PrefBlog

Jobs, jobs, jobs!

Employers added 253,000 jobs in April, the Labor Department reported Friday, in a reversal of the cooling trend that had marked the first quarter and was expected to continue.

The unemployment rate was 3.4 percent, down from 3.5 percent in March, and matched the level in January, which was the lowest since 1969.
…
All of that has benefited groups that have historically been at a disadvantage in the labor market. The unemployment rate for Black Americans reached its lowest point on record in April, at 4.7 percent, and the gap between the unemployment rates of white and Black people was also the smallest ever measured. The share of working-age people participating in the labor market reached 83.3 percent, matching a level not seen since 2008.
…
Average hourly earnings climbed by 4.4 percent in the year through April. That compared with 4.3 percent in the previous month, and was more than the 4.2 percent that economists had expected.
…
More than four out of every five people in their prime working ages between 25 and 54 are now in the labor force. That rate has jumped in recent months — and it continues to rise above prepandemic levels.

And in the frozen North:

The Canadian economy gained 41,400 jobs in April, exceeding expectations for an increase of 20,000, while the jobless rate stayed near a record low.
…
Money markets are still expecting an interest rate cut by the BoC this year, but chances of a cut as soon as October fell to about 30% from 70% before the data.
…
Canadian government bond yields were higher across a flatter curve. The 2-year rose 16.1 basis points to 3.728%, while the 10-year was up 12.3 basis points at 2.923%.

BIS has released a Working Paper by Mathias Drehmann, Mikael Juselius and Anton Korinek, titled Long-term debt propagation and real reversals:

Summary
Focus
Economic propagation mechanisms that capture how disturbances systematically feed through the economy over time are central to macroeconomic models. Such mechanisms allow us to understand the behaviour of key macroeconomic variables and help us make more reliable forecasts. Unfortunately, many macro models lack strong propagation based on understandable economic behaviour and instead rely on mechanisms for which there is no economic rationale.

Contribution
We describe a natural propagation mechanism through which new borrowing can systematically affect future output and lead to reversals in activity. The starting point is simple: the majority of debt contracts are long-term and imply regular future debt service payments (consisting of interest and amortisations). These payments pile up during a credit boom and, as time progresses, eventually outweigh the flow of borrowing. When this happens, the positive output effect from the credit boom reverses and output falls. We confirm this pattern using data from many countries over the last four decades.

Findings
Using a novel multi-country data set of debt flows, we find that the prevalence of long-term debt leads to predictable patterns in the data. In the short term, an increase in new household borrowing is associated with higher output growth. Over time, as the stock of debt increases, debt service payments place an increasing drag on output. Eventually the negative debt service effect outweighs the positive effect from borrowing, leading to a real reversal. We find that this mechanism largely accounts for the well documented fact that growth tends to systematically slow for several years after a credit boom.

Abstract
We examine a propagation mechanism that arises from households’ long-term borrowing and show empirically that it has sizable real effects. The mechanism recognises that when there is long-term debt, an impulse to new borrowing generates a predictable hump-shaped path of future debt service. We confirm this pattern using a novel multi-country dataset of debt flows. Whereas new borrowing boosts output contemporaneously, debt service depresses output. Credit booms thus lead to predictable reversals in real economic activity several years later. This long-term debt propagation channel is the main reason for why indicators of credit cycles have predictive power for future economic activity.

In addition BIS released a Working Paper by Katharina Bergant, Francesco Grigoli, Niels-Jakob Hansen and Damiano Sandri titled Dampening global financial shocks: can macroprudential regulation help (more than capital controls)?:

Summary
Focus
Fluctuations in global financial markets can severely destabilise emerging market economies (EMEs). The academic and policy debate on enhancing their resilience has focused on the role of capital controls and foreign exchange intervention because these tools directly target international financial transactions. In this paper, we provide a different perspective by asking whether EMEs might also rely on macroprudential regulation to protect themselves against global financial shocks.

Contribution
To tackle this question, we assemble a rich data set for 38 EMEs between 2000 and 2019. The econometric analysis examines whether a more stringent level of macroprudential regulation reduces the effects of global financial shocks on EMEs’ economic activity. We also investigate whether stricter macroprudential regulation allows for a more countercyclical monetary policy response in EMEs vis-à-vis global financial shocks. Finally, we compare the results with those associated with the use of capital controls.

