Cumberland Advisors Market Commentary – Interest Rates and Yield Curve Control, Part 1

“The Trimmed Mean PCE inflation rate is an alternative measure of core inflation in the price index for personal consumption expenditures (PCE). It is calculated by staff at the Dallas Fed, using data from the Bureau of Economic Analysis (BEA).” Through June 2020, “The Trimmed Mean PCE inflation rate over the 12 months ending in June was 1.8 percent. According to the BEA, the overall [June] PCE inflation rate was 0.8 percent on a 12-month basis and the inflation rate for PCE excluding food and energy was 0.9 percent on a 12-month basis.” (“Trimmed Mean PCE Inflation Rate,” https://www.dallasfed.org/research/pce)

Market Commentary - Cumberland Advisors - Interest Rates and Yield Curve Control, Part 1

The annualized one-month trimmed mean PCE inflation rate was 2.8% in January and plummeted to 1.1% in March; April was 1.3%; May was 1.5%; June was 1.7%. Note the steady increase of PCE inflation over the last four months. Using the trimmed mean PCE as the inflation measure of choice, we can conclude that the entire Treasury yield curve is now trading at negative REAL interest rates. We will have more on this later in this series (today is part 1).

In our view this is an important series to follow. Reason: Fed Chair Powell has publicly mentioned that he follows it. In simple terms the idea of trimmed mean inflation is to discard the very volatile items in the inflation statistics and thus narrow the estimate of inflation to the price changes of the majority of items in the center of the distribution. In Powell’s words, “It cuts off the big movements on the upside and the downside, looks at the mean movements of inflation on the various product categories and service categories.” (“Just when you got used to core inflation, Powell talks up another measure – ‘trimmed mean’,” MarketWatch, https://www.marketwatch.com/amp/story/just-when-you-got-used-to-core-inflation-powell-talks-up-another-measure-trimmed-mean-2019-05-01)

In my experience, the concept of trimmed mean has been controversial, with advocates (including me) facing off against detractors. Readers may want to look at all historical series that estimate rates of inflation. That’s what I do. Together they help me assess the rate of changes in prices.

The trimmed mean inflation estimation method originated, along with the trimmed mean CPI, in pioneering work done at the Cleveland Fed by Steve Cecchetti (now professor of global finance at Brandeis International Business School) and carried forward by Mike Bryan (now vice president and senior economist at the Atlanta Fed). Here is a link to the Cleveland Fed’s trimmed mean CPI monthly report: https://www.clevelandfed.org/our-research/indicators-and-data/median-cpi.aspx.

(Bryan and Cecchetti and their colleagues produced a wealth of research on inflation measurement when they were in Cleveland and since. Here is another of their seminal papers: “Measuring Core Inflation,” https://www.clevelandfed.org/newsroom-and-events/publications/working-papers/working-papers-archives/1993-working-papers/wp-9304-measuring-core-inflation.aspx.)

I’ve had occasion to participate on panels with Steve and Mike and respectfully hope I can articulate this concept in simple layman’s terms for our readers. The statistical method to optimize the “trimming” is, however, complex.

We believe that the trimmed mean estimation process has become extremely important during this very volatile pandemic period. We can see that volatility by examining the reports from the Dallas Fed and Cleveland Fed. I personally review them in detail every month as they are released.

Normally the various measures of inflation track closely with one another. We would expect that in normal times. But these are not normal times. That is why the trimmed mean process is important.

The trimmed mean estimation tells us that inflation bottomed coincidentally with the March–April plummet in the US and global economies. For the US, the sensitive (monthly and annualized) numbers suggest that inflation is gradually reappearing. We believe these early signs must be respected.

The implication is that US interest rates are nearing or have reached a bottom. We will have more to say about that as this series on rates and yield curve controls is published.

At Cumberland, we are using a barbell approach now in our managed bond accounts. The degree of barbell shifting and the structure of the barbells is a topic for a technical conversation that can be held with a number of folks in Cumberland’s fixed-income division. The trimmed mean methodology suggests that the fierce deflation pressures from the pandemic ended in March, coinciding with the bottoming of the economy and the March 23rd bottom in the US stock market. Readers, please note that is an early and not yet confirmed assertion. It will be a year before we have sufficient data to verify this assertion.

Also, note that at Cumberland we are portfolio managers, and our job is to assess and respond to changes in trends and in risk. Inflation shifting is an extremely important item for the performance of both bonds and stocks. That is why we are so focused on it. We’re working on part 2 of this series now.

David R. Kotok
Chairman of the Board & Chief Investment Officer
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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Barron’s – July Jobs Report: Better Than Expected, Better Than Feared

July Jobs Report: Better Than Expected, Better Than Feared

Excerpt from Barron’s – August 07, 2020

Cumberland Advisors Market Commentary by William "Bill" Witherell, Ph.D.

A portion of William Witherell, Ph.D.’s commentary, Why Investors Are Looking at Taiwan, was incorporated into Barron’s collective piece, “July Jobs Report: Better Than Expected, Better Than Feared“.

This commentary was issued recently by money managers, research firms, and market newsletter writers and has been edited by Barron’s.

Taiwan’s Prospects Brighten

Cumberland Advisors Market Commentary

Cumberland Advisors
Aug. 5: The Taiwanese economy is benefiting from both its success so far in combating the coronavirus and a $35.9 billion government stimulus program to help offset the headwind from the 4.9% decline projected for the global economy. Consumers started in July to spend government-issued vouchers for consumer goods and tourism, and several weeks ago the government tabled a second supplementary budget for 2020 of $7.13 billion to boost sectors hit by the pandemic. More important than these measures has been the resumption of strong demand for Taiwan’s high-quality telecommunications exports, helped by people around the globe working from home.

Taiwan’s manufacturing downturn in April and May eased in June, with the IHS Markit Taiwan Manufacturing PMI [purchasing managers index] rising to 46.2 from 41.9 in May. In July, the PMI moved into expansion territory at 50.6 with output stabilizing. Supply chains are still under pressure and employment continued to decline. Tourism and aviation have been hard hit….

