Category: Market Action

Jobs, jobs, jobs (US Version)!

The economy in March continued its descent from dizzying heights, with employment growing at a healthy rate but one that nonetheless signifies employers are pulling back as steadily rising interest rates take their toll.

Employers added 236,000 jobs last month, the Labor Department reported on Friday, while the unemployment rate decreased to 3.5 percent, from 3.6 percent in February.

The range of industries beginning to fade has widened, as warehousing, retail, manufacturing, construction and financial activities — those more sensitive to borrowing costs — either lost jobs or stayed flat over the month.
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• Year-over-year growth in average hourly earnings slowed slightly in March, to 4.2 percent, a sign the Federal Reserve has been looking for as it seeks to quell inflation. The report reflected a labor market that is gently decelerating, a sign of the kind of soft economic landing that the Fed has been shooting for.
• The U.S. labor force added nearly half a million workers in March and the share of Americans considered in their prime working age rose to 80.7 percent, the highest rate since 2001. So much for “nobody wants to work anymore.”
• The report delivered welcome news for President Biden, who has said that the job market needed to cool to tame high inflation. But analysts warn that the outbreak of banking sector turmoil means that the coming months could bring a more rapid deceleration in hiring.
• Bond yields jumped in response to the fresh data, as investors added to bets that interest rates would rise. Stock markets were closed on Friday for the Easter holiday but the bond market opened for a shortened session, during which yields continued to record unusually big swings.

So this year’s tussle is between the economists and the players! Who will win?

The Bank of Canada will keep its key interest rate steady at 4.50 per cent through 2023, according to most economists polled by Reuters, with an even smaller minority now expecting an interest-rate cut by year-end than a poll taken a month ago.

Markets still expect more than 50 basis points of cuts, pricing fuelled by fears last month over stresses in the U.S. and European banking sector, despite Canada’s economy and labour market performing better than expected.
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In March, the BoC was the first major central bank to stop its aggressive hiking cycle and is on what it calls a conditional pause. So all 33 economists polled March 31-April 6 said it will hold its overnight rate at 4.50 per cent on April 12.

A majority of forecasters, 23 of 31, said the rate would remain unchanged for the rest of 2023. Only seven expected at least one 25-basis-point rate cut by end-year, down from 13 in a survey taken about a month ago.

The IMF has released its Global Financial Stability Report which includes a chapter on Geopolitics and Financial Fragmentation: Implications for Macro-Financial Stability:

Rising geopolitical tensions among major economies have intensified concerns about global economic and financial fragmentation, which could have potentially important implications for global financial stability. Fragmentation induced by geopolitical tensions could affect the cross-border allocation of capital, international payment systems, and asset prices. This could pose macro-financial stability risks by increasing banks’ funding costs, reducing their profitability, and lowering the provision of credit to the private sector. Greater financial fragmentation could also exacerbate capital flow and macro-financial volatility by limiting international risk diversification. Policymakers need to be aware of potential financial stability risks associated with a rise in geopolitical tensions and assess and quantify geopolitical shock transmission to financial institutions. Financial institutions may need to hold adequate capital and liquidity buffers against rising geopolitical risks. The global financial safety net also needs to be buttressed through adequate levels of international reserves held by countries, central bank liquidity swap arrangements, and precautionary credit lines from international financial institutions.

One grudge the private-school boys at the major dealers have against market-making hedge funds is that they pull their capital out of the market when things get hairy. So, it turns out, do private mortgage lenders:

Private mortgage lenders are refusing to renew loans to their existing borrowers, leaving indebted homeowners without a source of funding.

Canadian Mortgages Inc., CMLS Financial, New Haven Mortgage Corp. and individual private lenders are some of those who have turned down requests to renew some of their borrowers’ loans after home prices tanked over this past year.

This is taking place in areas where home prices have dropped significantly. That includes Owen Sound, Bowmanville, Orillia, Timmins, Hamilton and Brampton in Ontario and Prince Rupert in British Columbia.

Private lenders are nervous they won’t be able to recoup their capital if borrowers are unable to make their monthly payments. Private lending is typically determined using a metric called the loan-to-value (LTV) ratio, which measures how much the homeowner owes relative to the appraised value of the property.
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Currently, many private lenders are only willing to lend up to 75 per cent of the property’s value – also known as an LTV ratio of 75 per cent. When home prices were soaring in 2021, private lenders were willing to offer loans with an LTV ratio of 90 per cent.

Now that home prices have dropped, that has increased the risk to the lender and they are no longer willing to renew loans. When borrowers try to renew their mortgage, the lender is either refusing to renew their loan or telling borrowers that their properties need to be reappraised. And when the property is reappraised, it has a much lower value.

The New York Fed has released its Survey of Consumer Expectations:

Inflation

• Median inflation expectations increased by 0.5 percentage point at the one-year-ahead horizon to 4.7%, marking the first increase in the series since October 2022. Median inflation expectations increased by 0.1 percentage point at the three-year-ahead horizon to 2.8%, but decreased by 0.1 percentage point at the five-year-ahead horizon to 2.5%. The survey’s measure of disagreement across respondents (the difference between the 75th and 25th percentile of inflation expectations) increased at all three horizons.
• Median inflation uncertainty—or the uncertainty expressed regarding future inflation outcomes—increased at the one-year-ahead horizon, decreased at the three-year-ahead horizon, and remained unchanged at the five-year-ahead horizon.
• Median home price growth expectations increased by 0.4 percentage point to 1.8% in March, remaining far below the 12-month trailing average of 3.0% as well as their pre-pandemic levels. The increase was most pronounced among respondents with no more than a high school education and for those who live in the Midwest Census region.
• Median year-ahead expected price changes declined by 0.1 percentage point for gas (to 4.6%), 1.4 percentage point for food (to 5.9%), 0.1 percentage point for the cost of medical care (to 9.3%), and 0.2 percentage point for the cost of rent (to 9.2%). Median year-ahead expected cost of college education increased by 0.8 percentage point (to 8.9%). All commodity price expectations remain well above their pre-pandemic (March 2020) levels.

Labor Market

• Median one-year-ahead expected earnings growth remained unchanged at 3.0% in March. The series has been moving between a narrow range of 2.8% to 3.0% since September 2021; March marked the fourth consecutive month it remained at 3.0%.
• Mean unemployment expectations—or the mean probability that the U.S. unemployment rate will be higher one year from now—increased by 1.3 percentage point to 40.7%. The increase was more pronounced for respondents with at least some college education, those between the ages of 40 and 60, and those with annual household incomes between $50k and $100k.
• The mean perceived probability of losing one’s job in the next 12 months decreased by 0.4 percentage point to 11.4%. The mean probability of leaving one’s job voluntarily in the next 12 months also declined by 1.5 percentage point to 19.3%.
• The mean perceived probability of finding a job (if one’s current job was lost) declined by 0.3 percentage point to 57.6% in March. The series has been moving between a narrow range of 57.2% to 58.2% since August 2022.

Something peculiar is happening at Emerge Canada Inc.:

Regulators have slapped the entire family of exchange-traded funds from Emerge Canada Inc. with a trading halt because the company has failed to find an auditor to review its financial statements.

Toronto-based Emerge revealed in mid-December that, nearly six weeks earlier, BDO Canada LLP had resigned as the auditors of the Emerge Funds. At the time, Emerge said it was “working expeditiously to appoint a successor auditor.”

Monday, Emerge acknowledged it has yet to find a new auditor. Lacking one, it failed to file audited annual financial statements for its funds by a March 31 deadline. As a result, the Ontario Securities Commission issued a cease-trade order on Thursday for all the Emerge funds.
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In its December 14 filing, Emerge said BDO “resigned, on its own initiative” on Nov. 3. Emerge said BDO Canada LLP had no reservations in its reports for the Emerge Funds for the two most recently completed financial years, which were 2020 and 2021. Also, there no were no “reportable events,” which are types of disagreements with auditors or other accounting issues that are defined in securities law.

The next day, in a filing to all provincial securities regulators, BDO said “We agree with the statements made in the Change of Auditor Notice pertaining to our firm.”

And we should all Raise a glass to Bing Newcomb:

Mr. Newcomb, who co-founded the company E*Trade and wrote the computer code that made it work, died on Jan. 29 at his home in Palo Alto, Calif. He was 79.
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In 1980, Mr. Newcomb and William A. Porter were introduced by a mutual friend at a Halloween party in Palo Alto. Mr. Porter, a onetime cowboy turned electronics whiz, had just purchased an Apple II personal computer, the company’s first model aimed at consumers. How, he wondered, could he and other individuals use the new technology to buy and sell stocks from home?

Mr. Newcomb, who had been working as a freelance computer programmer, hiring himself out to banks and other businesses that needed a guide to emerging digital technologies, provided the answers.

In 1982, with $15,000 in capital, the partners started TradePlus, one of the first electronic trading platforms. Its first trade was made on July 11, 1983, by a Michigan dentist.
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By 1994, revenues had risen geometrically, from $850,000 only two years earlier to nearly $11 million. A business journal proclaimed the firm to be the fastest-growing private company in Silicon Valley. It went public as the E*Trade Group in 1996.

Mr. Newcomb, who had been the company’s chief system architect and vice president for research and development, retired with 2.4 million shares of the company in 1997, when the price per share was about $23.

Jobs, jobs, jobs!

The Canadian economy added more jobs than expected in March and the unemployment rate remained near a record low for a fourth straight month, data on Thursday showed, a sign of economic resilience ahead of a central bank policy meeting next week.

The economy gained a net 34,700 jobs, almost entirely in the private sector, and the unemployment rate held steady at 5.0 per cent, Statistics Canada reported.
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Thursday’s jobs figures as well as robust GDP data released last week are likely to complicate the central bank’s plans to avoid further rate moves. The average hourly wage for permanent employees rose 5.2 per cent in March on a year-over-year basis, down from 5.4 per cent in February.

The bank’s next rate decision is due on Wednesday.
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The employment gains last month were driven by the services sector, which added a net 75,500 jobs, mostly in transportation and warehousing as well as support services. Those additions more than offset the decline of 40,900 jobs in the goods sector, which was dragged down by job losses in construction as well as natural resources.

The New York Fed has updated the Global Supply Chain Pressure Index:

• Global supply chain pressures decreased again in March, falling from .28 to 1.06 standard deviations below the index’s historical average.
• There were significant downward contributions by many of the factors, with the largest negative contributions from European Area delivery times, European Area backlogs, and Taiwanese purchases.
• The GSCPI’s recent movements suggest that global supply chain conditions have largely normalized after experiencing temporary setbacks around the turn of the year.