Findings
We find that macroprudential regulation can significantly enhance the resilience of economic activity in EMEs to global financial shocks. A broad set of macroprudential tools contributes to this result, including measures targeting bank capital and liquidity, foreign currency mismatches and risky credit. We also find that macroprudential regulation enhances monetary independence by allowing for a more countercyclical response to global financial shocks. The strength of these results is remarkable since we do not find evidence that capital controls provide similar benefits. Hence, macroprudential regulation emerges as a key instrument for bolstering the resilience of EMEs against the ebb and flows of the global financial cycle.

Abstract
We show that macroprudential regulation significantly dampens the impact of global financial shocks on emerging markets. Specifically, a tighter level of regulation reduces the sensitivity of GDP growth to capital flow shocks and movements in the VIX. A broad set of macroprudential tools contributes to this result, including measures targeting bank capital and liquidity, foreign currency mismatches, and risky credit. We also find that tighter macroprudential regulation allows monetary policy to respond more countercyclically to global financial shocks. This could be an important channel through which macroprudential regulation enhances macroeconomic stability. We do not find evidence that capital controls provide similar benefits.

The BoC released a fascinating Staff Working Paper by Rodney J. Garratt, Zhentong Lu and Phoebe Tian titled How Banks Create Gridlock to Save Liquidity in Canada’s Large Value Payment System:

Using detailed data from Canada’s new high-value payment system (HVPS), we show how participants of the system save liquidity by exploiting the new gridlock resolution arrangement. These observed behaviors are consistent with the equilibrium of a “gridlock game” that captures the key incentives that participants face in the system. The findings have important implications for the design of HVPSs and shed light on financial institutions’ liquidity preference.
…
In this paper, we examine the launch of a new HVPS [High Value Payment System] in Canada called Lynx that substantially alters financial institutions’ incentives to provide liquidity.2 Whereas the previous system adopted liquidity pooling and risk sharing mechanisms to reduce banks’ liquidity needs, the new system requires banks to provide liquidity up front for all payments, with an exception for banks that have insufficient liquidity available in the designated payment stream to make the payment. In this case, payments are queued and settled on a net basis, a process called gridlock resolution. Participants would like to save liquidity by queuing payments (which will be resolved by the gridlock resolution mechanism). However, now they cannot queue payments directly and can only do this indirectly by keeping their liquidity low, so this is a ”friction” for them to access the queuing/gridlock resolution process.

The ”voluntary” queuing would give them direct control. The new system has two payment streams. Both are what payments professionals call real-time gross settlement streams (RTGS), because payments are made on a gross basis and are final and irrevocable once processed. However, one stream includes a gridlock resolution mechanism (we denote this stream by RTGSG thereafter) that has added functionality, and thereby dominates the pure RTGS stream. FIs quickly figured out a clever way to use both streams to their advantage.

In the Lynx system, gridlock resolution is activated only if there is insufficient liquidity in the payment stream to settle payments on a gross basis. Participants cannot voluntarily put payments into the gridlock queue. Hence, the only way for FIs to obtain the liquidity savings associated with netting in the gridlock resolution mechanism queue is to starve that stream of liquidity. By submitting more payments than liquidity to the RTGS stream with a gridlock resolution mechanism, FIs are able to trigger gridlock resolution and settle payments on a net basis.
…
Recognizing an opportunity to save liquidity, on September 16, all the major participants jointly reduced their liquidity allocations to the RTGSG. As expected, this joint action created more gridlocks and queued payments, and activation of the gridlock resolution algorithm led to settling queued payments on a net basis, thus achieving the desired liquidity savings. Engaging the gridlock mechanism lead to delay in settlement of some payments. However, our calculations show that this shift in behavior brought down the system-wide liquidity level by about 76% and caused only about 30 minutes’ delay to the system.

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

• Global supply chain pressures decreased again in April, falling to 1.32 standard deviations below the index’s historical average. The March value was revised downward from 1.06 to 1.15 standard deviations below the index’s historical average.
• There were significant downward contributions from Euro Area delivery times, Euro Area stocks of purchases, and Korean delivery times. While the overall index declined, there was a notable upward contribution from Taiwan stocks of purchases.
• Looking at the underlying data, the GSCPI’s recent downward trend has been consistently driven by improvements in Euro Area delivery times.

