Cumberland Advisors Market Commentary – Narrow Banks

In a move largely overlooked due to the virus pandemic, on March 25, Judge Andrew L. Carter, Jr., of the United States District Court for the Southern District of New York dismissed a case filed by principals of The Narrow Bank (TNB) against the Federal Reserve Bank of New York (https://www.tnbusa.com/wp-content/uploads/2020/03/2020.03.25-TNB-Order.pdf). What is The Narrow Bank, and what are the issues it poses?

Narrow Banks

For the past two years, a former Fed employee and investors have been pursuing a charter for what they call The Narrow Bank. The Narrow Bank would be structured as a state-chartered, uninsured, non-retail bank whose sole function would be to hold a master account at the Federal Reserve Bank of New York, through which it would earn interest on its reserve holdings and pass that return, after extracting a small fee, to its depositors, comprised of hedge funds, accredited investors and other financially sound institutions.

The proposed bank applied for a charter in Connecticut, whose banking department issued a temporary approval subject to conditions, including obtaining a master reserve account at the Federal Reserve Bank of New York before final approval would be granted. All states require that a bank that accepts retail deposits (deposits from individuals who are not accredited investors) must have Federal Deposit Insurance from the Federal Deposit Insurance Corporation. However, because TNB would not accept retail deposits, it would be regulated only by the State of Connecticut and not need FDIC insurance, nor would it be regulated by the FDIC or any other federal bank regulator. It would also not be subject to the FDIC’s large bank risk assessment charge that large federally insured banks must pay should TNB attract significant deposits.

As noted in the judge’s ruling, the master account application process involves a one- page form and is usually acted upon in a week or so. But in this case the process dragged on for weeks, with the New York Fed’s attorney finally indicated that several conditions must be met, including having at least $500K in deposits, proof of final charter approval, and completion of due diligence by the New York Fed. In late December 2017 the application was escalated to the Fed’s Board of Governors, which was concerned about the implications of such an institution for the efficacy of the Fed’s monetary policy tools, including IOER (interest on excess reserves). On March 6, 2019 the Board issued proposed changes to Regulation D that would lower the interest rate paid on reserves to institutions such as The Narrow Bank, essentially making TNB uneconomic. No final ruling has been forthcoming from the Board, but the advent of the COVID-19 financial crisis has essentially made TNB uneconomic for the moment, given that the IOER is at 0.1%, compared with the 1.0% that it was in August 2017, when TNB was granted a temporary charter certificate, or the 2.4% that it reached in December 2018 before plunging to its current level.

Some might claim that TNB has been treated unfairly and has been denied due process, an argument that at least one court has rejected. But TNB raises three general policy questions. First, is there a public policy reason to broaden access to Federal Reserve services and interest on reserves beyond banks, perhaps even to individuals? Second, are there risks associated with narrow banks that may impact financial stability? Finally, what implications are there for the efficacy of the Fed’s monetary policy tools? The answers to these questions are complex and not always clear.

As for who should have access to Federal Reserve services, it should be recognized that as a central bank, the institution’s main function is to conduct monetary policy, not to provide payments services to individuals or to the general public. It does provide wholesale payments clearing and settlement services, which evolved out of its historical check-clearing activities. It also serves as fiscal agent for the US Treasury and aids in issuance of Treasury debt. The appeal of TNB and similar entities when it comes to retail payments is that they provide a riskless alternative. In this respect the idea of a 100% reserve backing as a means to provide riskless payments services to individuals is not new. Irving Fisher and others put forth such a proposal in 1935 in the aftermath of the Great Depression; and later, Milton Friedman supported a 100% reserve requirement for checking accounts to counter what many thought was the inherent instability of a fractional reserve banking system (https://monneta.org/en/100-money-and-chicago-plan-full-reserve-banking/). Today, there are many payments options, and for individuals it is possible to have FDIC insurance to cover most payments and savings needs. (There have even evolved workarounds to get more than $250K of insurance on accounts). So the case for individuals to have access to the central bank is weak and could provide a distraction to the Fed’s main monetary policy function.