Looking beyond 2020, Taiwan is well-situated to take advantage of the projected recovery of the global economy and continued outperformance of the technology sector. Its most important export is semiconductors, an industry key to the accelerating development of 5G technology. China, Taiwan’s most important export market, is expected to expand strongly next year.

Taiwan’s stock market has done better than most national markets this year. The iShares MSCI Taiwan ETF (EWR) has recovered from a sharp drop in March and is now up 9.8% year-to-date. In comparison, the iShares MSCI ACWI ex US ETF (ACWX) is still down 6.3%, and the advanced-country ex-US iShares MSCI EAFE ETF (EFA) is down 8.4%. The outperformance of EWT reflects the 54% weight of technology stocks in the ETF, with Taiwan Semiconductor Manufacturing (TSM) accounting for 23.3%.

Read the full collection of commentaries that make up this -article at Barron’s (Paywall): https://www.barrons.com/articles/july-jobs-report-better-than-expected-better-than-feared-51596843004


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Favor Asia Economies That Are Managing Pandemic: Kotok (Radio)

Favor Asia Economies That Are Managing Pandemic: Kotok (Radio)

July 30, 2020 – Running time 06:26

David Kotok, Chairman & Chief Investment Officer at Cumberland Advisors, on fiscal stimulus, the pandemic, and current investment outlook. Hosted by Paul Sweeney and Vonnie Quinn.

David Kotok Interview

LISTEN HERE: https://www.bloomberg.com/news/audio/2020-07-30/favor-asia-economies-that-are-managing-pandemic-kotok-radio

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 July 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: https://www.stitcher.com/podcast/bloomberg/masters-in-business/e/48339521

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More “Masters in Business” podcasts here:
http://www.bloomberg.com/podcasts/masters-in-business/




