Interesting economic times that hold a plethora of possibilities…

Interesting economic times that hold a plethora of possibilities…or how quickly does economic history repeat itself?
As we work our way through the struggle between highly leveraged monetary policy and uncontrolled fiscal policy, what shall the results (or lack thereof) of all of these initiatives (over the last several years) yield? Higher interest rates or lower interest rates? Improved economic growth or slower economic growth? Inflation or stagflation? Increasing levels of governmental intrusion or reduced levels of economic interference?
And as we experience ever increasing levels of leverage (national, state, local), the Fed taking on the role of sovereign asset ‘disintermediator’ on a global level, the continuing concentration of financial and economic power in fewer hands, commodity bubbling, and overall economic malaise what should we be doing?
Considering all of the unanswered questions about where we are headed economically community financial institutions are still foundational to their community’s economic well being. And in that light we must continue to focus on our strengths in helping to build stronger communities. Meeting credit and liquidity needs, helping our communities understand financial and economic risk (current and potential), being proactive instead of reactive, providing service levels that exceed customer expectations, dealing with the ever-present ‘tyranny of the urgent’ yet not forgetting about the ‘opportunities of the present’ with hope for the future. In spite of the hindrances and obstacles that have been placed before us let us take a fresh view of how we, as community financial institutions, can positively impact our communities in this time of economic uncertainty.
prb

In the News:
Bloomberg is running an article this morning saying that the Basel requirements for higher capital at SIFIs would give the largest banks a funding advantage because they would be seen as "too big to fail." This is an interesting take on the higher capital requirements that has some merit it would seem. If the regulators view the institutions as so critical that they need to retain more capital to ensure the safety of the financial system, does this also mean that governments would bail them out in the case of an emergency?
Nobel Economist Myron Scholes sounded a warning in the press that higher capital requirements may create more volatility in the financial system.
Separately, a Politico release quotes a senior Fed official as saying that "pushing capital requirements on banks could be very dangerous." According to the official, "The 1929 stock market crash is often regarded as the beginning of the Great Depression. In fact, the economy managed a weak recovery following the Crash, not unlike the one we`ve experienced since the financial crisis. But in September 1931, the [Fed] raised the discount rate sharply in an attempt to stem an outflow of gold reserves ... Within a year, the economy had relapsed dramatically, taking its deepest plunge between November 1932 and March 1933, ushering in the Great Depression and more than a decade of misery ... Capital requirements are an instrument of financial supervision, but also an instrument of monetary policy. Like the discount rate and reserve requirements, they determine the extent to which banks can lend and, therefore, the rate of growth in the money supply and the pace of economic activity. By insisting on higher and higher levels of required capital, regulators risk making precisely the same mistake as their predecessors at a very similar juncture in the current economic recovery -- with potentially disastrous consequences for the nation."
Craig Dismuke, The Market Today ONLINE, June 23, 2011

Bernanke Admits He’s Clueless On Economy’s Soft Patch

Interesting times from both a fiscal and as well as a monetary perspective...With Bernanke doing 'all' that he can do on the monetary front how will our fiscal policy 'monitors' deal with their end of our economic malaise? It all sounds so "Greek" to me!
It shall be very interesting to see what happens when the Fed begins to 'deleverage' their balance sheet and liquidates those 'bought assets' that 'saved' us from deflation.
prb

Bernanke Admits He’s Clueless On Economy’s Soft Patch

Jun. 22 2011 By AGUSTINO FONTEVECCHIA, FORBES

In his second post-FOMC press conference, Fed Chairman Ben Bernanke touched on every topic, admitting that the recovery was weaker than expected and that beyond temporary factors like supply chain disruptions in Japan and high energy prices, he was at a loss as to what was causing the soft patch. In a Q&A session with reporters, Bernanke said a disorderly default in Greece would have significant effects on the U.S. economy, while adding that Fed still had several tools at its disposal the to pump up the economy.

With markets at a crossroads, amid a cooling economic recovery and a dangerous Greek crisis threatening the euro and the global economy, reporters grilled Bernanke and asked many of the right questions.

Brutally honest, Bernanke admitted that he had no clue what was actually causing the current fragility in the U.S. economic recovery. While the FOMC statement assigned blame outside of the U.S., pointing at Japan along with rising food and oil prices, Bernanke was put on the spot by a reporter who noted the inconsistency behind that explanation and a lowering of long term forecasts. Bernanke took the hit, admitting only some of the factors were temporary and that he didn’t know exactly what was causing the slowdown, but that it would persist. “Growth,” said Bernanke, “will return into 2012.”

“Bernanke was just summing up what has happened in the markets, what has been priced in,” explained Nick Kalivas of MF Global. “But the Fed has taken extraordinary measures to support the economy, they have done what they can and monetary policy isn’t a solution for everything,” added Kalivas, pointing at problems with the fiscal situation and the debt ceiling debate.

The Fed chairman was explicit about the situation in Washington, directly slapping Republicans in the face saying “I don’t think sharp immediate cuts in the deficit would bring more jobs.” Having made clear before that Congress should raise the debt ceiling, Bernanke explained budgetary problems are very long run in nature.

Taking his time to address the situation in Europe, and the increased urgency of the crisis in Greece, Bernanke said U.S. bank exposure to Greek was minimal, and only indirect via positions in large, core-nation banks in Germany and France. Raising a red flag, the bearded academic said that money market mutual funds had substantial exposure to those same banks and could take a big hit if push comes to shove in Europe. “A disorderly Greek default would have significant effects on the U.S.” economy, he added.