The second concern is potential risks that TNB and similar institutions might pose to financial stability. Because narrow banks’ only assets are reserves on deposit at the Federal Reserve, they are essentially riskless, and the rate that they earn is a riskless rate. In times of financial stress, when there is a flight to quality, the concern is that funds would disintermediate from the Treasury market, from money market funds, and from banks into narrow banks, thereby creating liquidity and, potentially, solvency problems. While this is a hypothetical concern, recent experience in both the repo market and the liquidity problems that have emerged across a wide range of financial markets during the pandemic shows that in desperate times there can be extreme pressures on certain financial markets and institutions. The recently announced nine Fed programs to support primary dealers, the corporate credit market, the municipal market, money market mutual funds, and the commercial credit market are but a few examples of the need to address such stresses.

Finally, and perhaps most importantly, there is concern about the implications of narrow banks for the efficacy of the tools the Fed employs to implement monetary policy. These tools include, but are not limited to, reserve requirements, interest on reserves (IOER), the discount rate, and the federal funds rate. These tools provide levers that flow into the economy through short-term money markets and across the term structure. Reserve requirements have receded into the background as a tool, since they are so low as to not be binding. The Fed could not pay interest on reserves until it was permitted to do so under the Economic Stabilization Act of 2008, which authorized payment of interest on both required and excess reserves. Because of the Fed’s asset purchase programs, bank reserves ballooned; and the Fed began paying the same rate of interest on both excess reserves and required reserves. That remains the case today. The IOER was intended to put a floor on the band within which the Fed would set its fed funds target rate. However, for much of the period since IOER was adopted, the effective federal funds rate was slightly below the floor supposedly set by IOER. The reason for this lies in a technical problem, in that Freddie Mac and Fannie Mae as well as the Federal Home Loan Banks are permitted to hold deposits at the Fed but are not permitted to receive interest on those funds. So they lend the funds out in the overnight market at rates slightly below IOER. These entities would appear to be prime candidates for placing deposits in TNB and similar narrow banks. While eliminating the discrepancy between the effective federal funds rate and IOER might be a desirable outcome, it is not obvious that simply permitting the Fed to pay interest on GSE and Home Loan Bank funds is not a better alternative, especially since these entities are, at present, government institutions.

In summary, the issues raised by the narrow bank proposals are complex and not always clear. What is needed at this point is a serious and in-depth reassessment of the Fed’s policy tools, the structure of the markets in which those tools are applied, and how the tools are linked, both theoretically and practically, to the macroeconomy. Just one example may serve to illustrate that need. The present primary dealer system is a relic of the past when Treasury securities were paper documents and primary dealers submitted paper bids in connection with daily open-market operations. With the evolution of technology, including digital securities and electronic bidding, there is no reason that all sound member banks and other qualified entities should not be permitted to bid and eliminate the privileged position of the primary dealers. Right now, more than half of primary dealers are affiliates or subsidiaries of foreign banking institutions that are currently being supported by the Fed though the primary dealer credit program, effectively subsidizing foreign institutions.

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


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Cumberland Advisors Market Commentary – Repos Revisited

On March 12, a Wall Street Journal headline announced, “Fed to Inject $1.5 Trillion in Bid to Prevent ‘Unusual Disruptions’ in Markets” (https://www.wsj.com/articles/fed-to-inject-1-5-trillion-in-bid-to-prevent-unusual-disruptions-in-markets-11584033537).

Market Commentary - Cumberland Advisors - Repos Revisited

The inference was that the Fed was embarking upon a massive injection of funds into short-term money markets. That is, the first three offerings of $500 billion each were but the first of a much larger potential program to be played out over March and April and possibly subsequent months.

The program actually began on March 12 with a $500-billion, 84-day offering, followed on March 13 with two $500-billion offerings, one of 84 days and one of 31 days. A lot has happened since then in terms of government and Fed efforts to brace the economy against the costs of the coronavirus pandemic. For example, the Fed subsequently announced nine additional $500-billion offerings to be executed through April 13. Most recently, the Fed announced resumption of emergency lending facilities to money market funds and primary dealers, and even actions, which will begin shortly, to support the muni market.

Against this background Cumberland has been publishing daily updates on the Fed’s repo facility, and it is time to assess what has actually happened. The bottom line is that there have been few signs of liquidity problems in short-term markets, and the total takedown of potential offerings has been very small. In other words, the massive injection that people expected never happened. This means either that there have been no problems or else that the demand for Treasuries and MBS from the private sector has been so great that dealer inventories are small and there is no need for the extra funding. So let’s look back at how the NY Desk’s repo (reverse repo – remember, the Fed’s terminology is from the counterparty’s perspective) actually worked.