BIS has released a working paper titled Big techs and the credit channel of monetary policy:

Focus
Big techs are lending to small and medium-sized enterprises and vendors on their e-commerce platforms, thus encroaching on financial markets. These changes in financial intermediation could affect monetary policy transmission in at least two ways. First, the business model of big techs depends on using vast amounts of data instead of collateral to solve agency problems between borrowers and lenders. By using machine learning and big data to generate credit scores, big techs can assess a company’s creditworthiness more accurately than traditional credit bureau ratings can. As a result, this may decrease the relevance of the “collateral channel” and, simultaneously, increase the responsiveness of credit to changes in firms’ business conditions. Second, the threat of reputational damage, or of being excluded from the e-commerce platform, serves as an extra-legal but highly effective means of contract enforcement for big tech firms.

Contribution
We view big tech credit through the lens of a model where big techs facilitate matching on the e-commerce platform and extend loans. While bank credit is backed by collateral, big techs reinforce credit repayment by threatening to exclude borrowers from the platform. The most significant difference between big tech credit and bank credit lies in the borrowers’ cost of default. If a firm defaults on bank credit, it loses its collateral, usually real estate. In contrast, if a company defaults on big tech credit, it loses access to the e-commerce platform, thereby jeopardising future profits.

Findings
We find that, first, an improvement in big techs’ matching efficiency on the e-commerce platform raises the value for firms of trading on the platform and accessing big tech credit. Higher future profits ease financing constraints and increase firms’ production, driving aggregate output closer to the efficient level. Second, the response of credit and output to a monetary policy shock depends on how sensitive the firms’ opportunity cost of default on big tech credit (ie the stream of future profits from operating on the big tech platform) is compared with the cost of defaulting on bank credit (ie the value of physical collateral). In our baseline calibration, the introduction of big tech credit mitigates the initial responses of aggregate credit and output to a monetary shock. However, it increases the persistence of the effect of monetary policy on the macroeconomy. Third, big techs’ macroeconomic efficiency gains are limited by the distortionary nature of the fees collected from their users.

Abstract
We document some stylized facts on big tech credit and rationalize them through the lens of a model where big techs facilitate matching on the e-commerce platform and extend loans. The big tech reinforces credit repayment with the threat of exclusion from the platform, while bank credit is secured against collateral. Our model suggests that: (i) a rise in big techs’ matching efficiency increases the value for firms of trading on the platform and the availability of big tech credit; (ii) big tech credit mitigates the initial response of output to a monetary shock, while increasing its persistence; (iii) the efficiency gains generated by big techs are limited by the distortionary fees collected from users.
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Our paper aims to shed some light on the effects of big techs’ entry into finance on the macroeconomy and on monetary policy transmission. We develop a model that can replicate two key empirical facts about big techs. First, using macro data for China and the US, and extending previous evidence based on Chinese micro data, we show that big tech credit does not react to changes in asset prices and local economic conditions, unlike bank credit. Second, we use local projections to shed light on the importance of the physical collateral channel relative to the network collateral channel for the transmission of monetary policy. Key drivers of the strength of these channels is the sensitivity of commercial property prices and e-commerce sales to monetary policy. We show that commercial property prices respond more strongly than e-commerce sales to a monetary policy shock, although less persistently.
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The crucial difference between big tech credit and bank credit relates to borrowers’ opportunity cost of default. Firms that default on bank credit lose their collateral (real estate). In contrast, those that default on big tech credit lose access to big techs’ e-commerce platform, and hence their future profits. An incentive compatible contract thus limits the total amount of credit to the sum of physical and network collateral. Nominal wages are sticky, and monetary policy affects the real economy. When search frictions in the goods markets and credit frictions in the financial markets are set to zero, the model collapses to the basic New Keynesian model with sticky wages.3

We obtain three sets of results. First, an expansion in big techs, as captured by an increase in matching efficiency on the commerce platform, raises the value for firms of trading in the platform and the availability of big tech credit. This in turn relaxes financing constraints and increases firms’ production, driving aggregate output closer to the efficient level. Second, the reaction of credit and output to a monetary policy shock crucially depends on the sensitivity of firms’ opportunity cost of default on big tech credit (the stream of future profits from operating on the big tech platform) compared to that of defaulting on bank credit (the value of physical collateral). In our baseline calibration, the introduction of big tech credit mitigates the initial responses of aggregate credit and output to a monetary shock, but increases the persistence of the effect of monetary policy on the macroeconomy. Third, big techs’ macroeconomic efficiency gains are limited by the distortionary nature of the fees collected from their users.

AIMCo beat its benchmarks:

Alberta Investment Management Corp. reported a 3.4-per-cent loss last year as falling values for publicly traded stocks and bonds outweighed strong returns from investments in infrastructure and renewable resources.
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AIMCo’s 2022 returns were still 1.8-per-cent higher than its internal benchmark in spite of the loss, demonstrating how difficult it was to be an investor last year as high inflation and rapid interest-rate increases shook global markets. Like many of its peers, AIMCo suffered from a rare simultaneous dive in public equities and fixed income markets, which make up a large share of the plan’s assets.

Aimia is facing a shareholder revolt:

Mithaq Capital SPC, a family office based in Saudi Arabia that owns nearly 20 per cent of Toronto-based Aimia, announced plans Thursday to vote against the re-election of the company’s entire board of directors.
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In a statement, Mithaq said it has lost confidence in the board and the management team, and that “it would be in the best interests of Aimia to reconstitute the board.”

The reasons underlying Mithaq’s opposition “include concerns previously raised with Aimia regarding capital allocation decisions relating to acquisitions,” the statement said.

Mithaq is not planning to nominate any replacement candidates and declined to comment further on what exactly motivated it, though Aimia has recently made its two largest acquisitions since pivoting away from loyalty programs.

In January, Aimia bought Tufropes Pvt. Ltd. for $253-million. India-based Tufropes makes synthetic fibre ropes and netting for the aquaculture and maritime industries. Then last month, the company paid $332-million for Italian chemical company Giovanni Bozzetto SpA.
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Mithaq has amassed a significant portion of its stake in Aimia very recently. While the family office holds 19.9 per cent of Aimia’s outstanding common shares, that figure was only 12.6 per cent as of Feb 1.

Over the course of its transformation, Aimia’s work force has shrunk dramatically to about 20 people as of late 2020 from roughly 450. In its most recent quarter, Aimia reported a net loss of $23.3-million, which was roughly 60-per-cent wider than the $14.6-million loss the company reported during the same period a year earlier.

… and the company is fighting back:

Hours later, the company fired back, alleging what Mithaq really wanted was for Aimia to support its own investments.

“Many of the investments [Mithaq] recommended would have resulted in substantial losses to Aimia (including one target that subsequently filed for bankruptcy),” the company said in a statement released early Thursday afternoon.

Aimia also said Mithaq had “previously lobbied the company to invest in public securities, including some in which they hold an interest.” An unnamed former insider of an Amia affiliate – who the company claimed was recently terminated for allegedly misusing confidential information – lobbied alongside Mithaq for those investments, the statement said.

TXPR closed at 542.00, down 0.72% on the day. Volume today was 1.19-million, slightly above the median of the past 21 trading days.

CPD closed at 10.82, down 0.28% on the day. Volume was 54,850, below the median of the past 21 trading days.

ZPR closed at 8.88, down 0.45% on the day. Volume was 92,420, third-lowest of the past 21 trading days.

Five-year Canada yields down slightly to 2.90% today.

The Globe claims this is all due to recession fears:

The TSX, S&P 500 and the Nasdaq ended lower on Wednesday after a growing wave of weak economic data deepened worries that the Federal Reserve’s rapid interest rate hikes might tip the U.S. economy into a recession.
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Driving the recession fears, the ADP National Employment report showed U.S. private employers hired far fewer workers than expected in March. That followed Tuesday’s weak job openings data.

As well, the Institute for Supply Management’s survey showed the services sector slowed more than expected last month on cooling demand, while a measure of prices paid by services businesses fell to a near three-year low.

Earlier this week data showed falling factory orders and soft manufacturing activity.
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Reflecting worries about the economy and recent turmoil in the banking sector, interest rate futures imply 61% odds that the Fed will cut interest rates from current levels by the end of its July meeting, according to CME Group’s Fedwatch tool.

Money markets are currently pricing in only a 16% chance the Bank of Canada will cut interest rates at its April 12 meeting, but they are fully pricing in at least a quarter-point cut by September, according to Refinitiv Eikon data late Wednesday.

Gabriel Makhlouf, Governor of the Central Bank of Ireland and Member of the Governing Council of the European Central Bank, gave a speech titled Staying the course: monetary policy to avoid persistentinflation:

To achieve this, the Governing Council decided last month to increase the three key ECB interest rates by 50 basis points. The interest rate applied to our Deposit Facility is now at 3 per cent, up from minus 0.5 per cent last July. This represents a significant tightening of the monetary policy stance, commensurate with the challenges to price stability we have been facing.

The scale and pace of interest rate increases – up 3.5 percentage points in just nine months – is unprecedented. For comparison, previous rate hiking cycles in the euro area in 1999-2000 and 2005-07 saw rates rise by 2.25 and 2 percentage points over a 13 and 21 month period, respectively.
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The euro area economy slowed in the fourth quarter of 2022, with economic growth stagnant in the face of falling private domestic demand. High inflation, prevailing uncertainties and tighter financing conditions dented private consumption and investment, which fell by 0.9 per cent and 3.6 per cent respectively. However, the ECB staff March macroeconomic projections envisage a recovery in the next few quarters as supply conditions improve further, confidence recovers, and firms work off large order backlogs. Rising nominal wages and falling energy prices will partly offset the loss of purchasing power that many households are experiencing as a result of high inflation. This, in turn, will support consumer spending.

Looking ahead, with record low unemployment expected to hold steady at 6.7 per cent, the ECB staff’s current projections embed a significant degree of real wage catch-up, with wages returning to 2022 levels in real terms by end2025. Nominal wage growth projections of 5.0, 4.4 and 3.6 per cent in 2023, 2024 and 2025 are significantly above historic averages.

For wage developments, much will depend on ongoing levels of labour market tightness. While the number of job vacancies in the euro area have started to recede gradually since the turn of this year, the number of job openings relative to unemployed remains at a historic high. Meanwhile, despite the weaker PMI (Purchasing Managers’ Index) data we saw towards the end of 2022, employment expectations remained in significant positive territory (Chart 2, left panel). This suggests that some degree of labour hoarding is taking place, likely reflecting firms’ expectations of a transitory weakness in demand, as well as their ability to absorb higher costs through increased mark-ups (a point I will return to).
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There is potential for profit margins to absorb some of this near-term higher wage growth. As Chart 3 shows, labour costs have not risen by anything close to the same extent as profits in most sectors. For some sectors, the gap between growth in unit profits and unit labour costs during 2022 is very large, for example in agriculture, manufacturing and contact intensive services.
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While price and wage-setting will contain a backward-looking element, especially after a supply-driven surge in inflation, it is important that the forward-looking component remains close to our inflation target in order to avoid an entrenchment of higher inflation in expectations amongst the public. So far, there has been no indication that expectations have become de-anchored from our inflation target. This is true for both survey and market-based measures of longer-term inflation expectations.