Cumberland Advisors Market Commentary – A Modest Proposal

“In practice, the Fed has never adopted operating procedures designed to control reserves in order to use the money multiplier relationship to control deposits.” (Goodfriend and Hargraves, “A Historical Assessment of the Rationales and Functions of Reserve Requirements,” Source: https://www.richmondfed.org)
Market Commentary - Cumberland Advisors - A Modest Proposal
In response to the pandemic crisis, the Federal Reserve has cut the federal funds rate target to 0%–.25%; instituted a series of at least eleven special programs to support financial markets, including a facility to support the government’s paycheck protection program; begun an aggressive asset purchase program; expanded its central bank liquidity swaps program; and, in March, cut reserve requirements to zero. The Fed has also made clear that interest rates will be low for a long time – until the economy starts to really recover and, by implication, until inflation really starts moving back to its 2% target. The nagging question at this time, and still unaddressed, is what the Fed’s exit strategy is and what it will do about the elephant in the room – its balance sheet.
Coming out of the Great Recession, the Fed’s balance sheet peaked at $4.516 trillion on January 14, 2015, before drifting down to $3.760 trillion on August 28, 2019, after the Fed stopped rolling over maturing securities. It took a full four years and seven months to decline by only $756 billion, during which the FOMC pursued a zero-interest rate policy. But when the COVID-19 pandemic hit, the Fed again expanded its balance sheet, which peaked at $7.169 trillion on June 10, 2020, before slipping back to $6.965 trillion on July 23, 2020. Interestingly, this most recent decline was due almost entirely to a drop in its central bank liquidity swaps program, which peaked on June 6 at $445 billion before falling to $122 billion on July 23. If it took more than four and a half years for the balance sheet to decline to $3.76 trillion through the runoff of maturing securities, what strategies might the Fed employ to bring its balance sheet into a more normal equilibrium once the economy recovers, and how long will that process take? We are potentially looking at many years before equilibrium is reached, and there is the very real possibility that interest rate policy alone may not be sufficient to control the expansion.
What the Fed should not do is turn to asset sales. With less than $50 billion in capital and surplus, significant asset sales in a rising-interest-rate environment would generate capital losses that would have to be recognized, either by writing down capital or by creating a negative asset account into which to book losses that was negotiated by Chairman Bernanke with the Treasury during the Great Recession. If capital losses were incurred, then remittances would be curtailed until the losses could be recovered, posing problems for the Treasury, not to mention creating bad optics as far as domestic and international financial markets were concerned, should the losses in the negative asset accounts exceed the Fed’s capital.
For this reason, the Fed will likely have to employ other strategies to restore normalcy. There is a strategy that would buy the necessary time and provide the necessary policy flexibility for the Fed to normalize its balance sheet, and it could do so employing several complementary tools without having to resort to asset sales and without short-run costs to the banking system.
The key to managing the dynamic reduction in the Fed’s balance sheet over time lies in a timely and calibrated use of reserve requirements along with judicious use of differential interest rates on required versus excess reserves as a complement to the interest rate policy tools currently being employed. As the initial headline of the report linked above implies, neither the existing Board of Governors, nor the members of the FOMC, nor their staffs have had any practical personal experience in the use of reserve requirements as a policy tool, because reserve requirements have not been used as a monetary policy tool since WWII.  Indeed, as the next chart shows, because reserve requirements historically have been low and excess reserves minimal at best, making changes in reserve requirements has always been judged by Fed policy makers and economists to be a blunt, unwieldly, and impractical instrument compared to making marginal changes in outstanding excess reserves using changes in the overnight funding rate. This mindset has dominated economists’ thinking about reserve requirements as a useful policy tool. The relationship between excess and required reserves changed dramatically, however, after the Fed expanded its balance sheet in 2008 in response to the Great Recession. The ratio of required reserves to total reserves declined from about 95% before the Great Recession to only about 5% in its aftermath.
As a result, in a fractional reserve system, with required reserves set at zero, the Fed is sitting on a time bomb because of the potential increase in the money supply and the inflation that it implies. In a fractional reserve system, the potential increase in the money supply, in the limit, is equal to 1/reserve requirement times the volume of outstanding reserves. For example, if reserve requirements were 5%, then a dollar of reserves would support up to a $20 increase in the money supply. At zero, there is no limit or constraint. (As an aside, it is interesting to note that the Fed provided little convincing justification for the elimination of reserve requirements in March of this year.)
Right now, banks are sitting on over $2.732 trillion in excess reserves. However, they are not lending them out at an alarming or dangerous pace at present, in part due to the lack of loan demand; in part due to regulatory liquidity constraints; and in part due to the fact that, even with a low rate on reserves of only .10%, which is only two basis points below the rate on a one-month Treasury bill, that is still a riskless rate of return without the transactions and accounting costs of going back and forth into the Treasury market.
What the Fed should do now, as part of a multi-step process for putting in place a workable risk-management exit strategy, is the following:
  1. Raise reserve requirements to sterilize as much of the existing excess reserves as possible, e.g. perhaps up to 80%. This move will be especially important since most of the COVID-19 rescue package seems to have ended up on the Fed’s balance sheet.
  2. Commit to cut required reserves in parallel with the decline in the Fed’s balance sheet as assets mature and run off.
  3. Adjust the actual ratio applied to ensure that excess reserves are sufficient to provide adequate liquidity in the overnight federal funds market as well as the tri-party repo market.
  4. Vary the size of the excess reserve buffer created by a required reserve ratio less than 100% as an additional policy tool when markets change as the economy recovers. The flow of liquidity and pricing in the tri-party repo market could serve as the canary in the mine to indicate how large the buffer should be to ensure smoothly functioning financial markets. We saw, for example, in the fall of 2019, that there was a miscalibration on the part of the Fed as to how big its balance sheet should be, which resulted in a spike in the repo rate that went away only when the Fed introduced an emergency repo facility to support that market.
  5. Establish a different reserve requirement rate for large banks and for branches and agencies of foreign institutions, because reserve balances are not evenly distributed across banks of all sizes. Note that before the Fed reduced reserve requirements to zero, required reserves were zero for banks with eligible deposits up to $16 million, 3% for banks with eligible deposits up to $122.3 million, and 10% thereafter. So, there is historical precedent for differential reserve requirements. Right now, the 25 largest banks hold 61% of the deposits and have 56% of the reserves. Agencies and branches of foreign institutions hold only 7% of US deposits but hold 24% of the reserves. US chartered banks not in the top 25 together hold 32% of the deposits and only 20% of the reserves. Since the objective is to sterilize the excess reserves, it also makes sense, as was the case in the past, to establish different requirements for different-sized institutions, especially since 85% of the reserves are in just a few institutions and their propensity to lend and expand credit varies. At the same time, a lower reserve ratio that might continue to be zero for small institutions would ensure that these banks can accommodate individual and small business loan demand in their local communities. Because the objectives are to prevent an explosion in the money supply and a runup in inflation, to manage a smooth transition to a smaller Fed balance sheet, and to avoid having to sell assets, there is no economic justification for the Fed’s having reduced reserve requirements to zero last March.
  6. Establish different interest rates that the Fed pays on excess reserves as opposed to the rate paid on required reserves. This strategy would enable the Fed to dynamically control the opportunity costs of holding excess reserves as opposed to the incentives for expanding credit and shifting excess reserves into required reserves. With a rate on required reserves greater than the rate on excess reserves, for example, institutions would be incentivized on the margin to make loans rather than to hold reserves idle in the form of excess reserves. A zero rate on excess reserves would provide an additional stimulus and would not require maintaining a lower federal funds rate, which might otherwise be required. On the other hand, setting the rate on excess reserves greater than that on required reserves would tend to dampen incentives to expand lending on the margin. Thus, employing differential rates on required and excess reserves provides an additional tool for fine-tuning reserve holding incentives as a complement to differential reserve requirements themselves, which are not well suited for day-to-day adjustments in monetary policy.
The above proposals would expand the Fed’s tool box with a system of reserve requirement policy levers that would not impose costs on existing depository institutions, especially if the program were started in the near term. Banks are voluntarily holding a huge volume of excess reserves, so converting these to required reserves by imposing a non-binding constraint while still paying interest is effectively no different than what is currently in place, incentive-wise, since the rate is presently the same on both excess and required reserves. The expanded tool kit would include differential reserve requirements, differential interest rates paid on excess and required reserves, the federal funds target rate, the discount rate, the repo rate and open market operations, plus forward guidance in terms of a commitment to relax required reserves at a pace consistent with the Fed’s growth, inflation, and unemployment objectives. This policy approach avoids any risk that credit creation, the money supply, and inflation will get out of hand. In addition, the Fed would have no need to worry about selling assets and incurring all the risks and the public scrutiny that sales would entail. The Fed could announce the program now, clearly laying out how it would be implemented in coordination with the decline in the Fed’s balance sheet. Some might be concerned that it is too soon to announce such a program and that an announcement of one might cause problems in financial markets; but the reality is that now is perhaps the best time to announce the program, when reserves are plentiful, the increase in requirements would be costless to the affected banks, and the Fed’s other liquidity programs are in place and functioning.
Robert Eisenbeis, Ph.D.
Vice Chairman & Chief Monetary Economist
Email | Bio

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Cumberland Advisors Market Commentary –  Inflation coming? Maybe, maybe not?

There are many prescriptions and forecast models for a coming inflation or the lack of it. They range widely. Some forecasts include deflation.

Inflation adjusted bonds (like TIPS) are currently priced for very low inflation. Nominal bond markets are saying that little to no inflation is expected. That is why high grade bonds are pricing a long trajectory of very low interest rates. Because of that, stock prices are projecting a strong upward path for growth stocks which are the market’s expected winners during the COVID-19 and post-COVID-19 period. Remember, the lower the interest rate, the higher is the cap rate derived asset value. In theory a discounting rate of zero would yield an asset price of infinity.