First, some operational details. The Desk announced a monthly schedule of proposed daily transactions ranging from overnight repos to term repos of various maturities including 11 days, 13 and 14 days, 28 and 31 days, up to 84 days. The $500-billion offerings have all been for at least 28 days or longer. The shorter offerings have been for $45 billion, except for one $50-billion, 25-day offering on March 12. As for the overnight offerings, they were increased from $100 billion on March 4 to $150 billion on March 9 and later that week it was boosted to $175 billion on March 11.

While the Fed has been willing to supply liquidity, it is interesting to see how little of the potential lending has actually taken place. The chart below shows the amount of funding outstanding for different maturities as of the morning of April 8 in terms of overnight borrowings and the amount of term funding that has also been granted. The chart nets the amount of under/over funding of the potential takedowns that might have happened across maturities. The amount of underfunding includes both term (yellow) and overnight (green) amounts.

Total outstanding amounts peaked on March 18 and remained over $400 billion through March 25 but have declined steadily since then. Interestingly, overnight financing remained under $4 billion from March 30 through April 9 and summed to only $ 40.25 billion out of a possible $1.8 trillion of overnight financing over that period. Use of the longer-term offerings thus far has also been far below capacity. Over the same March 30–April 9 period, only $7.25 billion out of a possible $2.1 trillion was taken out.

Overall, conditions appear to have moderated in the repo market. We will look forward to monitoring the other emergency programs that the Fed has put in place as data become available. We need to avoid being complacent about financing conditions. With the additional borrowing the government has to do in order to finance the emergency spending programs that have been put in place, plus others that may be in the pipeline, we can only imagine what the dealer financing needs are likely to be and how much of that borrowing will ultimately end up on the Fed’s balance sheet.

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 Commentary – One Less Worry?

It is tempting to focus on the here and now, especially when we are worrying about the economic fallout from the coronavirus pandemic and its impact on the nation. We are withdrawing from social contact and are concerned about all sources of risks. We have seen reports of people sanitizing cash as one way of protecting against the transmission of the virus, and we have all experienced expanded use of electronic payments via cell phones, credit cards, and even no-signature requirements as a way of avoiding touching touchscreens at all point-of-sale terminals.

Cumberland Advisors Market Commentary - One Less Worry (Eisenbeis)

The fact is that we are moving closer to being a cashless society; and that may be, at least here in the US, one of the side effects of 9/11 and the growth of technology. When 9/11 occurred, the Fed was forced to arrange trucks to transfer checks across the country since its private fleet of airplanes that physically transported paper checks from place to place could not fly. In response to that experience, both the Fed and the private sector made changes to how transactions were cleared and settled and installed robust backup processes.

As a consequence of those changes, technology may be an important and underappreciated source of resilience for our financial system, mitigating some of the possible costs of the financial crisis. On CNN just recently there was an interview of an expert and her response to the NY governor’s claim that a lockdown of New York would cause economic disaster to the US economy. She made the point that financial markets are now essentially electronic and that we have already operated a week with the floor of the NY Stock Exchange closed. The exchange floor is basically a TV set at this point, and is not critical to the functioning of equity markets.

The same is true of all the actions that the Federal Reserve has taken to support financial markets. The Treasury market is electronic; the repo market is electronic; the federal funds market is electronic, as are the SWIFT international foreign exchange market, the large dollar transfer system, the credit card system, and the ACH funds transfer system among financial institutions, just to name a few.

As far as retail payments are concerned, prior to 9/11, checks and check clearing was so important that the Federal Reserve had 56 facilities across the country involved in the physical transfer of paper checks. Now it has only one office involved in that activity. The reason is that check images are now captured electronically and are truncated at the point of sale. Much of this shift was the logical fallout of the changes in the payment system that resulted from 9/11.

Why is this important today? Well, we can continue to go to the store and use credit cards, phones, and the like (electronics) to make purchases with greatly reduced risk of picking up the coronavirus or transferring it to others. While this convenience may not seem like a big deal, transferring money electronically certainly reduces risk in this time of crisis and is one less thing to worry about.

At Cumberland Advisors we have been working remotely for more than a week with full functionality, using technology and implementing emergency preparedness procedures that we had developed for exactly such a crisis.