Huw Pill, Chief Economist and Executive Director for Monetary Analysis of the Bank of England, gave a speech titled Inflation persistence and monetary policy:

In this speech Huw Pill discusses the outlook for the economy, including how lower energy prices might push down on inflation in the short term, but could also boost demand and therefore impact inflation in the medium term. He stresses that the MPC must continue to monitor how these external shocks to inflation might become embedded in the economy, and therefore risk persistently high domestically driven inflation. He goes into detail about the Monetary Policy Committee’s role in controlling inflation, and the potential impact of its recent significant increases to interest rates. He outlines how the Monetary Policy Committee carefully assesses the impact of interest rate rises that have yet to feed through, with the need to address current inflationary pressures.
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Let me start with some stark and uncomfortable facts. Annual UK CPI inflation was 10.4% in February. That is unacceptably high. The Bank of England’s Monetary Policy Committee (MPC) is committed to returning inflation to its 2% target on a sustainable basis.
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The MPC has tightened monetary policy over the past eighteen months to achieve the 2% inflation target. Bank Rate has been increased from its effective lower bound of 0.1% to today’s level of 4.25%. Quantitative easing (QE) has been halted and replaced with a programme of quantitative tightening (QT), involving the sale of gilts and corporate bonds held as a result of the Bank’s earlier asset purchase schemes.[1] And the MPC’s communication about the outlook for monetary policy has shifted significantly.
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For data series that exhibit ‘mean reversion’ – in other words series that return to some average level after being shocked away from it – persistence is typically understood in terms of how long it takes to get back to that average level.[7]

Given the MPC’s mandate, CPI inflation will revert to 2% over time. But it is taking longer to return to target than was originally expected, and longer than is desirable. From a policy perspective, we want to understand why this persistence in inflation has emerged. In thinking about that, it is helpful to distinguish between different sources of persistence.[8]

One reason for inflation to have risen above target is that there have been a series of inflationary shocks to the economy, each of which was transitory in itself but – by dint of coming one after the other and operating in the same direction – led to greater persistence in headline inflation overall.

I label this a form of extrinsic inflation persistence.

Such an account resonates with the way the MPC has described the inflation process over the past couple of years.[9] Inflation first rose on account of bottlenecks in international goods markets that emerged from the interaction of disruption to global supply chains and changes in the pattern of consumer demand, both stemming from the lockdowns triggered by the onset of the Covid pandemic. Then, just as these bottlenecks were easing as the pandemic receded, UK energy prices rose dramatically following the Russian invasion of Ukraine and the resulting dramatic increase in wholesale European natural gas prices. And now, just as those wholesale gas prices have fallen substantially in recent months, we are seeing another inflationary impulse coming from rises in food prices driven, at least in part, by unexpectedly weak crop yields in southern Europe and north Africa.[10]

Understood in this way, the persistence of UK inflation is largely a manifestation of ‘bad luck’ – a ‘series of unfortunate events’. It reflects a sequence of fundamentally transitory shocks – each of which monetary policy can do little about, for reasons I have already explained – that have cumulated through time into a more long-lasting elevation of headline inflation.

There is much truth in that narrative. But we have to guard against complacency in interpreting recent inflation developments in this way. I recognise that this is potentially both a self-serving and an incomplete view of recent inflation developments in the UK.

For one thing, we need to assess whether the surprises we have been confronted with over recent years could have been anticipated by better analysis and research: for example, could we have forecast the vulnerabilities in global supply chains once the pandemic had struck? Or could we have foreseen the dynamics in food prices given agricultural
ommodity prices? These challenges deserve further research – although it is naïve to believe that there are easy solutions to such formidable analytical problems.

And – in particular, from today’s perspective – we should recognise that persistent deviations of inflation from target, even if stemming from what are fundamentally a series of transitory inflation shocks, might prompt changes in behaviour that generate more long lasting inflationary dynamics.

For example, we might see a shift in long-term inflation expectations or the emergence of ‘second round effects’ in price setting behaviour that threaten to create momentum in inflation even after the original impulse has receded.[11]

This naturally leads to what I label intrinsic persistence in headline inflation. Rather than being driven by a series of external shocks, greater intrinsic inflation persistence emerges when the economy’s response to the same fundamental inflationary shock changes in a way that implies headline inflation takes longer to return to target.
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Of course, the evolution of inflation persistence against the background of the terms of trade
shock stemming from Russia’s invasion of Ukraine is only one of many challenges facing monetary policy makers at present. It needs to be seen in the context of other economic disturbances, not least the recent turmoil in the financial sector. We have been told by our colleagues in the Financial Policy Committee that the UK financial system remains robust and resilient. Nonetheless, those of us on the MPC need to remain vigilant to signs of tightening financial conditions and be prepared to respond to the macro implications of any dislocation to credit markets to the extent that they influence the outlook for inflation.

And Rogers got downgraded two notches:

DBRS Limited (DBRS Morningstar) resolved the Under Review with Negative Implications status of Rogers Communications Inc.’s (Rogers or the Company) by downgrading the Issuer Rating and Senior Unsecured Notes rating to BBB (low) from BBB (high). All trends are Stable. The resolution of the Under Review status reflects the completion of the $26 billion acquisition of Shaw Communications Inc. (the Shaw transaction) concurrently with the divestiture of Shaw’s Freedom Mobile to Videotron Ltd. (the Freedom transaction), a wholly owned subsidiary of Quebecor Media Inc. (not rated by DBRS Morningstar). The rating downgrades reflect the increase in gross leverage required to finance the Shaw transaction and anticipated challenges related to network, cultural, and operations integration amid an intensely competitive landscape, while acknowledging the long-term competitive benefits for Rogers as it enhances its national footprint and competitive positioning, particularly in Western Canada. The Stable trends reflect DBRS Morningstar’s expectation of a multiyear deleveraging path toward the Company’s long-term leverage target, as earnings are expected to benefit from a strong market position of the combined entity.

PerpetualDiscounts now yield 6.22%, equivalent to 8.09% interest at the standard equivalency factor of 1.3x. Long corporates yielded 5.06% on 2023-3-31 and since then the closing price has changed from 15.14 to 15.19, an increase of 33bp in price, with a Duration of 12.36 (BMO doesn’t specify whether this is Macaulay or Modified Duration; I will assume Modified) which implies a decrease in yield of about 3bp since 3/31 to 5.03%, so the pre-tax interest-equivalent spread (in this context, the “Seniority Spread”) has remained constant at about 305bp since reported March 29.

BIS has released a paper by Claudio Borio, Marco Jacopo Lombardi, James Yetman and Egon Zakrajšek titled The two-regime view of inflation:

Focus

The global surge of inflation that started in 2021 took most observers by surprise. While unforeseen shocks played a key role, the surprise also highlighted limitations of the analytical frameworks typically used to understand and forecast inflation.

Contribution

This study provides a new view of the inflation process. It characterises the process as two regimes – a low- and a high-inflation regime – with self-reinforcing transitions from the low- to the high-inflation one. The value added of this view is to highlight those elements that standard models downplay and to draw new implications for monetary policy.

Findings

First, inflation tends to be self-stabilising in a low-inflation regime but loses that property as it shifts to the high-inflation one. This reflects systematic differences in the co-movement of individual prices and in the behaviour of wage and price setters that determines them. As inflation increases above very low levels, it becomes a more focal point for workers and firms. This increases the likelihood of wage-price spirals.

Second, monetary policy has a smaller impact on inflation in a low-inflation regime, where individual price changes co-move little. It also operates through a quite narrow set of sectoral prices, typically in the services sectors that are more sensitive to economic activity.

As a result, when inflation has settled at a low level, monetary policy can afford to accept moderate, even if persistent, deviations from narrowly defined inflation targets. But it has to respond in a timely and forceful way when transitions to a high-inflation regime threaten.

Abstract

This study provides a view of the inflation process that is complementary to the one captured in standard models, such as those based on the Phillips curve. It characterises the process as two regimes – a low- and a high-inflation regime – with self-reinforcing transitions from the low- to the high-inflation one. The study documents the stylised facts describing the two regimes and the transitions between them based on disaggregated price dynamics and the joint behaviour of wages and prices. Two implications for monetary policy stand out. First, the desirability of conducting monetary policy in a flexible manner in a low-inflation regime, tolerating moderate, even if persistent, deviations from narrowly defined targets. Second, the importance of being pre-emptive when the risk of a transition to the high-inflation regime increases, even though assessing this transition in real time remains challenging.

BIS has also released a Committee on the Global Financial System paper from a Working Group co-chaired by Margarita Delgado (Banco de España) and Toni Gravelle (Bank of Canada) titled Central bank asset purchases in response to the Covid-19 crisis:

Large-scale asset purchases by central banks in response to the Covid-19 pandemic were broadly successful in addressing disruptions in monetary policy transmission and providing additional stimulus. In this report, the CGFS examines the experience of central banks in many small open and emerging market economies that conducted asset purchases for the first time during the Covid-19 crisis as well as in large advanced economies that expanded or reintroduced purchases.

The impact of asset purchases and relative importance of various transmission channels differed across time and economies. The liquidity channel, whereby purchases improved financial market liquidity, was particularly important during the early weeks of the Covid-19 crisis, when markets were stressed.

The signalling channel, whereby purchases foreshadowed the future stance of monetary policy, was less important than the portfolio rebalancing channel, through which purchases altered the duration and credit risk in private investors’ portfolios. The signalling channel contributed more to the easing of financial conditions in countries where policy rates were near the effective lower bound.

In many countries a strong economic rebound and surge in inflation prompted central banks to stop asset purchases within a year or two and to start raising policy rates. The report notes that the relatively short time span of the purchases thereby reduced the risk of unintended side effects.
…
As functioning in markets continued to rapidly deteriorate throughout March 2020, for the first time in its history, the BoC unveiled a wide range of large-scale AP programmes across various government and non-government securities markets. Each programme had its own size and scope in order to address dysfunction in a specific market. Similar to other programmes, the government bond purchase programme (GBPP) was introduced with a focus on addressing severe market dysfunctions, but it was the only asset purchase programme to subsequently shift its primary objectives. As market functioning in the government of Canada bond market returned closer to normal levels, the primary objective of the GBPP shifted from supporting market functioning to monetary policy objectives. Specifically, with the BoC’s policy rate at its effective lower bound, the GBPP became a tool for implementing quantitative easing with dual objectives of supporting the economy and achieving the inflation target.