Now we have a new research note that examines the experience of inflation during the pandemic outbreak period in France. It may allow us to draw inferences for the United States and other economic regions and certain countries. We are sending it because there are many readers who would not normally obtain insights form this source.

Here’s the abstract of the paper and a link to it:

“During the lockdown, inflation in France fell sharply while households expected a sharp increase. The profound and sudden change in the structure of household consumption and the strong dispersion of price changes for commonly purchased goods (fresh food, fuel) could explain this unprecedented divergence, which is set to narrow.”

“Inflation and households’ inflation expectations during the Covid-19 pandemic,” Banque de France, July 17, 2020,
https://blocnotesdeleco.banque-france.fr/en/blog-entry/inflation-and-households-inflation-expectations-during-covid-19-pandemic

Readers, please note that our experience with the research department of the Banque de France spans decades. They are very helpful and easy to approach for dialogue on diverse topics. Much of their research is publicly available.

At Cumberland, we’re concerned about an inflation surprise to the upside. We’re not sure when and we’re not sure “if.” History suggests we can get rising inflation. But there is no real history to guide us during the COVID-19 shock period. That is why our bond portfolio strategy includes a “barbell.” Any reader who wishes more information on barbells may email me, and I will arrange a response to your inquiry.

David R. Kotok
Chairman of the Board & Chief Investment Officer
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 Commentary – The Fed & Nonprofits

The extraordinary and massive COVID-19 economic shock has triggered another first-time action by our nation’s central bank. The Fed now has expanded a facility directed at lending to nonprofits. Among those nonprofits targeted are “educational institutions, hospitals, and social service organizations.” Here’s the link to the July 17 press release announcing the modification of the Main Street Lending Program: https://www.federalreserve.gov/newsevents/pressreleases/monetary20200717a.htm.

Market Commentary - Cumberland Advisors - The Fed & Nonprofits

This remarkable program deserves applause. Early in the pandemic, the Fed realized that the demand for the services of nonprofits and the requirements to provide those services were rising rapidly while their revenues were falling. Many don’t normally think of nonprofits in economic or market-impact  terms. We often take them for granted until we personally observe a need for them. Some immediate examples are hospitals and food banks. In April 2020, the Federal Reserve surveyed nonprofit organizations, financial institutions, government agencies, and other community organizations across the US to assess how organizations and the communities they serve were faring as the COVID-19 pandemic developed. Here’s a link to the Fed’s April survey: https://www.frbatlanta.org/-/media/documents/community-development/publications/federal-reserve-system-resources/05/04/perspectives-from-main-street-the-impact-of-covid-19-on-communities.pdf. Note that there were 3899 responses and that all twelve Federal Reserve district banks and the Board of Governors were involved.

Here’s a link to an interview between Georgia Grantmakers Alliance director Lydia Clements and Federal Reserve Bank of Atlanta president Raphael Bostic, in which Bostic outlines the Fed’s responses to Covid-19 and offers some of the findings from the survey and the requirements to support nonprofits: https://www.youtube.com/watch?v=EWIj8iNV6QU&feature=youtu.be.  In Sarasota, Florida we’re in the Atlanta Fed’s district and can personally attest to the need for nonprofit’s services as this COVID-19 forest fire rages around us.

And here’s a link to a research study from the San Francisco Fed which delves into the concerns for communities and nonprofits in the western region of the United States: https://www.frbsf.org/our-district/about/sf-fed-blog/nonprofit-concerns-covid19-coronavirus-pandemic/. Readers will note that the San Francisco Fed’s regional geography is huge.

Time will tell how well the Fed’s new program works. This expanded program is truly unique in the Fed’s history.  The Fed had to develop the program from scratch and without any precedents.  There may be issues with governance conditions in nonprofits as they accept the scrutiny that goes with a  borrowing that accompanies a program originating with the federal government through the use of taxpayer funds. In our view, this added scrutiny is needed.  The state of governance in nonprofits varies widely from high standards of accountability excellence to appalling misbehavior and cronyism management.  Remember, nonprofits do not have regulatory conditions Like ERISA over employee retirement funds or the Securities & Exchange Commission over investment advisors.  Example: how many nonprofits have you seen that report results of their endowment investments using GIPS procedures?

Please note the details in the new term sheet available from the link at the bottom of the Fed’s press release.  Note the 5 year amortization is “back loaded”.  Note the breakdown of revenue so that the Fed has a process to estimate repayment of the loan.  Part of the design challenge was to separate recurring non donor based revenue from the philanthropy.  It is a hard “ask” to seek a contribution from a donor to repay a loan.

Please note the interest rate of 300 basis points over LIBOR.  There are two observations to make here.  For some non-profits, there may a cheaper market access since certain organizations have the ability to issue tax-free bonds. Experience will reveal if there is an adverse credit selection bias in this program.  The second observation is very technical.  The Fed anchored the interest rate with a floating formula to LIBOR.  Why didn’t it use SOFR?  Was this just an oversight?  Will loan documents allow for the transition from LIBOR to SOFR as the reference rate?

COVID-19 continues to trigger huge alterations from what we have considered to be the norm. We have seen the Fed’s balance sheet grow to unprecedented size. We have seen the creation and deployment of new programs unlike anything previously imagined. And we do see a responsible central bank rising to the national purpose to assist the United States with its lending tools.  Just as it has in the past when the nation was attacked, whether in WW2 or after 9/11, the Fed has quietly and without any blame-game political rhetoric done what it can to keep the American economy and its citizens in better shape than it and they might otherwise be.

We applaud the Fed for this creative approach to helping nonprofits, whose roles in the COVID-19 fight are now critical to our survival.