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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Fed Outstanding Repo Transactions March 2020

Fed Outstanding Repo Transactions March 3 – March 31

Eisenbeis Chart - Fed Outstanding Repo Transactions March 2020 Overnight & Term Repos ($Billions)

Fed repo transactions have been declining is volume both in terms of outstanding credit being supplied as well as in take-downs of the daily offerings.  Today no one-day credit was applied for and only $250 million of the $45 billion 13 day-offering was taken down.  Most interesting is of the five the widely touted $500 billion 84-day and $500 billion 28  day offerings that have been put forward so far, which could have injected $2.5 trillion of liquidity into financial markets, only a total of $150 billion has been taken and none was taken of the $500 billion 28-day offering on March 27th.

This pattern suggests there the so-called liquidity squeeze in the repo market was a concern at the time but not a reality in fact and may be overblown.

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




Fed Outstanding Repo Transactions March 03-26, 2020

Fed Outstanding Repo Transactions March 3 – March 26

Fed Outstanding Repo Transactions March 2020 Overnight & Term Repos ($Billions). Chart by Robert Eisenbeis, Ph.D.

Liquidity needs in the repo market appear to have stabilized and transactions proposed are far below the amounts that the Fed is willing to buy from dealers. There was a slight bump up in demand for overnight funding, no doubt due to the uncertain status of the stimulus bill, which was resolved early Thursday morning.

The new claims for unemployment insurance are literally off the charts and is a harbinger for what we might expect to see next week. The support packages should ease the financial burdens for both the unemployed as well as businesses, but they will not bring back demand or spur production in the short run until the virus has run its course.

Eisenbeis Chart - Unemployment March 26, 2020

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




Cumberland Advisors Market Commentary – Whatever It Takes, Part II

On Thursday, March 12, the Federal Reserve announced additional measures designed to send a message to markets that the Fed is there should it be needed. Pundits hyped that the Fed was going to inject up to $1.5 trillion of liquidity into financial markets, but that amount is misleading in many important ways.

Whatever It Takes, Part II

First, the Fed has been adding to its balance sheet at the rate of $60 billion a month, mainly in T-bills, and had planned to continue through at least the second quarter of 2020. On March 12, this policy was modified to include purchases across the term structure (see: https://www.newyorkfed.org/markets/opolicy/ operating_policy_200312a).

Second, more significant than the change in the maturity structure of its purchases, however, was the announcement of the intention to offer a series of potentially large repo transactions, which the press reported would expand the Fed’s balance sheet by as much as $1.5 trillion (see: https://www.cnn.com/2020/03/12/investing/ny-fed-trillion-coronavirus/index.html or https://www.nbcnews.com/business/economy/why-did-federal-reserve-inject-half-trillion-dollars-financial-system-n1157166). Some interpreted the action as another QE but in some cases totally misstated what the Fed was proposing and missed the central point that the proposal was actually a series of short-term collateralized loans.

In any case, the press reports on the quantitative significance of the new repo transactions are actually significantly understated. The monthly announcement schedule of the Fed’s proposed repo offerings (https://www.newyorkfed.org/markets/domestic-market-operations/monetary-policy-implementation/repo-reverse-repo-agreements/repurchase-agreement-operational-details), which is adjusted each business day, shows, for example, for Thursday, March 12, a 25-day offering of at least $50 billion, a 14-day offering of at least $45 billion, and an 84-day offering of at least $500 billion. For March 13 it shows both an 84-day offering of at least $500 billion and a 31-day offering of $500 billion.  Similar patterns exist throughout March and up to April 13. Interestingly, New York Fed data show that, of the five above offerings, the 25-day and 14-day term repos were oversubscribed but only $119.4 billion of  the first three $500 billion offerings (on March 12 and March 13) were taken, indicating little demand for the $1.5 trillion of  repo transactions that could have been conducted.

While the press reported that the Fed intended to inject up to $1.5 trillion of liquidity through its repo operations,  no such limit is contained in either the monthly transactions schedule, referenced above, nor in the announcement accompanying the change. Indeed, up to 8 more potential $500 billion offerings are contained in the above-referenced schedule. It is hard to believe that that much would be injected, especially as the recent takedowns shown in the chart below provide evidence as to how much markets are stressed for liquidity.  But it does send the clear message that the Fed is willing to do whatever it takes.