The elevated uncertainty surrounding the impact of the pandemic on economic activity created an enormous demand for liquidity from practically all sectors of the economy that could not readily be accommodated by the financial system. As a result, there was a significant deterioration in market functioning across many markets and a relatively large and rapid rise in risk premia. The AP programmes were rolled out to first address this broad deterioration in market functioning. Reflecting the broad market dysfunction in fixed income markets that are critical to the Canadian financial system and economy, AP programmes spanned government (federal and provincial), mortgage and corporate fixed income markets. Each AP programme had its own individual size and scope of assets purchased. Programmes with multiple eligible issuers were set with outright issuer limits, a target relative to some measure (such as each province’s share of Canada’s GDP), or both. AP programmes in the credit markets specified a relatively high minimum credit rating for eligible assets.

By their end, the BoC’s APs totalled 23.6% of Canada’s 2019 nominal GDP (CAD 1.814 trillion). These purchase programmes were novel for the BoC and the largest in its history – a reflection of the unprecedented nature of the Covid pandemic and crisis. The largest share of purchases consisted of high quality public sector debt and the majority of assets purchased had a relatively short term to maturity. Government of Canada bonds purchased through the GBPP accounted for the largest share of purchased assets (Graph A2).
…
When sequencing the exit from quantitative easing, the BoC began to tighten only after net purchases were halted, and balance sheet reduction then took place. The pace of purchases gradually reduced during 2021 until October, when the BoC announced an end to quantitative easing and a move into the reinvestment phase. Well into the reinvestment phase, in March 2022 the BoC lifted its policy rate from the ELB. In April 2022, the BoC announced the beginning of quantitative tightening, whereby maturing government of Canada bonds on the BoC’s balance sheet would no longer be replaced.

The decision to conduct QT passively was influenced by the duration of purchased assets. In the case of Canada, the assets purchased by the BoC had a relatively short average term to maturity and thus the expected relatively fast material decline in asset holdings was not viewed as requiring additional outright sales to achieve the desired balance sheet decline. As information on the holdings of the BoC was publicly available, the passive approach taken towards QT benefited from a predictable transparent tightening for all market participants, limiting unnecessary volatility in markets and complementing increases in the policy interest rate – the primary monetary policy instrument.

The IMF has published a piece by Markus Brunnermeier titled Rethinking Monetary Policy in a Changing World:

Following a lengthy period of low interest rates and low inflation, the global economy is entering a phase characterized by high inflation and high levels of both public and private debt. Fifteen years ago, central banks saw an urgent need to incorporate financial stability and deflation concerns into their traditional modeling of the economy and developed unconventional tools to deal with both.

Although financial stability remains an important concern, there are important differences between the current environment and the one that followed the global financial crisis:

• Public debt is now high, so any interest rate increase to fend off inflation threats makes servicing the debt more expensive—with immediate and large adverse fiscal implications for the government. Since the beginning of the COVID-19 crisis in early 2020, it is also evident that fiscal policy can be a significant driver of inflation.
• Instead of deflationary pressures, most countries are experiencing excessive inflation. That means there is now a clear trade-off between a monetary policy that tries to reduce aggregate demand by raising interest rates and one that aims to ensure financial stability.
• The nature and frequency of shocks have changed. Historically shocks were mostly from increases or decreases in demand—with the prominent exception of the supply shocks during the so-called stagflation of the 1970s. Now there are many shocks: demand vs. supply, specific risks vs. systemic risks, transitory vs. permanent. It is difficult to identify the true nature of these shocks in time to respond. Central bankers need to be more humble.

Bond market volatility has some portfolios changing parameterizations (“Look, Mummy, I got a spreadsheet!”):

But the Treasury market volatility of March 2023 could have lasting consequences as investors may demand higher premiums across the bond yield curve and across the asset spectrum – preferring lighter positions than they would have otherwise.

Investors will now have to factor into their future models a past event that nobody predicted, even though the likelihood of it repeating is equally minimal.

Pim van Vliet, head of quantitative equities at Robeco, notes that investors with shorter-term horizons measured in days, weeks or months will almost certainly see an increase in their risk metrics, such as “Value-at-Risk”, or VaR.

VaR measures the potential maximum loss on a portfolio of investments over a given period of time, and is calculated using historical returns, current market conditions, and measures of past and expected volatility.
…
Using data going back to the mid-1980s, markets research and advisory firm Exante Data calculates that the two-year yield’s slide on March 13 was a 6.1 standard deviation move, and the one-week fall on March 15 was a 7.3 standard deviation move.

The statistical probability of a 6 standard deviation, or 6-sigma event, is around one in a billion, and the chance of a 7-sigma event occurring in any given day is 0.000000000129%.

This level of risk would barely be acceptable for investors trading a penny stock, crypto token, or distressed emerging market currency, never mind the asset widely considered to be one of the least volatile in the world.

Canadians expect higher than policy inflation:

Business sentiment in Canada continues to worsen with companies expecting sales growth to slow over the coming year and inflation to remain elevated until at least 2025, according to the Bank of Canada’s quarterly business survey.
…
The average respondent to the business survey expects inflation to be 3.9 per cent in two years’ time. That’s nearly twice the Bank of Canada’s 2-per-cent target.

Consumers, meanwhile, think that inflation will still be running at 4.27 per cent in two years. Most respondents blamed supply chain disruptions for high inflation, the Bank of Canada said, although many also pointed to high government spending.
…
“Firms indicated that it has become easier to find the workers they need. They attribute this to less competition for labour and an improved labour supply,” the Bank of Canada said, pointing to increased immigration.

“For the first time in several quarters, businesses no longer expect labour costs to put upward pressure on their output price growth,” the bank added.

Even with less competition for workers, businesses still expect to raise wages quickly this year, by an average of 4.7 per cent. That’s down from a peak of 5.8 per cent in the second-quarter 2022 survey, but well above the prepandemic average of around 3 per cent.

The jobs market in the States is cooling, but still hot:

Demand for workers in the United States eased in February, a sign that the red-hot labor market continues to cool off somewhat.

There were 9.9 million job openings, compared with 10.8 million on the last day of January, the Labor Department reported Tuesday in the Job Openings and Labor Turnover Survey, known as JOLTS.

A drop in open positions is a signal that the labor market is slowing down, but the report also showed that it remains healthy: Four million workers quit their jobs during the month, a slight increase relative to January, and the number of layoffs decreased slightly to 1.5 million.

There were 1.7 jobs open for every unemployed worker in February, compared with 1.9 in January, a measure the Federal Reserve has been paying close attention to as it looks to cool hiring, part of its effort to contain inflation.

BIS has released a working paper by Andrej Sokol, Michael Kumhof, Marco Pinchetti and Phurichai Rungcharoenkitkul titled CBDC policies in open economies:

Focus
Central banks are currently considering issuing digital money to the general public, known as central bank digital currency (CBDC). Much attention so far has focused on the microeconomic benefits of CBDC, while the implications for macroeconomic and financial stability remain less well understood. What are the macroeconomic gains and risks associated with CBDC, particularly if it could be transferred across borders? And how should the central bank set its CBDC policy in the light of these potential benefits and costs?

Contribution
We study the macroeconomic and monetary policy implications of CBDC issuance in a rich quantitative framework. We introduce CBDC into a carefully calibrated and estimated two-country DSGE environment, featuring a realistic financial system, monetary policy (via the conventional policy interest rate and a separate CBDC policy) and fiscal policy. We use the model to examine: (i) the consequences of transitioning to a CBDC economy; (ii) the design of optimal simple rules for CBDC policy, in terms of interest rate or quantity; and (iii) the open economy effects of introducing CBDC.

Findings
Transitioning to a CBDC economy brings about substantial welfare gains, worth over 2% of steady state consumption in the long run. By counteracting financial shocks, CBDC policy would also help stabilise aggregate demand and inflation. For example, the optimised CBDC interest rule that responds systematically to the credit gap improves welfare by over 1% of steady-state consumption. Finally, when countries adopt optimal CBDC policies, they reduce volatilities of cross-border banking exposures and exchange rates by about a third.

Abstract
We study the consequences for business cycles and welfare of introducing an interest-bearing retail CBDC, competing with bank deposits as medium of exchange, into an estimated 2-country DSGE environment. According to our estimates, financial shocks account for around half of the variance of aggregate demand and inflation, and for the bulk of the variance of financial variables. CBDC issuance of 30% of GDP increases output and welfare by around 6% and 2%, respectively. An aggressive Taylor rule for the interest rate on reserves achieves welfare gains of 0.57% of steady state consumption, an optimized CBDC interest rate rule that responds to a credit gap achieves additional welfare gains of 0.44%, and further gains of 0.57% if accompanied by automatic fiscal stabilizers. A CBDC quantity rule, a response to an inflation gap, CBDC as generalized retail access to reserves, and especially a cash-like zero-interest CBDC, yield significantly smaller gains. CBDC policies can substantially reduce the volatilities of domestic and cross- border banking flows and of the exchange rate. Optimal policy requires a steady state quantity of CBDC of around 40% of annual GDP.
…
We adopt the calibrated and estimated parameters of the pre-CBDC model in a post-CBDC model that is mostly identical, except for the presence of CBDC. We show that the introduction of CBDC equal to 30% of GDP by a single economy is highly beneficial, yielding long run output gains in that economy of just under 6% and long run welfare gains of around 2%. This is because the introduction of CBDC into a large economy like the US can lower real interest rates due to a reduction in the stock of defaultable debt combined with the funding cost advantage of CBDC over defaultable debt, lower distortionary tax rates due to the budgetary space created by lower real interest rates, and lower monetary frictions due to a reduction in tax-like monetary wedges that represent a move of the economy towards the ideal of the Friedman (1969) rule. Bank balance sheets grow significantly in the long run, while banks’ average cost of funding remains approximately constant, countering the notion that introducing a CBDC inevitably leads to bank disintermediation.
…
2. In a contractionary episode the CBDC interest rate should, ceteris paribus, increase rather than decrease. The reason is that increasing the CBDC interest rate relative to the rate on reserves lowers the opportunity cost of holding CBDC. This increases the overall quantity of money and thereby stimulates the economy.

3. A countercyclical CBDC interest rate rule can partly share the burden of a countercyclical Taylor rule for the interest rate on reserves in stabilizing inflation and output, while also stabilizing financial variables. The reason is that the CBDC interest rate works through a money supply channel that complements the intertemporal substitution channel of the interest rate on reserves.

