PrefBlog

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.
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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.

Bond market chaos is attracting attention in the popular press:

While the S&P 500 has edged higher in the two weeks since the federal authorities took control of SVB, parts of the government bond market have been subjected to moves not seen since the 1980s, when the economy fell into recession after the Federal Reserve’s last major fight against inflation.
…
Usually, yields on these bonds rise and fall in tiny increments measured in hundredths of a percentage point, or “basis points.” But in the past two weeks, the yield on two-year Treasury notes has consistently moved within a range of 0.3 to 0.7 percentage points each day.
…
The largest day-to-day move in yields this month, when the two-year yield on March 13 slid to 3.98 percent from 4.59 percent, was the biggest lurch lower since 1982 — worse than anything traders witnessed in the 1987 “Black Monday” stock market crash, the bursting of the tech bubble at the turn of the century or the 2008 financial crisis.
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Even since that March 13 plunge, the yield on two-year notes has gyrated sharply higher and lower. In a period of anxiety over the state of the economy, these swings stand out. Illustrated on a chart they resemble a sound wave that quieted after the last financial crisis but is growing louder again.

Daily change in 2-year Treasury note yield

The New York Fed published its underlying inflation gauge:

• The UIG “full data set” measure for February is currently estimated at 4.8%, a 0.3 percentage point decrease from the current estimate of the previous month.
• The “prices-only” measure for February is currently estimated at 3.9%, a 0.3 percentage point decrease from the current estimate of the previous month.
• The twelve-month change in the February CPI was +6%, a 0.4 percentage point decrease from the previous month.
  • For February 2023, trend CPI inflation is estimated to be in the 3.9% to 4.8% range, a similar range compared to January, with a 0.3 percentage point decrease of both its lower and upper bounds.

The IMF has published a Staff Discussion Note by Florence Jaumotte, Longji Li, Andrea Medici, Myrto Oikonomou, Carlo Pizzinelli, Ippei Shibata, Jiaming Soh and Marina M. Tavares titled Digitalization During the COVID-19 Crisis: Implications for Productivity and Labor Markets in Advanced Economies:

Digitalization induced by the pandemic was seen both as a possible silver-lining from the crisis that could increase longer-term productivity and a risk for further labor market inequality between digital and non-digital workers. The note shows that the pandemic accelerated digitalization and triggered a partial catch-up by less digitalized entities in advanced economies. Higher digitalization levels shielded substantially productivity and hours worked during the crisis. However, the extent to which the pandemic-induced digitalization led to structural change in the economy is less clear. Less digitalized sectors have rebounded more strongly, albeit after stronger declines, and while workers in digital occupations were more shielded from the crisis, there does not appear to be a structural change in the composition of labor demand. Meanwhile, shifts in labor supply are more likely to be permanent, driven by the increase in working from home.
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Recent evidence points out that workers highly value working from home. Working from home provides
more flexibility in time use over the day, greater personal autonomy, and less time spent commuting,
generating a significant amenity value for workers who can work from home. The value of these amenity gains
can range from 1.5 percent of earnings at the low end of the earnings distribution to 7.3 percent at the high end (Barrero, Bloom, and Davis 2021). There is some evidence suggesting that these amenity gains help explain the lack of solid wage growth after the pandemic in the US despite labor market tightness (Barrero and others 2022) because workers acquire the implicit gains from working from home.

The lack of wage growth is especially notable for high-skilled workers, while low-skilled workers, who are less likely to work from home, experienced wage gains, contributing to a recent decline in wage dispersion (Autor and Dube 2022).

By reducing the disutility from supplying labor, working from home could have positive consequences for employment in the longer term, although it is still too early to judge. Countries where a larger share of workers work from home have experienced a smaller drop in labor force participation and even an increase in labor force participation relative to the trend in 2021 (Figure 14, panel 1). The fact that this association is stronger in 2021 than 2020 suggests that the positive boost to labor force participation reflects not only digitalized workers’ greater likelihood of remaining in employment during lockdowns and hence lower likelihood of leaving the labor force. It also suggests that workers value working from home and that working from home may increase labor force participation by attracting marginally attached workers and extending the working life of elderly workers.
…
Time-use surveys suggest there may have been two shocks affecting labor supply as a result the pandemic. A critical benefit of working from home is the potential to save time commuting. Data from the American Time Use Survey (ATUS), which measures the amount of time people spend doing various activities, such as paid work, childcare, volunteering, and socializing, show that workers in teleworkable occupations save on average two hours a week by not commuting to an office.29 Part of this savings is associated with an increase in working hours, particularly for women in teleworkable occupations. However, surprisingly, the savings in commuting time is associated with a decline in working hours for men in teleworkable and non-teleworkable occupations (right bars in Figures 15, panels 1 and 2). The reduction in men’s working hours suggests that the pandemic may have increased men’s preference for leisure (independent of digitalization), leading to an acceleration in the long-term trend in men’s decline in labor market attachment.30

It’s my belief that although the amount of working from home will remain well above pre-pandemic levels, it will gradually decline in importance from the current peak. People are going to get tired of looking at the same four walls all day long and seeing the same old people. But we’ll see!

Thomas Jordan, Martin Schlegel and Andréa M. Maechler of the Swiss National Bank (the Central Bank) gave a speech:

I come now to our monetary policy decision. We have decided to tighten our monetary policy further and to raise the SNB policy rate by 0.5 percentage points to 1.5%. In doing so, we are countering the renewed increase in inflationary pressure. It cannot be ruled out that additional rises in the SNB policy rate will be necessary to ensure price stability over the medium term.