Interestingly, all of the overnight and under-25-day repos offered between March 3 and March 13 were oversubscribed, as indicated by the tan bars above the total line in the chart below; but the first three installments  installment of the  two 84-day and one 31-day $500 billion offerings amounted to only $119.4 billion and thus were  undersubscribed by more than $1.380 trillion(shown with the bars below the zero line), suggesting either that right now pressures are not anticipated to be great or that there are simply not many eligible securities needing to be financed. To put those numbers in perspective, the maximum amount outstanding last September and early October was about $281 billion. Given the fact that the Fed has proposed at least eleven such $500 billion offerings from March 12 through early April, we might have supposed that the Fed would have put out a more general announcement from both the Board of Governors and the New York Fed, rather than a communication to only those active in the repo market.

Fed Outstanding Repo Transactions

Epilogue

If last Thursday and Friday’s actions weren’t enough, on Sunday the FOMC in a series of actions made the unprecedented decision during a weekend-emergency meeting to slash its target rate for the federal funds to 0-.25%. The Board of Governors also slashed the discount rate by 150 basis points to .25 percent effective March 16 thereby narrowing the spread between the federal funds rate and discount rate to the top of the new federal funds target range. If that weren’t enough, the Federal Reserve also announced that it would restart its QE bond buying program. It will begin the purchase of $500 billion of Treasury bonds across the curve beginning March 16 and it will also buy $200 billion of mortgage backed securities as a means to support the housing market. As part of this new QE the Fed will resume reinvestment of both maturing Treasury securities and mortgaged backed securities. At the same time, the Board of Governors put out a statement that not only encouraged banks to rely upon intraday credit to support a smooth functioning payments system but also urged large bank holding companies to dip into their liquidity buffers as needed to support lending and the economy. Lastly, as part of a coordinated effort, the world’s major central banks (Canada, Bank of England, Band of Japan, the Swiss National Bank and Federal Reserve) announced they will expand the volume and lower the cost of standing US dollar standing swap lines by 25 basis points. Additionally, these banks will expand their current one-week maturity US dollar liquidity offerings to also offer an 84-day transaction as well.

We now have the makings of both a wave of fiscal policies to mitigate the costs of the coronavirus pandemic to the US economy, if the Senate enacts legislation that has already passed the House with presidential support, and complimentary monetary policy. This is not only “whatever it takes squared” but also all the chips are now on the table.

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 Commentary – Whatever It Takes!

Tuesday morning March 9, the Federal Reserve Bank of New York announced an increase in the current monthly schedule of repo transactions designed to deal with short-term liquidity problems for primary dealers and certain other market participants: from $100 billion to $150 billion in overnight repos and for two-week term repos from $20 billion to $45 billion.

Federal Reserve Building

Following that announcement, the one-day operation for March 9 resulted in a total of $112.932 billion in proposals being submitted consisting of $73.982 billion in Treasuries and $38.950 billion in MBS, all of which were accepted. To put this action in perspective, over the last 10 days prior to Tuesday’s change, submissions for overnight repos averaged $65.8 billion, with a high of $111.5 billion, a low of $26.24 billion, and a standard deviation of $32.3 billion. In only two days there was more than $100 billion in submissions received. By comparison, during the peak of the initial liquidity crisis in September and October of last year, overnight repos never exceeded $90 billion until the limits were increased in early November, but total repos outstanding were closer to $300 billion during the latter half of October 2019.

So, while the Fed’s action is accommodative, it is more sending the message of a willingness to “do whatever it takes.” By historical standards the Fed has much more room to move to alleviate market liquidity problems should the need arise, and we have no doubt that it will act if needed.

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


Want to know more about the repot market? John Mousseau discusses it in this interview: https://youtu.be/GwfwSziFKQA



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 – Did the Fed Just Waste 50 Basis Points?

On Tuesday morning, shortly after the market opened, the Fed did what other central banks concerned about the coronavirus didn’t do, and that was cut its policy rate. Not only did it cut the rate, it did so by 50 basis points, dropping its policy rate to the range of 1%–1.25%.

Market Commentary - Cumberland Advisors - Did the Fed Just Waste 50 Basis Points?