P.S. For those in the Sarasota-Bradenton area, there is now an acute need for blood. The SunCoast Blood Centers site and map of their locations is here: https://donor.scbb.org/donor/schedules/geo. Another is One Blood, and their site is: https://www.oneblood.org/donate-now/ They will administer a COVID-19 test and an antibody test, with results in minutes. If you have antibodies and are willing to donate blood, they will organize that promptly. Sarasota Memorial Hospital and other area hospitals are able to treat COVID-19 patients with convalescent plasma, so your pint of blood can literally and quickly help save a person’s life. Sarasota Memorial is a nonprofit. The blood banks are nonprofits. They are critical examples of nonprofits at work saving lives. Please help if you can.

David R. Kotok
Chairman of the Board & Chief Investment Officer
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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The Fed’s Corporate Credit Facility

On June 15, the Federal Reserve published revised terms and conditions for what it calls its Secondary Market Corporate Credit Facility, which is a special-purpose vehicle (SPV) created to purchase in the secondary market corporate debt that meets certain eligibility requirements. See https://www.newyorkfed.org/markets/secondary-market-corporate-credit-facility/secondary-market-corporate-credit-facility-terms-and-conditions. Included will be individual corporate bonds, certain exchange-traded funds (ETFs), and bond portfolios that track a broad market index. The US Treasury will contribute about $25 billion in capital to provide loss protection to this SPV; and it is anticipated that this vehicle and another SPV, the Primary Market Credit Facility, could reach a combined size of $750 billion.

The market index that the bond portfolios must track has been created by the Federal Reserve and is now being published on the website of the Federal Reserve Bank of New York, which is administering the program. The securities in that portfolio must meet the program’s eligibility criteria for purchase. Just to mention a few of the more important requirements, entities must have a credit rating of at least BBB-/Baa3 as of March 22, 2020; they must be US-chartered companies, and eligible securities will be those with less than 5 years remaining maturity. The details on the names of the entities meeting the criteria, their industry category, and weights are provided. The information offered so far does not disclose how the weights were determined or how and under what circumstancesthe other end of the scale in terms of index weights, 54 firms are listed whose weights each are less than .01%. Among these are Boeing, Lockheed, Northrop Grumman Systems, CBS, Starwood Hotels, Quaker Oats, Blue Cross Blue Shield, Nomura America Finance, and Consolidated Rail Corp, just to name a few.

Another interesting feature of the list is that while the Fed says it will not purchase securities of foreign institutions, the index of securities eligible for purchase as noted earlier contains the US-chartered subsidiaries of foreign institutions. In addition to the names of the auto companies mentioned above, other notable entities include Komatsu Finance America, American Honda Finance, Daimler Finance, Nissan Motor Acceptance, three subsidiaries of Anheuser-Busch now owned by INBEV, three US subsidiaries of Germany’s Fresenius AG, and ABB Finance US, a subsidiary of the Swiss company ABB Ltd. In many instances, the parent companies issue dollar-denominated debt in the US as well as guarantee the debt of the issuing subsidiary. To the extent that the Fed creates a market support system for the subsidiaries of foreign institutions, the strength of the parent is improved, and indirect subsidies flow to foreign entities even though the Fed is not purchasing their debt directly. It is hard to justify such subsidies in the name of supporting a market.

It is also important to ask the question, “What problem is the bond-purchase program attempting to solve?” The Fed argues that it is trying to ensure the smooth functioning of the bond market; but it has provided little or no evidence of problems, especially in 2020 after the pandemic hit the economy. In fact, the SFMA (Securities Industry and Financial Markets Association) reports that corporate debt issuance for each month in 2020 through June exceeded monthly totals for the comparable period in 2019. Year-to-date issuance in 2020 was $1.2 trillion, compared with $660 billion in 2020, an 89.2% increase (https://www.sifma.org/resources/ research/us-fixed-income-trading-volume/). This volume is quite surprising given what has happened to the US economy because of the pandemic. Moreover, the program has only been in place a short while and as of July1 totaled only about $10 billion.

One case study is especially relevant here. Boeing’s problems have been well documented for over a year as its sales have crashed due to problems with its 737 Max aircraft. The pandemic has contributed to both a broad-based decline in air traffic and a cutback in acquisition of aircraft, and the end is not in sight. Yet in late April, Boeing had a blockbuster debt issuance of $25 billion, bringing its total outstanding debt burden to $54 billion and increasing its projected interest expense from $722 million in 2019 to $1.2 billion in 2020 (https://www.forbes.com/sites/jeremybogaisky/2020/05/01/boeing-25-billion-debt/#40d246041f88). To be sure, the issue came at a large interest cost of about 5%; but considering the fact that Boeing is extremely risky, that the deal was even consummated suggests that financial markets are functioning.

In the face of a questionable rationale, the expansion of the Fed’s activities beyond the Treasury market represents a slippery slope that puts the Fed at risk of committing to more such activities in the future, especially if Congress regards the Fed as a cash cow whose activities don’t involve Congressional funding of projects, as it did when it raided the Fed’s capital surplus to fund a highway bill in 2015 and again in 2018 to help fund the Economic Growth Act of 2018. Moreover, the Fed now finds itself in the business of picking corporate winners and losers. Firms whose debt is eligible for purchase receive a subsidy that is not available to all, and with little or no oversight. Finally, the relationship with Goldman Sachs also raises issues. Goldman is a primary dealer with access to the primary dealer credit facility, but it also owns a bank that has access to the discount window at subsidized rates. This close relationship ranks it, along with JPMorgan Chase and BNY Mellon (who provide the plumbing for the tri-party repo market), among the three institutions that are most likely to be too big to fail under any foreseeable circumstance.

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


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Barron’s – The Unemployment Rate Is “Grossly” Understated. Here’s Why

The Unemployment Rate Is “Grossly” Understated. Here’s Why.

Excerpt from Barron’s – July 02, 2020

Cumberland Advisors John Mousseau

A portion of John Mousseau, CFA’s commentary, The Muni Selloff That Was, was incorporated into Barron’s editorial piece, “The Unemployment Rate Is ‘Grossly’ Understated. Here’s Why.

