team shares their thinking on global economic developments, market news and other factors that often influence investment opportunities and strategies.




TNB and the Regulatory Dialectic

Back in the 1980s Professor Edward Kane coined the term regulatory dialectic to capture the dynamics of how regulated financial institutions found innovative ways to circumvent regulations designed to restrict their behavior.
Cumberland Advisors' Bob Eisenbeis
For example, banks adopted the one-bank holding company form in the late 1960s to avoid the restrictions on permissible activities. They subsequently used that device to create non-bank banks that also enabled them to cross state lines, avoiding the restrictions on interstate banking. The process led to a new era of nationwide banking that we now take for granted. Similarly, when Regulation Q restricted the rates that depository institutions could pay retail customers, money market mutual funds came into existence to solve that problem. And when federal law capped the amount of Federal Deposit Insurance an individual could receive to $250K per account, Promontory Financial Group (now a subsidiary of IBM), formed by former Comptroller of the Currency Eugene Ludwig and former Federal Reserve Board Vice Chairman Alan Blinder, found a way to pool accounts to expand deposit insurance coverage for large depositors far beyond the $250K limit.

The most recent example of the regulatory dialectic was the subject of an American Enterprise Institute program on December 2 in Washington, devoted to what is known as The Narrow Bank (TNB). The recently retired executive vice president of the Federal Reserve Bank of New York, Dr. James McAndrews, is now chairman of a newly licensed, uninsured, special-purpose wholesale bank in the State of Connecticut that has applied to the Federal Reserve Bank of New York for a master account. TNB would only do one thing: It would accept deposits from large accredited investors, namely the GSEs, Federal Home Loan Banks, money market mutual funds and selective other large investors; deposit those funds in the master reserve account at the Federal Reserve Bank of New York; receive an interest payment (known as interest on excess reserves [IOER]) from the Bank on those funds; and transfer all that interest to the depositing institutions, less a small fee for the service. So what is the regulatory avoidance? GSEs and Federal Home Loan Banks are permitted to hold deposits at the Fed, which serves as their fiscal agent, but they are not permitted to receive interest on those accounts.

In lieu of this option, what have the GSEs and Federal Home Loan Banks been doing with their deposits held at the Fed? They have been lending those funds out in the overnight market at rates somewhat below IOER, in part frustrating the Fed’s attempt to achieve its target for the federal funds rate with IOER operating as a floor on the funds rate. Whom have the GSEs been lending to? Interestingly enough, they have been lending to foreign banks, which borrow fed funds at a rate slightly below IOER and deposit the funds with the Fed to receive the IOER, earning a risk-free arbitrage. In fact, the terms are so attractive that about 35% of the excess reserves on deposit at the Fed are owned by foreign entities with US-chartered bank subsidiaries. This is despite the fact that such entities hold less than 10% of total deposits. These foreign institutions have some advantages over US banks. First, they are not subject to the hefty Federal Deposit Insurance rate charge to US banks on their total assets. Second, the reserves count towards the Liquidity Coverage Ratio stipulated in the Basel III regulations. Finally, the positive IOER of 2.2% is a risk-free alternative to the ECB’s negative 0.4% levied on reserves.

So what problem does TNB solve for the Fed? The main benefit is to bring the effective funds rate in line with the IOER floor. Of course, the federal funds rate target is above the floor, so what we are talking about is putting a downside limit on the intraday fluctuations in the federal funds rate.

The other issue is that TNB’s existence hinges critically upon there being a large volume of excess reserves. The Fed, as the FOMC’s most recent minutes suggest, has not decided on the desired size of its balance sheet; nor has it determined to revert to the pre-crisis policy implementation strategy that targeted the federal funds rate in an environment with a very small volume of excess reserves. Its alternative is to continue with a much larger balance sheet and rely primarily upon its current reverse repo strategy for policy implementation. In the pre-crisis world, there would be only a limited opportunity for TNB, and there is the risk that its presence might serve to disintermediate funds, especially from smaller banks, and disrupt the credit process.

The threshold question the Fed faces as it decides whether to grant TNB a master account is what the size of its balance sheet should be. In the pre-crisis world, its balance sheet was determined primarily by the volume of currency outstanding; required reserves were largely met by banks’ cash holdings; and reserve balances were about $8 billion in 2006, or slightly less than 1% of the Fed’s total assets of $850 billion. As of the most recent data, from November, excess reserves were about $1.6 trillion, and assets were $4.1 trillion. If the Fed were to shrink its balance sheet to restore the old relationship between currency and GDP, it would need about $1.9 trillion and an additional $17 billion to account for excess reserves. Additionally, the Fed has other liabilities to the Treasury and to official foreign accounts, which total about $430 billion. Together, these liabilities would imply a balance sheet for the old regime of about $2.3–$2.4 trillion.[1] How big would the balance sheet have to be if the current reverse repo regime were to be followed? The answer hinges on the expected size of the reverse repo market. The market has shrunk considerably since the policy was put in place. The principal users are money market mutual funds. In 2017 the average daily transaction volume in the market was $143 billion, with a standard deviation of $60 billion. By comparison, through the first half of 2018 the average daily transaction volume was only $19 billion, with a standard deviation of $23 billion. These numbers suggest that a balance sheet of about $2.4–$2.5 trillion would enable the Fed to pursue either its historical or new policy regime with a much smaller balance sheet than is presently in place. Such a balance sheet would imply a small role for TNB (and any other copycats that might arise), since reserves would constitute only a small portion of the Fed’s liabilities.