As the chart below of the Dow Jones Industrial Average shows, the market’s reaction was initially positive, but that optimism lasted only about an hour, as market participants began to digest what the rate cut might or might not accomplish. By about 11:30 AM, the market had dropped over 400 points and then continued to slide, closing about 800 points below the open.


Dow Jones Industrial Average

The Fed’s move was clearly intended as insurance designed to convince participants that the Fed will do what it takes to support the economy in the face of the coronavirus threat. As the day proceeded, however, the realization set in that rate cuts aren’t medicine when it comes to the threat of a pandemic. It can’t get consumers out of their homes to spend and it can’t fix supply chain bottlenecks.  Furthermore, financial conditions were extremely accommodative even before the rate cut.  Given the number of unknowns about the virus and the criticism of the government’s handling of the crisis so far, it was logical for market participants to ask, “Does the Fed know something they aren’t telling us?”  Were conditions so dire that they could not wait two weeks until the next FOMC meeting?

We don’t entirely know why the market responded the way that it did. Did algorithmic trading play a part in the sell-off, for example? We do know that investors shed equity holdings and bid up Treasury prices, with the 10-year Treasury closing below 1% for the first time ever.

The most likely explanation for the market’s behavior is that we are looking at a classic case of uncertainty.  No one knows how the virus will spread within the US or what the domestic and international economic consequences will be. It is arguable that the Fed may have exacerbated market concerns and thereby, contributing to that uncertainty by its actions, rather than providing comfort or the insurance that it sought to supply. There is no economic theory, as we have argued in previous commentaries, that tells us how monetary policy will work when we can’t reasonably estimate the probability of various economic outcomes, and this case is no exception. While we don’t know how the markets would have responded if the Fed had not acted, the Dow was clearly on a positive track. Interestingly, following Super Tuesday’s election results, market participants on Wednesday seem to have largely shrugged off the Tuesday market decline, adding over 1,170 by the end of the day.  The rally was apparently buoyed by the election results and the House’s passage of a bill authorizing $8.3 billion to combat that Coronavirus, with healthcare stocks leading the rally.  However, on Thursday, March 5 the index again slumped as focus again returned to the economic impact of the Coronavirus.  The bottom line is that it looks like the Fed simply wasted 50 basis points of ammunition when the alternative would have been to wait, as other central banks had decided to do.

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 Commentary – The Fed — What Next?

With the no-change decision by the FOMC, rendered as the impeachment finale was playing out, and with the next FOMC meeting about a month away, the most important upcoming event for the Fed is Chairman Powell’s semiannual testimony before Congress this week. The Board’s report is already out, and it provides a fairly clear indication of where policy is likely to be the next few meetings. See https://www.federalreserve.gov/monetarypolicy/2020-02-mpr-summary.htm.
Here is what is in the report and what we can glean from its contents.

The report is divided into several sections, beginning with a statement on “Longer-Run Goals and Monetary Policy Strategy,” which in broad terms reaffirms the FOMC’s goal of a symmetric inflation target and it argues is consistent with its statutory mandate to foster stable prices, moderate long-term interest rates, and maximum employment. The statement goes on to note that employment is largely determined by nonmonetary factors which vary over time, such that it is not appropriate to specify a fixed target. The goal statement concludes by stating that the Board seeks to minimize deviations of inflation from its target and in doing so that policy is consistent with and complementary to its other statutory objectives. However, when it is not, the Committee will pursue a balanced approach to its policy decisions.

With both this goals and strategy statement and the obligatory report summary out of the way, the report is divided into three main parts: a discussion of both domestic economic and financial developments and international issues relevant to policy, a discussion of current monetary policy, and an explanation of the Committee’s Summary of Economic Projections (SEPs). What follows is brief summary of some of the key points in each of these three sections, intended for those who have neither the time nor, perhaps, the inclination to read the report or watch the testimony.

The economic developments section notes that while the labor market continues to be strong and job creation remains solid, the pace is somewhat behind that of 2018. Nevertheless, the number of jobs created in 2019 was greater than the number of new entrants to the market. As a result, the unemployment rate moved down to 3.5%, and the participation rate for key ethnic cohorts increased. However, despite the solid job market, wage gains were at best moderate. The inflation story was short and sweet. Although the headline PCE (personal consumption expenditures) was close to the 2% target in 2018, 2019 saw the rate fall to 1.6% y/y by the end of the year. Economic growth in the first half of 2019 was a bit below that in the first half of 2018, but growth was seen as moderate in the second half of 2019. (However, the Q4 number has not yet been published.) Consumer spending was moderate, while business fixed investment declined, in part, no doubt, because of trade uncertainties. However, downside risks to growth were somewhat lower, as some of the uncertainties began to be resolved toward the end of the year. The new risk to growth going forward is seen as the still-unknown fallout from the coronavirus in China and elsewhere.  And this risk will clearly be raised during the testimony.