July 1: The infrastructure bill being considered by Congress contains two pluses for the muni market. The first is a resumption of the Build America Bonds program. This program enjoyed great success during the last recession, with the issuance program lasting from April 2009 through December 2010. It allowed issuers to issue bonds in the taxable bond market with a federal subsidy on the interest payments. The issues had to be for new projects, which was the stimulus part of the program. The resumed program may not have the same 35% subsidy that the original had, but rather may hard-code the subsidy at a lower level. Sequestrations at the federal level caused that original subsidy to go from 35% down to the mid-20% levels over time.

Another positive aspect in the infrastructure program is the return of advance refundings in the tax-free bond market. This practice was removed by the 2017 tax bill, but had been a way for municipalities to save money by refunding older higher-coupon bonds to their first call date. Anything that allows municipalities to lower their cost of future funding is a very big positive, in our opinion, as we move forward from the pandemic.

John R. Mousseau

Read the full article at Barron’s:  https://www.barrons.com/articles/the-unemployment-rate-for-june-is-grossly-understated-51593732640


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Cumberland Advisors Market Commentary –  Update from ECRI

“A Nasty, Short and Bitter Recession”: An Update

Market Commentary - Cumberland Advisors - A Nasty, Short and Bitter Recession (ECRI)

First: here’s some very important history; then, the updated forecast!

The Economic Cycle Research Institute (ECRI) specializes in “calling cycle turning points in economic growth and inflation” and has a long, exemplary history of getting those forecasts right (https://www.businesscycle.com). Cofounded by the late Geoffrey H. Moore, winner of the American Economics Association Distinguished Fellow Award, Lakshman Achuthan, and Anirvan Banerji, ECRI analyzes not the gyrations of the markets but larger business cycles.

ECRI has its roots in the National Bureau of Economic Research (NBER), formed in 1920 by Wesley C. Mitchell and colleagues with a primary objective of investigating business cycles. In 1927, Mitchell formulated the standard definition of business cycles (see https://en.wikipedia.org/wiki/Economic_Cycle_Research_Institute#History). In 1938, at the request of US Treasury Secretary Henry Morgenthau, Jr., that NBER “draw up a list of statistical series that would best indicate when the recession would come to an end,” Mitchell and partner Arthur F. Burns identified the first leading indicators of revival. Also in 1938, Geoffrey H. Moore joined Mitchell and Burns at the NBER.

In 1950, Moore developed the first-ever leading indicators of cyclical revival and recession. Then, from 1958 to 1967, Moore, working with Prof. Julius Shiskin, developed the original composite index method, and the composite indexes of leading, coincident, and lagging indicators of the US economy. In 1968, NBER gave these indexes over to the US Commerce Dept., which published them regularly in its Business Conditions Digest and used the Index of Leading Economic Indicators (LEI) as its main forecasting gauge.

In 1979, Moore retired from the NBER and established the Center for International Business Cycle Research (CIBCR) at Rutgers University, moving it four years later to Columbia University. In 1996, Moore, with protégés Achuthan and Banerji, left Columbia to start ECRI.

The Economist noted in 2005 that “ECRI is perhaps the only organisation to give advance warning of each of the past three recessions; just as impressive, it has never issued a false alarm.” However, in 2011, ECRI did foresee a recession that narrowly failed to materialize. (See https://en.wikipedia.org/wiki/Economic_Cycle_Research_Institute#Recession_and_Recovery_Calls.)

In the days following the stock market’s March 23, 2020, bottom, as the world was pounded by COVID-19 and the economy by shutdowns designed to contain the virus, ECRI issued a forecast for “A Nasty, Short and Bitter Recession.”

Since that forecast was issued on April 5, April data released in May and May data released in early June have reflected the depths of the April–May bottom. While the stated unemployment rate for May was 13.4%, a U3 headline unemployment true count was impossible and is likely to have reached 20% at the bottom. (That is a Kotok analysis, not an ECRI one – for details see Bob Eisenbeis’s June 9 commentary, “Digging Deeper,” https://www.cumber.com/cumberland-advisors-market-commentary-digging-deeper/.)

In the US we lurched from 4% to 20% unemployment within a couple of months.

ECRI co-founders Lakshman Achuthan and Anirvan Banerji, co-authors of Beating the Business Cycle: How to Predict and Profit from Turning Points in the Economy, have graciously agreed to allow us to share their April forecast, “A Nasty, Short and Bitter Recession,” with our readers, and have kindly collaborated to address in thoughtful detail four questions I posed to them by way of an update.

The April 5 forecast link is http://m.businesscycle.com/ecri-news-events/news-details/business-cycle-economic-cycle-research-ecri-recession-recovery-lakshman-achuthan-anirvan-banerji-a-nasty-short-bitter-recession.

It is hard to overstate how important and how difficult these forecasts are. We don’t yet know when a vaccine or effective treatments will be made widely available; we don’t yet know how extensive or destructive the next surge of the virus will be; we don’t yet know the full impacts of political decision making or of human behavioral responses such as wearing masks and social distancing or refusing to do so. Nor do we yet know the extent of political and social unrest and their implications. With those variables in mind, here is where Lakshman Achuthan and Anirvan Banerji now see things, two months after their original report.

–––––––

Kotok: We have metaphors in history: the Spanish Flu of 1918, World War 2 deficit financing, Great Financial Crisis (2008–09) monetary expansion, and, tragically, an updated version of the 1968 inner city turmoil, rioting and destruction. Others may be added to the list. My first question: How do you use these strategic and historical metaphors to help you forecast in these extraordinary times? What metaphors are the strongest for you?

ECRI: ECRI’s focus remains economic cycles, and on business cycles going back more than a century and in a variety of market-oriented economies. A key insight is that – across space and time, so to speak – cycles have always been driven by a common set of drivers, regardless of the metaphors, narratives, and shocks surrounding them.