The TD takeover of First Horizon has been terminated:

Toronto-Dominion Bank and First Horizon Corp. have terminated TD’s proposed US$13.4-billion takeover of the Memphis, Tenn.-based bank, killing the Canadian lender’s expansion in the southeast United States.
…
First Horizon’s share price fell sharply when markets opened, and was down 36 per cent to US$9.60 in early trading. TD’s share price rose 1.7 per cent to $82.89 on the Toronto Stock Exchange.

In recent months, TD investors had expressed concerns about the valuation and timing of the First Horizon deal because the banking sector is struggling and share prices have dropped. There were also questions about TD’s ability to turn around a business that was generating subpar growth and that had faced integration issues of its own [from] a prior merger, according to National Bank Financial analyst Gabriel Dechaine.

Charlotte Gerken, Executive Director of Insurance Supervision of the Bank of England, gave a speech titled Moderation in all things:

From historic lows of 0.1% in December 2021, the UK Bank rate rose to 4.25% in March 2023. While it could hardly be described as plain sailing for pension schemes or their sponsors, the rise in interest rates has generally reduced the value of their liabilities and boosted funding ratios (see chart 1). This has greatly improved the affordability of buy-outs for many pension schemes.

At the same time, trustees of pension schemes are reported to be increasingly viewing buy-outs as a long-term target[4]. Increased affordability and a decreased appetite to retain this risk have led to a growing appetite for schemes to transact in one go, rather than perform staged buy-ins spread over several years[5]. So called ‘jumbo’ schemes may also present exciting opportunities for the insurers. This all points to a material increase in pension schemes’ demand for BPA in 2023. But I’d note that this is an acceleration of the existing demand for BPA in a large but finite market in run-off (see chart 2 and 3).
…
Secondly, the disruption in the UK gilt market last autumn resulted in some pension schemes being overweight in illiquid assets[7] as gilt values fell significantly, and schemes sought to reduce their leverage under liability driven investment strategies[8]. We see insurers increasingly developing solutions to accept illiquid assets as part of the BPA premium, as pension schemes may be reluctant to dispose of these assets in the open market, potentially at a large discount. This requires significant due diligence, and we are seeing insurers seeking more advice from third party specialists such as property valuation experts both for illiquid asset valuation and to calibrate adequate market value haircuts. Alternatively, we have seen deferrals of premiums incorporated in deals giving pension schemes time to dispose of such assets in an orderly fashion[9]. These premium arrangements can be complex and potentially capital intensive due to the increased uncertainty they can create.
…
Related to that point, the third area I would like to touch on is a key aspect of the changing pensions and insurance landscape. One industry estimate, suggests that the UK life insurance industry could onboard more than £500bn of pension liabilities – and associated assets – over the coming decade[13] [14]. This is a big structural change in the control of long-term investments in the UK, and the decisions that insurers make now will have long term consequences for the performance and development of the broader economy.

The Fed released its FOMC Statement on schedule:

Economic activity expanded at a modest pace in the first quarter. Job gains have been robust in recent months, and the unemployment rate has remained low. Inflation remains elevated.

The U.S. banking system is sound and resilient. Tighter credit conditions for households and businesses are likely to weigh on economic activity, hiring, and inflation. The extent of these effects remains uncertain. The Committee remains highly attentive to inflation risks.

The Committee seeks to achieve maximum employment and inflation at the rate of 2 percent over the longer run. In support of these goals, the Committee decided to raise the target range for the federal funds rate to 5 to 5-1/4 percent. The Committee will closely monitor incoming information and assess the implications for monetary policy. In determining the extent to which additional policy firming may be appropriate to return inflation to 2 percent over time, the Committee will take into account the cumulative tightening of monetary policy, the lags with which monetary policy affects economic activity and inflation, and economic and financial developments. In addition, the Committee will continue reducing its holdings of Treasury securities and agency debt and agency mortgage-backed securities, as described in its previously announced plans. The Committee is strongly committed to returning inflation to its 2 percent objective.