In financial markets, rates declined while equity prices surged due to the policy accommodation that the Board implemented in the latter half of the year. Spreads over Treasuries declined, and mortgage rates were low, while credit conditions remained accommodative. The financial system was characterized as being resilient compared to where it was prior to the financial crisis – leverage was low and household debt grew at a slower pace than in the past 10 years. In contrast, the corporate sector continued to leverage itself, and this was especially the case for the riskier firms. Thus, valuations became elevated in the second half of the year. Finally, on the international side, growth slowed in both developed and developing countries as a result of a decline in manufacturing, trade uncertainties, and political and social unrest in some countries. Central banks responded with more accommodation, which resulted in a slight upward movement in equity prices, a narrowing of sovereign risk spreads, and a decline in long-term interest rates. We note that the Board’s report came out before the most recent market reactions to the coronavirus outbreak and the epidemic’s emerging hit to global financial markets. This topic will likely get attention in the hearings.

The monetary policy section of the report is short. It simply notes that the FOMC lowered its target federal funds range by 75 basis points in a series of moves in three meetings beginning in July. Also, at its July meeting the Committee stopped the reduction in the size of its balance sheet, And in October the Fed supplied funds in response to what appeared to be a liquidity shortage and an increase in volatility in short-term markets, especially the repo market. This section ends with a discussion of three special topics: business cycles in manufacturing, the role and usefulness of monetary policy rules, and the review of the Committee’s policy framework with regard to the Fed Listens initiative.

The last section, on the Summary of Economic Projections, simply reproduces and summarizes the Committee’s economic projections, with an emphasis on the material compiled in conjunction with the December 2019 FOMC meeting. (New projections will be provided at the March 2020 meeting.) Near-term median expectations for GDP remained at 2.2% for 2019 and only slightly lower for 2020, at 2%; unemployment was expected to decline and remain in the 3.5–3.7% range through 2022; and inflation was expected to edge up to 1.9% in 2020 and hit 2% in 2022. These results were expected to materialize with an essentially unchanged federal funds rate target through 2020. With the majority of Committee members expecting only one rate hike in 2021, it appears this year may be an uneventful one as far as FOMC policy is concerned; and the best guess now is that policy is on hold unless and until some shock hits the economy or financial markets more broadly. Can this happen? Surely, and the report concludes with a discussion of the risks and uncertainties that accompany the SEP projections, but with the clear understanding that the FOMC will respond to events as they unfold.

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


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What to Expect When China’s Markets Reopen

Excerpt from…

Barron’s – What to Expect When China’s Markets Reopen

Jan. 31, 2020

Cumberland Advisors Robert "Bob" Eisenbeis Ph.D. In The NewsCumberland-Advisors-Robert "Bob" Eisenbeis Ph.D. In-The-News

Job Outlook Firms

Cumberland Advisors Market Commentary
by Cumberland Advisors
Jan. 28: Perhaps the most telling information about how strong the economy is concerns the job market. On almost any measure, the job market is strong. To be sure, the December CES [Current Employment Statistics] jobs number of 145,000 was off from the 256,000 for November, but the monthly numbers tend to be quite variable. At the same time, the unemployment rate is 3.5%, which is a 50-year low; and new unemployment claims have been declining, from 252,000 for the week of Dec. 7 to 211,000 for the week of Jan. 18. Finally, job openings as reported in the JOLTS [Job Openings and Labor Turnover Surveys] series have continued to decline and now are at 6.8 million, and this figure still exceeds the number of unemployed workers. In short, the job market is strong and shows little sign of wage pressure, which suggests that there is no evidence that the market is overheating or should be a cause for concern.

 

Read the full article at Barron’s (Paywall): https://www.barrons.com/articles/the-dow-is-down-198-points-because-the-jobs-number-was-a-bit-too-good-51581097020/

 


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.