Our indicators also go way back. So we can see how ECRI’s objective leading and coincident indexes behaved around the Spanish flu, World Wars I and II, the global unrest in 1968, and the Global Financial Crisis, as well as the panic of 1907 – the first 20th century recession generally classified as a depression – that ultimately led to the creation of the Federal Reserve in 1913. And we regularly monitor 22 economies including the G7 and the BRICS, so we understand how business cycles have evolved in a wide variety of structural circumstances.

Most importantly, our quest has long been to understand the conditions under which our cyclical framework would fail. We find that good leading indexes – created on a conceptual basis rather than being optimized and back-fitted – continue to work in terms of cyclical direction in a very wide range of circumstances. So, in constructing our indexes, our emphasis has always been on robustness, rather than optimization.

The seven-month 1918–19 recession – which overlapped with the Spanish flu – was relatively mild, but still deeper than the milder post-WWII recessions. However, just nine months after that contraction ended in March 1919, the 1½-year 1920–21 depression took hold. With the Fed raising rates and the government focused on balancing its budget, this became a far deeper downturn – substantially deeper than the 1937–38 recession and at least double the depth of the 2007–09 Great Recession. But it took only a couple of years for economic activity to get back to pre-recession highs, before the Roaring Twenties got underway in earnest. Unfortunately, more recent recoveries have been much slower.

So a danger highlighted by the 1918–19 recession is that, just because a recession ends and a pandemic passes, it doesn’t mean blue skies ahead. A more recent example is the eight-month 2001 recession that ended in November 2001. During that downturn, the S&P 500 plunged to a new low the week after the 9/11 attacks, but then surged more than 20% in 3½ months. However, stock prices turned down in early January 2002 – ahead of a new growth rate cycle downturn, i.e., a mere slowdown – and fell to a much lower low by October 2002. Those historical precedents behoove us to keep a close eye on our leading indexes.

Kotok: When you wrote your forecast two months ago, you had the best information available then. Things have dramatically changed worldwide. COVID-19 cases and deaths, US-China tensions, and the Hong Kong financial center alteration are just some examples. How do you make adaptations for events like these, and are they considered extreme adjustments?

ECRI: When we wrote that piece in early April, we explained that a recession’s severity was measured by its depth, diffusion and duration – the 3Ds – and explained why the recession would be “extremely deep, very broad, but relatively brief.”

At the time, ECRI’s publicly available Weekly Leading Index (WLI) was “in free fall,” but we expected some answers from the WLI and our other leading indexes regarding the evolving future course of the economy.

Today, with several weeks of additional data available, we see our expectation of a “relatively brief” recession bolstered by sequential improvements in our leading indexes, including nine straight weeks of increases in the WLI. This constitutes objective evidence that our earlier thesis had been correct: The recession is likely to end by summertime. In fact, because stock prices always turn up a few months before business cycle troughs, their upturn is also entirely consistent with that prospect.

We also wrote: “After we restart the economy’s engines, it will pull out of its nosedive. But without all engines firing, it won’t be a steep climb back up.” Rather, we expected “a slow, halting recovery from a severe economic contraction.” On this score, our assessment hasn’t changed.

Kotok: ECRI has an enormous and prestigious reputation in its approach to the business cycle. The elements we have discussed are not part of the normal cycle. Each of them is in the category of “shocks.” It seems like we are in living through a continuous series of shocks. Doesn’t this force a rethinking of the traditional cycle forecast models?

ECRI: History is punctuated by shocks, large and small. But because we have a good understanding about what is cyclical, it makes it easier for us to strip out the cyclical component to reveal underlying structural developments sooner than most. For example, we warned of the structural decline in trend growth in the summer of 2008, more than five years before “secular stagnation” became a hot topic.

And recall that the unrest of 1968 happened to be followed by the mild 1969–70 recession. Yet, the more consequential structural change that followed that period of unrest and uncertainty was the downshift in productivity growth in the early 1970s. Today, we are concerned that the uncertainty created by the unrest will inhibit investment, further curbing the economy’s productive capacity.

What our late mentor, Geoffrey H. Moore, called business cycles “of experience,” i.e., as actually observed, were always influenced not only by exogenous shocks, but also by endogenous cyclical dynamics, meaning that a complete explanation of any historical business cycle can’t be purely exogenous or purely endogenous. It’s really about both endogenous cycles and external shocks.

For example, some believe that the San Francisco earthquake was the shock that triggered the chain of events that culminated in the panic of 1907. Yet, what’s notable to us is “the dog that didn’t bark”: Though the earthquake happened in April 1906, no recession occurred that year. From our perspective, despite a major external shock, there was no recession precisely because of the endogenous cyclical dynamics of the U.S. economy that were not predisposed to one. We know this because, at the time the San Francisco earthquake hit in 1906, our leading index was in a clear cyclical upswing, signaling that the endogenous cyclical forces would ensure the economy’s resilience to exogenous shocks. The precise nature of the shock didn’t really matter. But by early 1907, the configuration of the endogenous cyclical forces had changed, opening up a recessionary window of vulnerability, as signaled by a cyclical downturn in that leading index. The 1907–08 recession started soon thereafter.

The December 1941 attack on Pearl Harbor was a huge shock, but didn’t trigger a recession before wartime deficit spending had a chance to boost economic activity. The reason was that the economy was in a cyclically resilient state, as shown by the strong upturns in ECRI’s leading indexes in the lead-up to that attack.

You see, a good leading index of recession and recovery should be conceptually sound, and have the ability to capture the endogenous cyclical forces that determine the economy’s resilience to exogenous shocks. When such a leading index enters a cyclical downturn, it signals the economy’s entry into a recessionary “window of vulnerability,” within which any significant exogenous shock will tip the economy into recession. This is key to assessing recession risk on an ongoing basis.

Such well-designed leading indexes work in other market-oriented economies, as well. Readers may recall that the consensus view going into the June 2016 Brexit vote was that it would trigger an immediate recession. But the week beforehand, based on our U.K. Long Leading Index, ECRI reaffirmed that a vote in favor of Brexit wouldn’t be recessionary. This was because our Long Leading Index was in a cyclical upswing, signaling a U.K. economy resilient to exogenous shocks.