In assessing the appropriate stance of monetary policy, the Committee will continue to monitor the implications of incoming information for the economic outlook. The Committee would be prepared to adjust the stance of monetary policy as appropriate if risks emerge that could impede the attainment of the Committee’s goals. The Committee’s assessments will take into account a wide range of information, including readings on labor market conditions, inflation pressures and inflation expectations, and financial and international developments.

Voting for the monetary policy action were Jerome H. Powell, Chair; John C. Williams, Vice Chair; Michael S. Barr; Michelle W. Bowman; Lisa D. Cook; Austan D. Goolsbee; Patrick Harker; Philip N. Jefferson; Neel Kashkari; Lorie K. Logan; and Christopher J. Waller.

For media inquiries, please email media@frb.gov or call 202-452-2955.

The NYT points out:

But in their statement announcing the decision, policymakers also indicated that they will watch to see whether future rate moves are necessary. That marks a shift in stance: For months, they had assumed that additional changes would be needed.

The change opens the door to a possible pause in Fed interest rate increases, but it also leaves central bankers with options. Officials could raise rates by more if the economy and inflation prove hot.
…
Investor bets on where interest rates go from here are firmly tilted toward a pause and then lower interest rates later in the year. One calculation put the likelihood the Fed holds off changing interest rates when it next meets in June at 80 percent.
…
Stocks rose after the Fed raised rates and omitted previous language in its statement that signaled more rate increases to come, ushering in the pause investors had hoped for. The S&P 500 rose 0.4 percent.
…
The yield on two-year government bonds, which are sensitive to changes in interest rates, latched on to the potential pause, falling to 3.93 percent.
…
Cutting interest rates this year is “not in our forecast” says Powell, in response to a question about investors already pricing in swift cuts to interest rates as soon as September.
…
The S&P 500 skidded at the end of Powell’s press conference, down 0.5 percent, having initially reacted to the Fed’s policy announcement positively. Investors appeared to react to Powell repeating that the central bank does not expect to cut interest rates this year, with interest rates remaining higher for longer weighing on the market.

PerpetualDiscounts now yield 6.24%, equivalent to 8.11% interest at the standard equivalency factor of 1.3x. Long corporates yielded 4.87% on 2023-4-28 and since then the closing price has changed from 15.38 to 15.47, an increase of 59bp in price, with a Duration of 12.42 (BMO doesn’t specify whether this is Macaulay or Modified Duration; I will assume Modified) which implies a decrease in yield of about 5bp since 4/28 to 4.82%, so the pre-tax interest-equivalent spread (in this context, the “Seniority Spread”) has widened to about 330bp from the 315bp reported April 26.

Still no time!

First Republic finally succumbed:

Regulators seized control of First Republic Bank and sold it to JPMorgan Chase on Monday, a dramatic move aimed at curbing a two-month banking crisis that has rattled the financial system.

First Republic, whose assets were battered by the rise in interest rates, had struggled to stay alive after two other lenders collapsed last month, spooking depositors and investors.

First Republic was taken over by the Federal Deposit Insurance Corporation and immediately sold to JPMorgan. The deal was announced hours before U.S. markets are set to open, and after a scramble by officials over the weekend.
…
JPMorgan will “assume all of the deposits and substantially all of the assets of First Republic Bank,” the F.D.I.C. said in a statement. The regulator estimated that its insurance fund would have to pay out about $13 billion to cover First Republic’s losses. JPMorgan also said that the F.D.I.C. would provide it with $50 billion in financing.
…
By last week, after an alarming earnings report in which the bank disclosed that customers had withdrawn more than half of its deposits, it became clear that there was no option outside a government takeover.
…
Like the other two failed banks — Silicon Valley Bank and Signature — First Republic collapsed under the weight of loans and investments that lost billions of dollars in value as the Federal Reserve rapidly raised interest rates to fight inflation.
…
Other regional lenders, like Utah’s Zions Bank and PacWest of Los Angeles, have firmed their footing faster than First Republic, and bank analysts do not see another collapse as imminent. The stocks of every other bank in the S&P 500 stock index rose on Friday even as First Republic’s shares ended the day down more than 40 percent in anticipation of the government takeover.

Sic transit gloria mundi!

I still have no time to catch up on all the links I have saved …

So here’s the 2023-4-28 report, very late, but it’s here! I have all kinds of links to discuss, but they’ll just have to wait!