The BoC has released a Staff Working Paper by Carola Conces Binder, Rodrigo Sekkel titled Central Bank Forecasting: A Survey:

Central banks’ forecasts are important monetary policy inputs and tools for central bank communication. We survey the literature on forecasting at the Federal Reserve, European Central Bank, Bank of England and Bank of Canada, focusing especially on recent developments. After describing these central banks’ forecasting frameworks, we discuss the literature on central bank forecast evaluation and new tests of unbiasedness and efficiency. We also discuss evidence of central banks’ informational advantage over private sector forecasters—which appears to have weakened over time—and how central bank forecasts may affect private sector expectations even in the absence of an informational advantage. We discuss how the Great Recession led central banks to evaluate their forecasting frameworks and how the COVID-19 pandemic has further challenged central bank forecasting. Finally, we consider directions for future research.
…
A seminal paper by Romer and Romer (2000) shows that Federal Reserve staff forecasts of inflation in the Greenbook are more accurate than private sector forecasts from Blue Chip, Data Resources, Inc., and the Survey of Professional Forecasters (SPF), and that access to Greenbook forecasts could have helped commercial forecasters improve forecasts. Indeed, “someone with access to both the Federal Reserve and commercial forecasts should not just put positive weight on the Federal Reserve forecast, but put little weight on the commercial one” (Romer and Romer, 2000, p. 438). Correspondingly, the mean squared errors of the Greenbook forecasts are around 25% lower than those of commercial forecasters at most horizons. For real GNP growth, the Fed’s informational advantage is most prominent at short horizons but varies at longer horizons.

To demonstrate the implications of the informational advantage they document, Romer and Romer (2000) show that the Fed’s monetary policy actions reveal some of their private information about the economic outlook. Thus, when the Fed raises the federal funds rate, forecasters revise their inflation expectations upward, which can help explain why interest rates at long horizons respond to monetary policy. Subsequent research has continued to probe the informational advantage of central banks and to examine how central bank expectations influence private sector expectations, even in the absence of a clear informational advantage.

And Central Bankers are examined again in an IMF article by RAGHURAM RAJAN titled More focused, less interventionist central banks would likely deliver better outcomes:

Central bankers of industrialized countries have fallen tremendously in the public’s estimation. Not long ago they were heroes, supporting feeble growth with unconventional monetary policies, promoting the hiring of minorities by allowing the labor market to run a little hot, and even trying to hold back climate change, all the while berating paralyzed legislatures for not doing more. Now they stand accused of botching their most basic task, keeping inflation low and stable. Politicians, sniffing blood and mistrustful of unelected power, want to reexamine central bank mandates.

Did central banks get it all wrong? If so, what should they do?
…
Yet stopping the postmortem at this point is probably overly generous to central banks. After all, their past actions reduced their room to maneuver, and not only for the reasons just outlined. Take the emergence of both fiscal dominance (whereby the central bank acts to accommodate the government’s fiscal spending) and financial dominance (whereby the central bank acquiesces to the imperatives of the market). They clearly are not unrelated to central bank actions of the past few years.

Long periods of low interest rates and high liquidity prompt an increase in asset prices and associated leveraging. And both the government and the private sector leveraged up. Of course, the pandemic and Putin’s war pushed up government spending. But so did ultralow long-term interest rates and a bond market anesthetized by central bank actions such as quantitative easing. Indeed, there was a case for targeted government spending financed by issuing long-term debt. Yet sensible economists making the case for spending did not caveat their recommendations enough, and fractured politics ensured that the only spending that could be legislated had something for everyone. Politicians, as always, drew on unsound but convenient theories (think modern monetary theory) that gave them license for unbridled spending.

Central banks compounded the problem by buying government debt financed by overnight reserves, thus shortening the maturity of the financing of the government and central bank’s consolidated balance sheets. This means that as interest rates rise, government finances—especially for slow-growing countries with significant debt—are likely to become more problematic. Fiscal considerations already weigh on the policies of some central banks—for instance, the European Central Bank worries about the effect of its monetary actions on “fragmentation,” the yields of fiscally weaker countries’ debt blowing out relative to those of stronger countries. At the very least, perhaps central banks should have recognized the changing nature of politics that made unbridled spending more likely in response to shocks, even if they did not anticipate the shocks. This may have made them more concerned about suppressing long rates and espousing low-for-long policy rates.

The Office of the Comptroller of the Currency released the OCC Mortgage Metrics Report for 22Q4:

• • As of December 31, 2022, the reporting banks serviced approximately 12 million first-lien residential mortgage loans with $2.7 trillion in unpaid principal balances (see figures 1 and 2). This $2.7 trillion was 22 percent of all residential mortgage debt outstanding in the United States.2
• • Overall mortgage performance this quarter improved from the fourth quarter of 2021. The percentage of mortgages that were current and performing at the end of the fourth quarter of 2022 was 97.1 percent compared with 96.4 percent at the end of the fourth quarter of 2021 (see figure 6). The CARES Act, signed into law on March 27, 2020, and extended on February 18, 2022, allows for loan forbearance that can extend up to 360 days and is reflected in the mortgage performance data.
• • Servicers initiated 9,166 new foreclosures in the fourth quarter of 2022, a decrease from the prior quarter, but a higher volume than a year earlier (see figure 7). The new foreclosure volume in the fourth quarter of 2022 is lower than pre-COVID-19 pandemic foreclosure volumes. Home forfeiture actions during the fourth quarter of 2022—completed foreclosure sales, short sales, and deed-in-lieu-of-foreclosure actions—increased 42.8 percent from a year earlier to 2,525 (see figure 8). Events associated with the COVID-19 pandemic, including foreclosure moratoriums that began March 18, 2020, and were extended to July 31, 2021, have significantly affected these metrics.

It doesn’t look like we’re in a recession. Not yet, anyway!

The Canadian economy has picked up momentum in the early stages of 2023 and avoided slipping into a recession, despite the highest interest rates in more than 15 years.

Real gross domestic product rose 0.5 per cent in January from the previous month, Statistics Canada reported on Friday. In a preliminary estimate, the agency said the economy grew by a further 0.3 per cent in February.

On an annualized basis, growth is trending toward 2.5 per cent in the first quarter – far stronger than the 0.5 per cent pace that the Bank of Canada had projected. This also marked a rebound from no growth in the fourth quarter, a result that was largely owing to a sharp pullback in inventory investments.

The BoC has released a Staff Working Paper by Serdar Kabaca and Kerem Tuzcuoglu titled Supply Drivers of the US Inflation Since the Pandemic:

This paper examines the contribution of several supply factors to US headline inflation since the start of the COVID-19 pandemic. We identify six supply shocks using a structural VAR model: labor supply, labor productivity, global supply chain, oil price, price mark-up and wage mark-up shocks. Our shock identification relies mainly on sign restrictions. But for the global supply chain shock, we propose a new identification scheme combining sign, narrative and variance decomposition restrictions. Historical decomposition results suggest that global supply chain and oil price shocks are the biggest supply contributors to the US inflation during the pandemic. In contrast, labor shortages only mildly contribute to inflation, but their impact on output is larger in that period. Additionally, price and wage mark-up shocks start to significantly contribute to inflation only towards the middle of 2022. Finally, our analysis, which also allows the identification of monetary policy and aggregate demand shocks, suggests that demand and supply factors are almost equally responsible for the movements in the inflation rate during the pandemic.
…
On the demand side, some scholars attribute a considerable portion of the rise in inflation to monetary and fiscal policy mistakes. Reis (2022) and Summers (2022) emphasize the cost of a delayed monetary policy response to increases in inflation. Jord`a et al. (2022), Jord`a and Nechio (2022) and Summers (2021) underline the role of fiscal expansions in the sharp increase in inflation. Our results highlight that monetary policy significantly contributes to inflation, especially in 2021 during which authorities use the “transitory” language in their guidance. We also find the aggregate demand increasingly contributes to the rise in inflation following the month when the second fiscal stimulus is announced under the Biden administration in 2021. Overall, in our framework, demand factors including monetary policy shocks are found to contribute to half of the rise in US inflation

The BoC has released a Staff Discussion Paper by Sarah Miller and Patrick Sabourin titled What consistent responses on future inflation by consumers can reveal:

Inflation expectations play a vital role in determining inflation. Central bankers need to understand their intricacies and the information they can reveal. We look at the consistency of consumers’ answers to questions on inflation expectations in the Bank of Canada’s Canadian Survey of Consumer Expectations. We analyze factors that may explain consistencies among individuals and overall. We also compare the inflation forecasts of consumers with consistent responses with those of professional forecasters and consumers with varying responses.
…
Consumers aged 30 years and over with income above $100,000 and a post-secondary degree are more likely to provide consistent answers. The most important characteristic for consistency is age. For instance, respondents aged 55 years and over are almost twice as likely to provide consistent answers than respondents under 30 years old. We also find that women are less likely to be consistent than men—their point predictions exceed their subjective distributions more often. Indigenous people are less likely than non-Indigenous people to respond consistently. Similar to the gap between consumers’ perceptions of inflation and actual inflation, the likelihood that consumers provide consistent responses may also vary by their shopping patterns.5 For instance, they may be influenced by the prices of goods they purchase frequently, such as food and gasoline. Several factors may influence why certain demographic groups are more likely than others to provide consistent responses. These factors include:

•  a propensity for overpredicting because it is less costly than underpredicting (or vice versa). This is known as asymmetric loss and may cause a consumer to report a point forecast that is outside the interval from their subjective probabilities (for more details, see Patton and Timmermann 2007).
•  a tendency to round probabilities, although Engelberg, Manski and Williams (2009) tested and rejected this hypothesis
•  the possibility that youth, with less experience of high inflation, update their inflation expectations more strongly in response to surprise inflation than older people do (proposed by Malmendier and Nagel 2016)
•  other unobserved personal characteristics such as patience and maturity

…
To determine whether the inflation expectations of consumers with consistent responses are more informative of actual CPI inflation than those of other consumers, we look at perceived inflation (i.e., inflation over the past 12 months) separately for these two groups. Chart 7 reveals striking differences. Perceived inflation averaged across consumers with consistent responses is close to actual CPI, but well above actual CPI for consumers with inconsistent responses. Instead, the pattern of perceived inflation averaged across the inconsistent group is closer to CPI inflation for gasoline.
…
We know that consumers with consistent views are better than other consumers at forecasting inflation. But how does their forecasting compare with that of professional forecasters? Before the pandemic, the one-year-ahead inflation expectations of consumers with consistent views were systematically above actual inflation four quarters later (Chart 8). Forecasting errors for these consumers were larger than those of professional forecasters in Canada surveyed by Consensus Economics.10 Since the pandemic started, forecasting performance has deteriorated for both groups. However, the one-year-ahead inflation expectations of consistent consumers have been closer to actual inflation than those of professional forecasters. This suggests that, when assessing risks around inflation, we should seriously consider the survey results from these consumers. Their expectations represent an upside risk to the inflation outlook presented in the January 2023 Monetary Policy Report.
…
However, like Braitsch and Mitchell (2022), we think targeted and additional forms of communication may be needed to reach consumers with inconsistent responses to encourage them to moderate their inflation expectations. The Bank’s The Economy, Plain and Simple series and the Bank of Canada Museum’s education programs are steps in that direction.