In other words, in our analytical framework, what matters is whether the endogenous cyclical forces measured by our leading indexes are so arrayed as to open up a recessionary window of vulnerability, within which any of those kinds of shocks would trigger a recession. And so we’ll continue to focus on our leading indexes for primary guidance about the cyclical risks to the economy.

Kotok: Last question. If you had to write or rewrite the outlook piece of two months ago today, what would you do differently? What would the outcome be, knowing what you now know but had to estimate two months ago?

ECRI: The main conclusion of our piece in early April – “that this recession will be extremely deep, very broad, but relatively brief” – remains valid, and would not benefit from hindsight. In fact, the NBER Business Cycle Dating Committee yesterday reiterated our central point about the three D’s, writing that, “in deciding whether to identify a recession, the committee weighs the depth of the contraction, its duration, and whether economic activity declined broadly across the economy (the diffusion of the downturn).” In that regard, the Committee wrote that “the unprecedented magnitude of the decline in employment and production, and its broad reach across the entire economy, warrants the designation of this episode as a recession, even if it turns out to be briefer than earlier contractions.”

With regard to the nature of the recovery, in early April we posited that “the public may not be eager to resume going to restaurants and entertainment venues until they feel safe. That could take a while, and will hamper the services side of the economy. They’ll venture out only when health officials can credibly assure them that the pandemic has been contained, and that a vaccine or, at least, a therapeutic drug – is available. Indeed, while we all appreciate the urgency of reopening the economy, saving lives is a precondition for saving livelihoods.”

However, with the benefit of hindsight, we now know that many will not abstain from going out to restaurants and entertainment venues until “health officials can credibly assure them that the pandemic has been contained, and that a vaccine or … a therapeutic drug is available.” The mood has changed, and it’s now clear that many prefer to prioritize normalcy, their livelihoods, and protests over any perceived risk to their lives.

_______

Closing Remarks (Kotok)

Whether the recovery is a V or a U or something else is still an open question. But highly credible forecasting work will help us determine the direction of the US economy and, because of the ties to that economy, the US stock market. Global influences are now huge, and international policy choices will assist or impair those effects.

Bottom line: We may have just seen the sharpest and fastest decline in history, which bottomed in April. It is the way back that counts now. How fast and how far remains to be seen, and credible forecasts help frame the questions.

We are most appreciative of Lakshman and Anirvan for sharing their views with our readers.

We wish them and our readers safety during this second COVID-19 surge. Please be careful, and please wear a mask.

David R. Kotok
Chairman of the Board & Chief Investment Officer
Email | Bio


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Cumberland Advisors Market Commentary – Not What It Seems: Where’s the Beef?

As reported previously, the Federal Reserve has embarked upon an evolving series of support and lending programs as part of its emergency response to the COVID-19 pandemic. As Chairman Powell stated in his post-FOMC meeting press conference and in subsequent Congressional testimony, the Fed has responded “forcefully, proactively and aggressively” to the crisis. This is an update to our previous comments on the Fed’s responses.

As of last week, the Fed had announced about a dozen asset-purchase and swap arrangements with central banks and lending programs. Some have been in place since March, while others have yet to get off the ground. Details on these programs are published weekly in the Fed’s H.4.1 report, and details on the programs are shown in the chart below.

Not What It Seems - Where’s the Beef - Fed Lending Chart

Eight of the programs are now functioning; but several, including three Main Street Lending Facilities and the TALF, have yet to become fully operational. Two observations seem to jump right out from this chart. All of the asset-related programs total a little more than $160 billion, according to Fed statistics. All those programs pale in comparison to the Central Bank Liquidity Swaps. This past week, the swaps stood at $352.5 billion, which is down from $444.5 billion the previous week but more than three times the reported size of all the other programs combined. And the size of those special programs, it turns out, is significantly overstated.

Beginning with the data released last week, the Fed added an additional table that breaks down the components of the five special credit facilities that have been put in place. Most importantly, it separates for the first time the actual amount of credit extended from the Treasury’s capital contribution to the programs. What we see is how limited these programs have been to date. Previously, we would have concluded from the net portfolio holdings that the five programs accounted for $99.7 billion, but the actual credit extended was only $12.5 billion, making the large size of the Central Bank Liquidity Swaps even more significant relative to domestic programs.

Federal Reserve Credit Facilities – June 17, 2020 ($ Millions)
Source: Federal Reserve Board H.4.1 Report
Facility Outstanding Amount Treasury Contribution Total
Commercial Paper Funding Facility $4,251 $8,547 $12, 707
Corporate Credit Facility $7,027 $31,889 $38,916
Main Street Lending Facility $0 $31,876 $31,876
Municipal Liquidity Facility $1,200 $14,879 $16,079
TALF $0 $0 $0
Total $12,478 $87,191 $99,669

 

The real beef is not in these special programs but in the Fed’s more traditional Treasury and MBS purchases. Total holdings of US Treasuries and MBS increased from $3.8 trillion on September 11, 2019, to $7.1 trillion last week, an increase of $3.3 trillion. Not only are these purchases quantitatively more important than the special programs are, but the relationship between the Fed’s balance sheet and GDP, measured by either outstanding currency or total assets, is at historic highs, as the next chart shows. GDP was about 18 times nominal GDP in 2009 and a little over 16 times the size of the Fed’s assets. Those ratios have declined to 11.9 and 3.2, respectively.

Not What It Seems - Where’s the Beef - Fed Ratio Chart

The Fed truly is the 1000-pound gorilla in the economy and financial markets now. To be sure, policy makers can argue that even the announcement and establishment of the special programs was sufficient to restore confidence in financial markets, reinforcing participants’ willingness to trade and lend; and they may be right. But what the data on the size of the Fed’s portfolio suggests is that in the future, the real challenge will be to establish a new equilibrium when the crisis is over, and the problem is several orders of magnitude larger than it was in the aftermath of the Great Recession.

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


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