 
Robert Eisenbeis, PH.D.
Vice Chairman & Chief Monetary Economist
Email | Bio 


[1] Data as of November 29, 2018.

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The FOMC: What Next?

In another week the FOMC will have its final meeting of 2018 and its last with the current mix of policy makers. Already, the discussion has turned to what the Committee will do at that and subsequent meetings: Will it proceed with further 25bp increases in the target range for the federal funds rate, or will it pause?

Federal Reserve - FOMC

Markets appear to have priced in another rate increase in December, at least as signaled by what has happened to the short end of the Treasury curve, shown in the chart below.


 

Chairman Powell afforded this view credibility in a speech he gave on November 28 in New York.[1] Although the purpose of the speech was to highlight the release of the Fed’s first-ever financial stability report, he did touch on monetary policy. After noting the delicate balance between moving policy rates too fast or too slow to achieve the Fed’s dual mandate and the need to consider information contained in incoming data, he stated that, as far as current policy is concerned, “Interest rates are still low by historical standards, and they remain just below the broad range of estimates of the level that would be neutral for the economy….” What Powell is clearly saying is that he would be comfortable with at least one more rate increase, and this sets the stage for the FOMC’s next move in December.

There are two important reasons why the FOMC will move at its next meeting. First, it has provided justification of where rates should be to be “neutral”- that is, neither too tight nor too loose with regards to slowing down or speeding up growth. Second, that justification blunts any perception that the FOMC may be bowing to political pressure from the White House when it comes to setting rates. By saying it is “almost there” and stating that further moves are data-dependent, the FOMC is setting the stage for a possible pause. And the rationale for such a pause will be contained in the Summary of Economic Projections, if the Committee does indeed decide that it has achieved a neutral policy stance.  Clearly, world growth is slowing and should the slowing continue that may be sufficient to justify a pause by the Committee.

The minutes of the November FOMC meeting, released November 29, reinforce the “almost there” view articulated by Chairman Powell in his speech. The minutes reveal some concern on the part of FOMC participants about the risks to inflation posed by uncertainty concerning the fiscal situation and trade policies. The Committee laid those concerns aside, however, in commenting on the path for policy, and there was agreement that “another increase in the target range for the federal funds rate was likely to be warranted fairly soon if incoming information on labor market and inflation was in line with or stronger than their current expectations.” However, some expressed uncertainty over the timing of further increases, while at least two participants expressed the view that the neutral policy stance had been achieved. The bottom line is that the minutes, combined with Chairman Powell’s “almost there” hint in his NY speech, perfectly position the FOMC for another rate increase at its December meeting, while preserving flexibility to pause at future meetings and putting some distance between the FOMC and the White House.

The minutes are interesting for another reason as well, because they indicate the nature of the current state of the discussions about how future policy might be conducted once the Fed has normalized its balance sheet. That decision is shown to hinge critically on whether the FOMC decides to return to the pre-crisis regime of a balance sheet determined primarily by currency demand and a low level of excess reserves or favors instead a large balance sheet with a large volume of excess reserves. The former would imply policy exercised by small changes in the volume of excess reserves achieved through manipulation of the federal funds rate in the overnight market. The latter would imply continuing the reverse repo approach and dealing with a larger number of potential non-bank counterparties, such as money market mutual funds. It is clear from the discussion that no decision on these alternatives has been made, and the decision process is complicated by changes in how financial markets have functioned in the wake of the financial crisis. The clear message in the minutes is that this discussion is “to be continued.”

Robert Eisenbeis, PhD.
Vice Chairman & Chief Monetary Economist
Email | Bio


[1] Chairman Jerome H. Powell, “The Federal Reserve’s Framework for Monitoring Financial Stability,” The Economic Club of New York, New York, November 28, 2018.

Links to other websites or electronic media controlled or offered by Third-Parties (non-affiliates of Cumberland Advisors) are provided only as a reference and courtesy to our users. Cumberland Advisors has no control over such websites, does not recommend or endorse any opinions, ideas, products, information, or content of such sites, and makes no warranties as to the accuracy, completeness, reliability or suitability of their content. Cumberland Advisors hereby disclaims liability for any information, materials, products or services posted or offered at any of the Third-Party websites. The Third-Party may have a privacy and/or security policy different from that of Cumberland Advisors. Therefore, please refer to the specific privacy and security policies of the Third-Party when accessing their websites.

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