And the BoC has released (boy, they were busy today!) a Staff Discussion Paper by Lin Chen and Stephanie Houle titled Turning Words into Numbers: Measuring News Media Coverage of Shortages:

We generate high-frequency and up-to-date indicators to monitor news media coverage of supply (raw, intermediate and final goods) and labour shortages in Canada. We use natural language processing to construct two news-based indicators and time-varying topic narratives to track Canadian media coverage of these shortages from 2000 to 2022. This makes our indicators an insightful alternative monitoring tool for policy. Notably, our indicators track well with monthly price indexes and measures from the Bank of Canada’s Business Outlook Survey, and they are highly correlated with commonly tracked indicators of supply constraint. Moreover, the news-based indicators reflect the attention of the public on pressing issues.
…
We use the Cision news media database to build a corpus (a collection of written texts) of Canadian English economic and management news articles published between January 1, 2000, and July 4, 2022. We extract sentences containing the keyword “shortage” and collect them into daily documents. Then, we use unsupervised natural language processing (NLP) to decompose the news corpus into different shortage topics. These topics reflect media attention on, among others, the supply and labour shortages that affected Canada’s economy from the early 2000s to the 2020–22 period of the COVID-19 pandemic.

SEC Commissioner Caroline A. Crenshaw gave a speech titled Fixed Income and Options: The Other Market Structures:

The corporate bond and municipal securities markets are relied upon by both retail and institutional investors, including Americans who are approaching retirement or are already there. In the corporate bond market, trades under $100,000 account for between 60% and 70% of reported customer transactions.[17] In the municipal securities market, transactions of less than $25,000 account for more than half of the trades, and those less than $100,000 account for 87% of trades, reflecting that individual investors hold the majority of outstanding municipal bonds.[18]

Investors in these markets are incurring trading costs that far outstrip the costs of transacting in the equity markets. While estimates of trading costs can be a challenge in part due to the relative lack of transparency, academics have estimated corporate bond trading costs at around 84 basis points[19] and municipal bond trading costs as high as 90 basis points for retail-size trades.[20] Surprisingly, smaller bond transactions, which are more likely to originate from retail investors, are more expensive to complete than larger transactions – the opposite of the pattern typically observed in equity markets.[21]

One way to reduce transaction costs and improve investor outcomes would be to improve price transparency. Post-trade price transparency, via TRACE and EMMA, has been a feature of the U.S. fixed income markets, to varying degrees, since the 1990s, and there have been significant improvements over the last several years. However, fixed income markets still largely lack the pre-trade price transparency that has been a feature of the equity markets for decades. While there are some quotation data available from dealers and electronic venues, smaller dealers are less likely to have access to these data or the ability to consolidate them effectively, and they are generally not visible to the retail customer and therefore cannot be used to help the customer negotiate a better price with its dealer.[22] And post-trade information for infrequently traded bonds can be stale or even unavailable.[23] Consistent with this, research on municipal bond markets from the SEC’s Division of Economic and Risk Analysis showed that the majority of customer trades execute at worse prices than best available dealer quotes.[24]

The Corporate Bond Market Distress Index was updated:

• Corporate bond market functioning appears healthy, with the overall market-level CMDI remaining stable around its historical 25th percentile.
• Market functioning in the investment-grade segment has continued to improve in March. The high-yield segment is slightly up, but still at low historical levels.

BIS has released a working paper by Ernest Dautović, Leonardo Gambacorta and Alessio Reghezza titled Supervisory policy stimulus: evidence from the euro area dividend recommendation:

Focus
In March 2020, the European Central Bank made the recommendation that, at least until October 2020, no “significant institution” should pay out dividends. We investigate the recommendation’s impact on the credit supply to non-financial corporations amid the Covid-19 economic shock. Bank managements effectively faced a choice of how to allocate their capital when deciding whether to follow the ECB recommendation, with differing implications for the credit supply. On the one hand, given constant demand and price effects, they might have opted to use the surplus capital to increase lending supply, thus responding countercyclically to support the economy. On the other hand, they might have decided to increase their resilience to future shocks by saving capital, and/or strengthening their loss-absorption capacity by making additional provisions. The paper asks whether the ECB’s dividend recommendation led to an increase or a decrease in the credit supply to non-financial corporations, and whether this effect varied for different types of firm and sector.

Contribution
The study compares the credit supply of banks affected by the ECB recommendation with a group of unaffected banks, and controls for other pandemic-related support measures. To address identification issues, we rely on credit registry data and a direct measure that captures differences in compliance with the dividend recommendation across banks in the euro area. The analysis disentangles the confounding effects stemming from the wide range of monetary and fiscal policies that supported credit during the Covid-19 downturn and investigates their interaction with the dividend recommendation.

Findings
We find that dividend restrictions have been an effective policy in supporting financially constrained firms, adding capital space to banks, and restricting some forms of procyclical behaviour. In particular, the study finds that the dividend recommendation added 4.4 percentage points to the growth rate of euro area credit supply to non-financial corporations. The effects on lending are larger for small and medium enterprises and for firms operating in sectors that were exposed to the effects of Covid-19. We also find evidence that the dividend recommendation has sustained bank lending even in the absence of government guarantees. At the same time, we do not find evidence of a significant increase in lending to riskier borrowers and “zombie” firms.

Abstract
At the onset of the Covid-19 outbreak, central banks and supervisors introduced dividend restrictions as a new policy instrument aimed at supporting lending to the real economy and strengthening banks’ capacity to absorb losses. In this paper we estimate the impact of the ECB’s dividend recommendation on bank lending and risk-taking. To address identification issues, we rely on credit registry data and a direct measure that captures variation in compliance with the recommendation across banks in the euro area. The analysis disentangles the confounding effects stemming from the wide range of monetary and fiscal policies that supported credit during the Covid-19 downturn and investigates their interaction with the dividend recommendation. We find that dividend restrictions have been an effective policy in supporting financially constrained firms, adding capital space to banks, and limiting some forms of procyclical behaviour. The effects on lending are larger for small and medium enterprises and for firms operating in Covid-19 vulnerable sectors. At the same time, we do not find evidence of a significant increase in lending to riskier borrowers and “zombie” firms.

I must admit, this kind of research makes me nervous. Look at the abstract! “… central banks and supervisors introduced dividend restrictions as a new policy instrument aimed at supporting lending to the real economy and strengthening banks’ capacity to absorb losses.” OK, the second objective is well within the aegis of the supervisory class, but the first? That’s just mission creep. If the authorities want to boost lending, they have lots of less invasive tools in the box already.

And in Canada, thirty year mortgages will become more common:

Proposals from the Financial Consumer Agency of Canada are aimed at ensuring fairness and consistency in terms of relief offered for struggling borrowers. The plan was highlighted in the federal budget this week in a clear sign that Ottawa endorses the idea of allowing mortgages to grow to keep payments down.
…
The FCAC said it developed the guidelines for mortgage borrowers at risk of missing monthly payments because of what it called “exceptional circumstances.” The FCAC did not provide a measurable definition of “exceptional circumstances” except to say it could be the combined effects of high household debt, rapid interest-rate hikes and higher cost of living.

Under the proposal, banks could lengthen their troubled borrowers’ amortization periods either temporarily or permanently. The guideline would apply to all types of mortgages, including those with a fixed interest rate.

If it is temporary, the watchdog said banks should take into account the borrower’s ability to restore the amortization to the original period within what it said was a “reasonable time frame.” If it is a permanent solution, the bank must ensure the amortization period is “reasonable.” FCAC would not comment on what it considered reasonable.

PerpetualDiscounts now yield 6.25%, equivalent to 8.12% interest at the standard equivalency factor of 1.3x. Long corporates yielded 4.95% on 2023-3-24 and since then the closing price has changed from 15.18 to 14.98, a decrease of 132bp in price, with a Duration of 12.41 (BMO doesn’t specify whether this is Macaulay or Modified Duration; I will assume Modified) which implies an increase in yield of about 11bp since 3/24 to 5.06%, so the pre-tax interest-equivalent spread (in this context, the “Seniority Spread”) has narrowed substantially to about 305bp from the 330bp reported March 22.

Dr Joachim Nagel, President of the Deutsche Bundesbank, gave a speech:

The unemployment rates in the European Union and the euro area, at currently (January) 6.1% and 6.7%, respectively, are around their lowest levels since the start of this data series in 1998. Employment in the EU (European Union) and the euro area fell only slightly during the pandemic and was, in the final quarter of 2022, well above the 2019 level. In Germany at the end of last year, more people (45.9 million) were in paid employment than ever before.

The labour market has also proven very robust in the United Kingdom and especially in Scotland. At 3.7% the UK (United Kingdom) unemployment rate for November to January was clearly lower than in the euro area. The Scottish unemployment rate even stands at 3.1%. Employment in the UK (United Kingdom) has recovered swiftly from the pandemic. And from November to January, the number of vacancies was still at high levels despite continuing its downward trend. Furthermore, the Scottish employment rate has reached its highest figure on record, at over 76%.
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Let me quote the chief economist of the Bank of England in this context. Huw Pill recently said in a speech: “In an attempt to protect their own real income from the unavoidable impact of higher external prices, the longer that firms try to maintain real profit margins and employees try to maintain real wages at pre-energy price shock levels, the more likely it is that domestically-generated inflation will achieve its own selfsustaining momentum even as the external impulse to UK (United Kingdom) inflation recedes.”

To illustrate what Pill said with German data: In Germany in 2022, the price index of gross value added rose more strongly than unit labour costs. This is an indicator that profit margins increased. The German ifo (Information und Forschung) Institute noted recently: “In the fourth quarter of 2022, some German companies continued to increase their sales prices more than was indicated by the development of purchase prices.” It seems plausible that pent-up demand due to the pandemic enabled such price-setting behaviour in some sectors. Nevertheless, firms’ pricing power is likely to diminish, as inflation has been increasingly eroding consumers’ purchasing power.

Last year, nominal wages and salaries per employee climbed in the EU (European Union) by 5½%, in the euro area and in Germany by more than 4½%. For Germany, it was the largest increase in 30 years, which came on the heels of German reunification. However, due to high inflation, employees suffered the largest loss in real wages since the beginning of monetary union: a decrease of more than 3½% from the previous year.

It is now understandable that workers and trade unions are trying to compensate for the loss of purchasing power in wage negotiations. These wage negotiations are entirely up to the social partners. Having said that, the wage deals currently reached in Germany are, overall, not compatible with price stability for the euro area in the medium term. There are signs of second-round effects from inflation-induced higher wage increases back to prices.

Wage growth constitutes an important component of “homemade” inflation. In particular, elevated services inflation is likely to partly counterbalance abating upstream price pressures on goods inflation. On the one hand, stronger wage growth is necessary for burden sharing. It prevents employees from bearing too much of the high inflation. On the other hand, wage developments are likely to prolong the prevailing period of high inflation rates. In other words: Inflation will become more persistent.