Patting himself on the back, Bernanke once again defended his controversial programs of long-term asset purchases, dubbed QE1 and 2. “People don’t appreciate how pernicious deflation could be” for the economy, said the chairman, who then said QE2 saved the economy from deflation and was completely justified at the time. “[Back then] we were missing on both sides of our dual mandate, today we are much closer [to fulfilling it].”

Adding that they had made no decision on interest rates and further asset purchases at the moment, Bernanke listed cutting interest rates on excess reserves held at banks, giving guidance on balance sheet changes, as well as further asset purchases as “additional action we are prepared to take if the situation warrants it.”

Humbled by a question on his stark criticism of Japanese policymakers before the “lost decade,” Bernanke said he’s “a little more sympathetic to Central Bankers now than ten years ago.” Still, Bernanke avoided responding on whether the U.S. could be entering its own lost decade by highlighting the success of his QE policies in averting deflation. “A determined central bank can always do something about deflation.”

The second post-FOMC press conference saw sharper reporters asking the right questions, as opposed to their soft-ball pitching last time. Bernanke, as usual, avoided asking the uncomfortable questions and was even humble enough to admit he didn’t have all the answers. The question is, are we better off knowing Bernanke himself doesn’t know?

a confluence of events

As a confluence of events step onto the economic stage in the upcoming months they shall most surely provide us with very interesting fiscal theater. And as we anxiously watch these events unfold I am sure that we will be glued to our seats with anticipation as to how this melodrama will ultimately unfold.
Who wrote this script anyway?
1) The end of the Fed’s QE2 program
2) The US government’s debt ceiling reached
3) Double dip housing stress
4) Unemployment levels
5) The EU’s PIIGs leverage and growth dilemma
6) China’s inflation rate and slowing growth
7) Continuing strife and unsettledness in the middle east
prb

Some interesting economic data bits and pieces:

Leverage - The Fed’s Flow of Funds report found the deleveraging process to be continuing as the debt outstanding in US credit market declined to a three-year low of 336% of GDP. While that is down almost 10% (from 363% of GDP) at its peak in early 2009, it remains well above longer-term levels and there is room for the deleveraging trend to continue.

Federal Budget Deficits Are Structural, and Unsustainable - According to the baseline alternative scenario modeled by the bipartisan Congressional Budget Office (the alternative scenario that current policies continue into the future), federal spending on entitlement programs and debt service, alone, will exceed federal revenues in 14 years. Something must change. Either tax collections will have to in-crease or federal spending will have to be cut. Either way, this will drag on GDP for the foreseeable future. The worst-case scenario is more paralysis in Washington leading to a loss of confidence from global investors.

Market Reaction to Conclusion of QE2 Purchases Remains Uncertain -
While our analysis points to there being little market reaction to the end of QE2, this is still yet-to-be-seen. There is certainly the risk that the lack of buying from the Fed will result in higher yields. However, it looks more likely that the bid from other buyers will remain strong and yields will continue to respond to growth expectations, inflation expectations, and the global flight-to-quality. Our expectations are that yields are al-ready reflecting market sentiment and anything more than a 50 bps increase would be a surprise. There are plenty of analysts arguing that rates remaining flat is the strongest likelihood.
(Source: Weekly Outlook)

The Fed Is the Biggest Holder of US Debt

A fascinating set of circumstances has been created with the Fed’s ballooning of their balance sheet. With the end of QE2 in sight and, if we believe what we hear, the ‘non-probability’ of QE3 materializing, I believe that we shall experience some very interesting times ahead. With our country’s debt level, governmental spending habits, growing level of unfunded liabilities and our apparent proclivity to ignore peril until it is upon us, one could not ask for much better drama – the ultimate question being; how will the final act of this traveling show be resolved and how will that effect our country! Also, what will history have to say about our ‘unique’ times?
prb

June 9, 2011

The Fed Is the Biggest Holder of US Debt

This isn’t new news, but today’s flow of funds report has one nugget that is getting some attention today, so we might as well offer this reminder: The Fed is the world’s biggest holder of US debt.
UniCredit economist Harm Bandholz put together this chart that puts it in perspective.
China is not surprisingly the second-biggest holder of debt. In one hopeful sign, U.S. households are the third-biggest holders. This group includes hedge funds, so we’re not exactly talking the US version of Mrs. Watanabe here.
But you could argue that hedge funds represent wealthy households. And you could more easily argue that US households still hold fewer Treasurys than they did in the past. The hope is that their appetite for Treasurys picks up as they age, helping to make up for some of the demand that will inevitably fade from China and Japan in the years to come.

http://blogs.wsj.com/marketbeat/2011/06/09/the-fed-is-the-biggest-holder-of-us-debt/

Pushing the string

It appears that the yield curve will continue to remain in its current familiar surroundings, notwithstanding a ‘surprise occurrence’ in the financial markets of the world. It would appear that there is not much ‘good news’ around to change the status of ultra low yields on the short end of the curve. One of the key questions moving forward will be – who will buy our debt? With China continuing to ‘unload’, especially in the short end, who will step forward (other than the Fed)? Another interesting item to ponder at this time is: what does an interest rate stress test on the Fed’s currently ballooned balance sheet look like!
prb

Friday's weak jobs report will likely lead to the Fed maintaining the current target for the funds rate through this year and into early 2012. While most market participants had expected Fed policy to remain on hold through this year, the report showing anemic job growth led to those that had been holding out for an increase to start to throw in the towel.
According to the Fed Funds futures market, the probability of a hike in the funds rate to 0.50% by the end of this year has declined from 14.2% one-month ago to 11.4% now. Similarly, Eurodollar futures are projecting 3-month LIBOR to remain exceptionally low through mid-2012. The implied rate for 3-month LIBOR to March 2012 is 0.47% and through June 2012 is 0.61%.

(Stone & Youngberg Portfolio Strategy Group – June 6, 2011)