To provide appropriate monetary conditions, we also remain willing to be active in the foreign exchange market as necessary. For some quarters now, the focus has been on selling foreign currency.

The SNB policy rate change applies from tomorrow, 24 March 2023. Banks’ sight deposits held at the SNB will be remunerated at the SNB policy rate of 1.5% up to a certain threshold. Sight deposits above this threshold will be remunerated at an interest rate of 1.0%, and thus still at a discount of 0.5 percentage points relative to the SNB policy rate.

Powell’s doing a little sparring with the Republicans:

Republican lawmakers say spending programs signed into law by President Biden are pumping too much money into the economy and fueling an annual inflation rate that was 6 percent in February — a decline from last year’s highs, but still well above historical norms. Mr. Powell disputed those claims in congressional testimony earlier this month and in a news conference on Wednesday, after the Fed announced it would once again raise interest rates in an effort to bring inflation back toward normal levels.

Asked whether federal tax and spending policies were contributing to price growth, Mr. Powell pointed to a decline in federal spending from the height of the Covid-19 pandemic.

“You have to look at the fiscal impulse from spending,” Mr. Powell said on Wednesday, referring to a measure of how much tax and spending policies are adding or subtracting to economic growth. “Fiscal impulse is actually not what’s driving inflation right now. It was at the beginning perhaps, but that’s not the story right now.”
…
One recent model, from researchers at the Federal Reserve Bank of New York, the University of Maryland and Harvard University, estimates that about a third of the inflation from December 2019 through June 2022 was caused by fiscal stimulus measures.
…
The Hutchins Center at the Brookings Institution in Washington estimates that in the first quarter of 2021, when Mr. Biden’s economic aid bill delivered direct payments, enhanced unemployment checks and other benefits to millions of Americans, government fiscal policy added 8 percentage points to economic growth. At the end of last year, the center estimates, declining government spending was actually reducing economic growth by 1 percentage point.

The Bank of England hiked its rate 25bp to 4.25% today:

Consumer prices rose 10.4 percent in February from a year earlier, up from 10.1 percent the month before, ending a three-month downward trend and stubbornly keeping inflation in the double digits, according to data from the Office for National Statistics published on Wednesday.
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Earlier on Thursday, the Swiss National Bank, the country’s central bank, raised interest rates by half a percentage point, to 1.5 percent, to counter “the renewed increase in inflationary pressures” in Switzerland.
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The Bank of England forecast that the inflation rate would fall significantly this year, and average about 4 percent around the end of the year. In fact, inflation should fall more than expected in the second quarter of this year because of the government’s decision to extend its subsidy for household energy bills for an additional three months to the end of June. And wage growth has been weaker than expected, easing policymakers’ concerns that high wages in the private sector would make it harder to return inflation to the bank’s 2 percent target.
…
Andrew Bailey, the governor of the central bank, told reporters after last month’s meeting that there had been a “turning of the corner” on inflation but warned “it’s very early days, and the risks are very large.”

To some extent, those risks materialized in the surprising upturn in Wednesday’s data, which showed food prices rising in February at their fastest pace in 45 years and a measure of services inflation increasing. This week’s meeting showed the challenge the bank faces in determining the path of inflation.

The increase in inflation, which was 0.6 percentage points higher last month than the central bank expected, came from rising food prices and higher prices for goods, namely clothing and footwear.

Speaking of rising wages, Christine Lagarde had a few words yesterday:

For the seven countries covered by the ECB’s wage tracker, collective bargaining during 2022 led to an aggregate wage rise of 4.7% for this year. This is already playing a stronger role in core inflation. While wage-sensitive items contributed only around 0.5 percentage points to core inflation before the pandemic, that contribution has more than doubled in recent months.

If both workers and firms accept fair burden sharing, and stronger wage growth represents merely a rebalancing between labour and capital, then both wage and price pressures should diminish as this process plays out. But if both parties attempt to unilaterally minimise their losses, we could see a feedback mechanism between higher profit margins, wages and prices.

The risk of such a “tit-for-tat” dynamic is also heightened by the prospect that labour market tightness will
linger.

Unlike other jurisdictions, labour participation in the euro area has grown robustly since last year, helping to address part of the soaring labour demand driven by reopening. But the pandemic has also led to a sharp increase in public employment, reducing the pool of labour available to the private sector. And how much further labour supply can expand overall will depend, among other things, on complex policy questions such as countries’ attitudes to immigration and childcare.

At the same time, the unemployment rate is at a historical low and, in some countries, it is so low that it
will be increasingly difficult to recruit from the remaining pool of labour.

All this means that we could see a more prolonged cost-push shock coming from wage growth. This is unlikely to prevent goods disinflation, since wages represent only around 20% of direct input costs for manufacturing firms. But wages make up around 40% of direct input costs for services providers, and services inflation accounts for almost two-thirds of core inflation.

In parallel, firms’ profit margins continue to grow, in part because some are taking advantage of supply-demand imbalances to test consumer demand with large price increases – over and above their increase in costs. But in the absence of a persistent rise in market power, this can only continue insofar as demand remains resilient. Otherwise, firms will have to absorb cost increases in margins and price pressures will start to ease.