To be clear: Preventing inflation to become persistent via the labour market requires that employees accept sensible wage gains and that firms accept sensible profit margins. Despite signs of second-round effects, we have not observed a destabilising price-wage spiral in Germany so far. From the Bundesbank’s view, it is necessary to avoid such a price-wage spiral.

Ms Isabel Schnabel, Member of the Executive Board of the European Central Bank, also gave a speech:

On 1 March, the ECB started quantitative tightening (QT) after eight years of balance sheet expansion. At the peak in 2022, the Eurosystem held monetary policy assets corresponding to around 56% of euro area GDP. This was substantial both from a historical perspective and in international comparison (Slide 2, left-hand side).

The first wave of balance sheet expansion was a response to the low-inflation environment prevailing in the aftermath of the euro area sovereign debt crisis. Between 2014 and 2016 headline inflation ran persistently below our target of 2%, averaging just 0.3% (Slide 2, right-hand side).
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The second wave of balance sheet expansion came with the ECB’s response to the pandemic. The launch of the pandemic emergency purchase programme (PEPP) and adjustments to the third series of TLTROs resulted in a further large increase of our monetary policy assets. These measures were necessary to protect the euro area economy from falling into a full-blown financial crisis and economic depression.
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Last July, balance sheet growth came to a halt when we ended net asset purchases under the asset purchase programme (APP). Since autumn, the size of the balance sheet has been declining as banks began repaying their outstanding TLTRO loans. The balance sheet has declined further since the beginning of March, when we stopped fully reinvesting maturing securities bought under the APP.

Further TLTRO repayments and a gradual run-down of our monetary policy bond portfolio imply that our balance sheet is expected to decline meaningfully over the coming years, thereby reducing excess liquidity.
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When we launched the APP in 2015 and excess liquidity started to grow rapidly, we effectively
moved from a “corridor” towards a “floor” system.

Conceptually, the supply curve shifted further and further to the right, now crossing the demand curve at its flat, highly elastic part, where discrete changes in liquidity have very little effect on the level of shortterm interest rates (Slide 6).

Balance sheet run-down will reverse this shift, progressively moving the supply curve back towards the steep part of the demand curve. In the current situation, the large volume of excess reserves means that we should still be at a significant distance from that point. Yet, uncertainty about the exact location of the “kink” is very high.

One reason for this is that years of large excess reserves have blurred our understanding of banks’ underlying demand for liquidity. The aggregate level of reserves has been largely determined by thequantity of asset purchases rather than by banks’ liquidity choices.

Should the demand for reserves have shifted more fundamentally, then upward pressure on interest rates may well start earlier than estimates of the historical relationship between the level of excess reserves and market rates would suggest (Slide 7).

This is broadly what happened in the United States in the autumn of 2019, when interest rate volatility spiked unexpectedly although the supply of reserves was still considerably above what banks had indicated in surveys as their lowest comfortable level.
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The ability to effectively steer overnight rates in the pre-2008 corridor framework relied heavily on two features.

The first was our ability to accurately predict the reserves needed to steer the operational target towards the middle of the corridor. In the steep part of the demand curve, even small changes in the supply of, or demand for, reserves can lead to large swings in interest rates.

The second feature was a well-functioning interbank market that distributed central bank reserves efficiently across the euro area banking system. The standing facilities were not designed to be used on a regular basis but were supposed to accommodate unforeseen liquidity shocks.

Over the past decade, however, the environment in which central banks operate has changed fundamentally.

In the aftermath of the global financial crisis, large excess reserves and prevailing fragmentation have considerably reduced the volume of reserves intermediated through the unsecured interbank market (Slide 8).

It is not clear whether the interbank market will recover once excess reserves become scarcer.

A structural decline in banks’ risk tolerance may have permanently reduced the capacity of the euro area interbank market to efficiently distribute reserves across banks all over the euro area. And while tighter financial regulation has made our financial system safer and more resilient, it has made interbank lending more costly.

Banks might also want to hold much higher liquidity buffers than in the past. The recent experience of Sveriges Riksbank is a case in point.

In recent weeks, it regularly issued certificates amounting to the estimated liquidity surplus of the banking system to steer the Swedish Krona short-term rate to the middle of the interest rate corridor.

However, banks often decided to hold on to about one fifth of excess reserves which they placed in the deposit facility that pays a lower rate of remuneration, so that the short-term rate remained stuck to the floor of the corridor (Slide 9).

This points to banks’ strong preference for reserves, which may affect the ability of central banks toeffectively steer short-term rates in a large corridor system, such as the one we had before 2008.

There are two main reasons as to why banks may today wish to hold a higher level of excess reserves.

One relates to regulatory changes. The introduction of Basel III has resulted in a measurable increase in the demand for high-quality liquid assets (HQLA) that banks need to hold to comply with the liquidity coverage ratio (LCR).

Many euro area banks currently use excess reserves to meet regulatory requirements, especially in those countries with high excess liquidity. For the euro area as a whole, excess reserves currently account for 60% of HQLA holdings (Slide 10).

The second factor relates to banks’ precautionary behaviour in guarding against liquidity risks, as the turbulent events in the past few weeks forcefully underline.

Overnight deposits at euro area banks have shown an upward trend in relation to banks’ total deposits until about mid-2022 (Slide 11, left-hand side).

As a result, the risk of withdrawals or portfolio rebalancing has increased.

And here’s part of a speech by Mr Andrew Bailey, Governor of the Bank of England:

UK Consumer price inflation is currently at 10.4%. This is much too high, and we need to, and will, bring it back down to the 2% target. That is why last Thursday the Monetary Policy Committee increased Bank Rate at the eleventh meeting in a row, to 4.25%. We have increased Bank Rate by more than 4 percentage points since December 2021. These increases are being felt by households and businesses across the country.
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In the New Keynesian models that have dominated monetary macroeconomics over the past three decades, monetary policy has real effects because market prices are sticky. So when nominal interest rates change, the real interest rates that determine real consumption and investment decisions change with them. And markets may operate with ‘excess supply’ or ‘excess demand’ for as long as it takes wages and prices to adjust to shifts in either demand or supply.
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Chart 4, reproduced from our latest Monetary Policy Report, shows that there has been a marked and sustained fall in productivity growth in the United Kingdom following the global financial crisis in particular.
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Whatever the reason, when productivity growth is weak, companies gain less from installing new capital. So weaker productivity growth has meant that firms have sought to borrow less to finance investments at a given interest rate. This reduction in the demand for capital has lowered the equilibrium rate.

The second important factor is population ageing.
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As people accumulate savings over their working life to fund their retirement, wealth in the economy increases as the age distribution shifts towards older cohorts (indicated in this chart by bars in different colours).

So ageing households have sought to lend more at a time when less productive firms have sought to borrow less. The only way to establish an equilibrium between the supply and demand in the market for investable funds – that is, to incentivise firms to invest this additional wealth into productive capital – has been for the price of those funds, the real interest rate, to fall.

The trend equilibrium rate, R*, is like a long-term anchor for monetary policy. As R* has fallen, monetary policy has moved with it. This is an important point. The low level of interest rates over the past few decades reflects deep underlying factors on the supply side of the economy. As these underlying factors – trends in technology and demographics – only move slowly, it is not unreasonable to expect that R* will remain low.

This means that, even as we now respond to rising inflation by raising Bank Rate, interest rates will not necessarily have to return fully to, and remain around, the higher levels they once had.

The New York Fed has released the 2023 SCE Housing Survey:

• Households expect home price growth to decline to 2.6 percent over the next twelve months, down sharply from 7.0 percent a year ago. This marks the lowest such reading since the series’ inception in 2014. Expectations over the five-year horizon rose, with households anticipating average annualized price growth of 2.8 percent from 2.2 percent.
• Households expect rents to increase by 8.2 percent over the next twelve months, compared with 11.5 percent in February 2022.
• Renters put the probability of owning a home in the future at 44.4 percent, up slightly from 43.3 percent a year ago.
• Households expect mortgage rates to rise to 8.4 percent a year from now and 8.8 percent in three years’ time.

… as well as the more general and more frequent SURVEY OF CONSUMER EXPECTATIONS:

Sharp Fall in Short-Term Inflation Expectations; Labor Market Expectations Improve
Median one-year-ahead inflation expectations declined by 0.8 percentage point to 4.2 percent, according to the February Survey of Consumer Expectations. Three-year-ahead expectations remained at 2.7 percent, while the five-year-ahead measure increased by 0.1 percentage point to 2.6 percent. Labor market expectations improved, with unemployment expectations and perceived job loss risk decreasing and job finding expectations increasing. Expectations for voluntary job quits reached the highest level since the start of the pandemic.

And there’s more scandal from the Bankman-Fried investigation:

Federal prosecutors added a foreign bribery charge to the growing list of crimes already pending against the FTX founder Sam Bankman-Fried, according to a new indictment filed in federal court in Manhattan on Tuesday.

Federal prosecutors said that in 2021 Mr. Bankman-Fried instructed those working for him to pay a bribe of $40 million to one or more Chinese officials to help unfreeze trading accounts maintained by Alameda Research, FTX’s sister company, that held about $1 billion in cryptocurrencies.

The bribe money was paid to the Chinese officials in cryptocurrency, the document said. The indictment said the effort to pay off the unnamed Chinese officials was successful in getting the trading accounts unfrozen.

And what should we think of central bankers?

Central bankers of industrialized countries have fallen tremendously in the public’s estimation. Not long ago they were heroes, supporting feeble growth with unconventional monetary policies, promoting the hiring of minorities by allowing the labor market to run a little hot, and even trying to hold back climate change, all the while berating paralyzed legislatures for not doing more. Now they stand accused of botching their most basic task, keeping inflation low and stable. Politicians, sniffing blood and mistrustful of unelected power, want to reexamine central bank mandates.
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Long periods of low interest rates and high liquidity prompt an increase in asset prices and associated leveraging. And both the government and the private sector leveraged up. Of course, the pandemic and Putin’s war pushed up government spending. But so did ultralow long-term interest rates and a bond market anesthetized by central bank actions such as quantitative easing. Indeed, there was a case for targeted government spending financed by issuing long-term debt. Yet sensible economists making the case for spending did not caveat their recommendations enough, and fractured politics ensured that the only spending that could be legislated had something for everyone. Politicians, as always, drew on unsound but convenient theories (think modern monetary theory) that gave them license for unbridled spending.

Central banks compounded the problem by buying government debt financed by overnight reserves, thus shortening the maturity of the financing of the government and central bank’s consolidated balance sheets. This means that as interest rates rise, government finances—especially for slow-growing countries with significant debt—are likely to become more problematic.
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The private sector also leveraged up, both at the household level (think Australia, Canada, and Sweden) and at the corporate level. But there is another new, largely overlooked, concern—liquidity dependence. As the Fed pumped out reserves during quantitative easing, commercial banks financed the reserves largely with wholesale demand deposits, effectively shortening the maturity of their liabilities. In addition, in order to generate fees from the large volume of low-return reserves sitting on their balance sheets, they wrote all sorts of liquidity promises to the private sector—committed lines of credit, margin support for speculative positions, and so on.

The problem is that as the central bank shrinks its balance sheet, it is hard for commercial banks to unwind these promises quickly. The private sector becomes much more dependent on the central bank for continued liquidity. We had a first glimpse of this in the UK pension turmoil in October 2022, which was defused by a mix of central bank intervention and government backtracking on its extravagant spending plans. The episode did suggest, however, a liquidity-dependent private sector that could potentially affect the central bank’s plans to shrink its balance sheet to reduce monetary accommodation.
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High asset prices, high private leverage, and liquidity dependence suggest that the central bank could face financial dominance—monetary policy that responds to financial developments in the private sector rather than to inflation. Regardless of whether the Fed intends to be dominated, current private sector forecasts that it will be forced to cut policy rates quickly have made its task of removing monetary accommodation more difficult. It will have to be harsher for longer than it would want to be, absent these private sector expectations. And that means worse consequences for global activity. It also means that when asset prices reach their new equilibrium, households, pension funds, and insurance companies will all have experienced significant losses—and these are often not the entities that benefited from the rise. Bureaucrat-managed state pension funds, the unsophisticated, and the relatively poor get drawn in at the tail end of an asset price boom, with problematic distributional consequences for which the central bank bears some responsibility.

Moody’s commented about two weeks ago:

Pandemic-related fiscal stimulus, more than a decade of ultralow interest rates and unconventional monetary policy (i.e., quantitative easing) resulted in significant excess deposit creation in the US banking sector. Indeed, US banks’ loan to deposit ratio dropped to a 50-year low of roughly 60 percent in September 2021. Very low US interest rates pressured net interest margins and encouraged some banks to invest at least a portion of their excess deposits into longer-dated fixed-income securities. This proved to be a poor risk-management decision for some banks, as the rapid rise in US interest rates in 2022 has resulted in significant unrealized losses on some US banks’ AFS and HTM securities holdings even as the Federal Reserve’s quantitative tightening has reduced banking system deposits, pressuring some banks’ funding. US banks’ loan to deposit ratio has risen to 68 percent as of February 2023, but a further rise seems likely as the ratio is still well below pre-pandemic levels in the high 70s. The newly created BTFP is intended to buffer banks from the increased risks that ongoing tightening in bank funding raise; namely, the possible need to sell underwater securities and crystallize unrealized losses related to higher interest rates, reducing their capitalization.

We have commented on the broader risk of US banks’ high AFS and HTM securities holdings, especially in a period of renewed quantitative tightening (QT2), as well as regional banks’ weakened liquidity as tighter monetary policy has created greater deposit competition and even deposit outflows. QT2 and rising interest rates have driven up substantial unrealized losses on banks’ AFS and HTM holdings, which banks increased during the preceding period of ultralow interest rates to defend falling net interest margins. In 2005, US banks’ holdings of government securities totaled $1 trillion, or 13 percent of US banks’ balance sheet. Today banks’ holdings of government securities have ballooned to $4.4 trillion, or a whopping 19 percent of US banking system assets (Exhibit 3).
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Specifically, for regional and community banks, unrealized AFS losses reduce the shareholders’ equity of the firm, but not the regulatory capital measures unless the AFS or HTM securities actually are sold to meet the bank’s liquidity needs. By contrast, for US Global Systemically Important Banks (G-SIBs), unrealized AFS losses not only reduce shareholders’ equity, but also flow through directly to a bank’s regulatory capital through adjustments to other comprehensive income. For some US G-SIBs, these unrealized AFS losses have reduced capital. G-SIBs’ unrealized HTM losses, however, do not flow through to regulatory capital.

On a brighter note First Citizens BancShares will acquire Silicon Valley Bank:

The deal for the bank, which became Silicon Valley Bridge Bank after the F.D.I.C. seized it, included the purchase of about $72 billion in loans, at a discount of $16.5 billion, and the transfer of deposits worth $56 billion. Roughly $90 billion in Silicon Valley Bank’s securities and other assets were not included in the sale, and remained in the F.D.I.C.’s control.

The bank regulator will receive rights linked to the stock of First Citizens, which could be worth up to $500 million. The F.D.I.C. estimated that the cost of Silicon Valley Bank’s failure to the government’s deposit insurance fund would be around $20 billion.

First Citizens and the F.D.I.C. will share in any losses on the loans included in the transaction, in an arrangement that often features in sales of failed banks. For example, the F.D.I.C. agreed to reimburse First Citizens for half of any losses above $5 billion on the portfolio of commercial loans transferred in the deal.

But the fingerpointing continues:

The Federal Reserve’s vice chair for supervision blamed Silicon Valley Bank’s demise on poor internal management and excessive risk-taking and detailed the steps that Fed supervisors took to address the snowballing problems that ultimately killed the company, according to prepared remarks ahead of a congressional hearing on Tuesday.

The vice chair, Michael Barr, who will appear at a Senate Banking Committee hearing along with other regulators, also acknowledged in his written testimony that bank supervision and regulation might need to change in the wake of the collapse.
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“SVB’s failure is a textbook case of mismanagement,” he said, while adding that the “failure demands a thorough review of what happened, including the Federal Reserve’s oversight of the bank.”
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And questions could arise about issues that Mr. Barr did not address in his remarks. For instance, while he pointed out that supervisors were aware of risks at Silicon Valley Bank, he did not note that the group of Fed Board staff members and supervisors overseeing the bank gave it a satisfactory rating when it came to liquidity in 2022 — even after a range of problems, including some with liquidity risk management, had already been flagged.

There will also be testimony from Martin J. Gruenberg, Chairman, FDIC:

In addition, I will share some preliminary lessons learned
as we look back on the immediate aftermath of this episode.
In that regard, the FDIC will undertake a comprehensive review of the deposit insurance system and will release a report by May 1, 2023, that will include policy options for consideration related to deposit insurance coverage levels, excess deposit insurance, and the implications for risk-based pricing and deposit insurance fund adequacy.

In addition, the FDIC’s Chief Risk Officer will undertake a review of the FDIC’s supervision of Signature Bank and will also release a report by May 1, 2023. Further, the FDIC will issue in May 2023 a proposed rulemaking for the special assessment for public comment.

Subsequently, as word of SVB’s problems began to spread, Signature Bank began to experience contagion effects with deposit outflows that began on March 9 and became acute on Friday, March 10, with the announcement of SVB’s failure. On March 10, Signature Bank lost 20 percent of its total deposits in a matter of hours, depleting its cash position and leaving it with a negative balance with the Federal Reserve as of close of business. Bank management could not provide accurate data regarding the amount of the deficit, and resolution of the negative balance required a prolonged joint effort among Signature Bank, regulators, and the Federal Home Loan Bank of New York to pledge collateral and obtain the necessary funding from the Federal Reserve’s Discount Window to cover the negative outflows. This was accomplished with minutes to spare before the Federal Reserve’s wire room closed.

Over the weekend, liquidity risk at the bank rose to a critical level as withdrawal requests mounted, along with uncertainties about meeting those requests, and potentially others in light of the high level of uninsured deposits, raised doubts about the bank’s continued viability.
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A significant number of the uninsured depositors at SVB and Signature Bank were small and medium-sized businesses. As a result, there were concerns that losses to these depositors would put them at risk of not being able to make payroll and pay suppliers. Moreover, with the liquidity of banking organizations further reduced and their funding costs increased, banking organizations could become even less willing to lend to businesses and households. These effects would contribute to weaker economic performance, further damage financial markets, and have other material negative effects.
Faced with these risks, the FDIC Board voted unanimously on March 12, to recommend that the Secretary of the Treasury, in consultation with the President, make a systemic risk determination under the FDI Act with regard to the resolution of SVB and Signature Bank.28 That same day, the Federal Reserve Board unanimously made a similar recommendation, and the Secretary of the Treasury determined that complying with the least-cost provisions in Section 13(c)(4) of the FDI Act would have serious adverse effects on economic conditions or financial stability, and any action or assistance taken under the systemic risk exception would avoid or mitigate such adverse effects.
The systemic risk determination enabled the FDIC to extend deposit insurance protection to all of the depositors of SVB and Signature Bank, including uninsured depositors, in winding down the two failed banks. At SVB, the depositors protected by the guarantee of uninsured depositors included not only small and mid-size business customers but also customers with very large account balances. The ten largest deposit accounts at SVB held $ 13.3 billion, in the aggregate.
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The FDIC estimates that the cost to the DIF [Deposit Insurance Fund] of resolving SVB to be $20 billion. The FDIC estimates the cost of resolving Signature Bank to be $2.5 billion. Of the estimated loss amounts, approximately 88 percent, or $18 billion, is attributable to the cost of covering uninsured deposits at SVB while approximately two-thirds, or $1.6 billion, is attributable to the cost of covering uninsured deposits at Signature Bank. I would emphasize that these estimates are subject to significant uncertainty and are likely to change, depending on the ultimate value realized from each receivership.
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One clear takeaway from recent events is that heavy reliance on uninsured deposits creates liquidity risks that are extremely difficult to manage, particularly in today’s environment where money can flow out of institutions with incredible speed in response to news amplified through social media channels.

And finally, the Cleveland Fed has released a working paper by Ina Hajdini, Edward S. Knotek II, John Leer, Mathieu Pedemonte, Robert W. Rich and Raphael S. Schoenle titled Low Passthrough from Inflation Expectations to Income Growth Expectations: Why People Dislike Inflation:

We implement a novel methodology to disentangle two-way causality in inflation and income expectations in a large, nationally representative survey of US consumers. We find a 20 percent passthrough from expected inflation to expected income growth, but no statistically significant effect in the other direction. Passthrough is higher for higher-income individuals and men. Higher inflation expectations increase consumers’ likelihood to search for higher-paying new jobs. In a calibrated search-and-matching model, dampened responses of wages to demand and supply shocks translate into greater output fluctuations. The survey results and model analysis provide a labor market channel for why people dislike inflation.
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In a seminal paper, Shiller (1997) argued that consumers associate higher inflation with a reduction in their purchasing power. We find that this negative relationship between inflation and consumers’ earning prospects holds causally based on our experimental setup. We also explore the consequences of these results. Respondents appear to perceive that their nominal incomes are very rigid with their current employers, as higher inflation expectations only make them more willing to look for another job in order to improve their wages rather than asking for a raise. The implication from these results is that consumers associate inflationary shocks with a reduction in welfare, which can explain why consumers more generally associate higher inflation expectations with worse economic outcomes, as shown by Candia, Coibion, and Gorodnichenko (2020)). Overall, our empirical findings and our theoretical model provide evidence of a labor market channel that can explain why people dislike inflation.