PrefBlog

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.
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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.
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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.
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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.
…
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.
…
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.

The Fed hiked its policy rate 25bp today:

Recent indicators point to modest growth in spending and production. Job gains have picked up in recent months and are running at a robust pace; the unemployment rate has remained low. Inflation remains elevated.

The U.S. banking system is sound and resilient. Recent developments are likely to result in tighter credit conditions for households and businesses and to weigh on economic activity, hiring, and inflation. The extent of these effects is 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 4-3/4 to 5 percent. The Committee will closely monitor incoming information and assess the implications for monetary policy. The Committee anticipates that some additional policy firming may be appropriate in order to attain a stance of monetary policy that is sufficiently restrictive to return inflation to 2 percent over time. In determining the extent of future increases in the target range, 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.

The economic projections were also released. The dot-plot shows the policy rate above 5% for all of this year, above 4% in 2024,3%+ in 2025 (with projections showing a pronounced skew upwards) and longer run of about 2.5%.

US equities, after some volatility, decided not to like the decision and its accoutrements:

With minutes left until the official end of stock trading for the day, the S&P 500 has given up its earlier gains and is sliding toward a 1 percent loss. Despite acknowledging stress in the banking system, some investors have said the central bank was too dismissive of the extent of the pain still to come.
…
Powell makes an interesting nod toward the role of social media and other new factors in the speed of the deposit flight from Silicon Valley Bank. He says the rapid run on the bank was different from what the Fed has seen in the past, and suggests it will need to update regulation and supervision to keep pace.
…
Investors are hanging on every word Powell utters, swinging sharply higher and lower in response to his comments. Having risen as high as 0.9 percent, the S&P 500 is now 0.4 percent lower.
…
Powell draws a clear distinction between the Fed’s normal bond buying programs, which buy assets to push down long term interest rates, and the lending it is doing to banks right now to calm jitters. This is a question people often ask: Doesn’t emergency lending pump money into the system? One big distinction, in my mind, is that those emergency loans are snuffed out pretty quickly (one year max, in this case).
…
Powell, asked about Silicon Valley Bank, starts with the obvious: Its leaders, he says, “failed badly.”
…
A lot of lawmakers and analysts have worried about the Fed’s rate increases further destabilizing the financial industry. Powell basically just brushed those concerns away after being asked about them.

The BoC released its Summary of Governing Council deliberations:

Members of Governing Council were comfortable with the MPR outlook that inflation will continue to ease this year as monetary policy tightening works its way through the economy and base-year effects pull down 12-month rates of inflation. However, they remain concerned about the risk that inflation could get stuck materially above the 2% target. They discussed what needs to occur for inflation to return sustainably to target. Short-term inflation expectations need to come down, as do measures of core inflation. As well, competitive pressures need to return to normal to make businesses cautious about passing on higher input costs to final goods prices. That will require a better balance between demand and supply, so businesses worry more about losing customers if they increase prices. Unit labour costs also need to moderate, with some combination of slower wage growth and faster productivity growth. This is particularly important to ease inflation in prices for most services, which is proving sticky in the face of rising unit labour costs.

Governing Council also noted that, at 3.9%, growth in government spending in the fourth quarter was stronger than expected. They observed that sustained growth in government spending that is considerably faster than potential growth would boost domestic demand. The Bank will incorporate announced fiscal plans by federal and provincial governments into its updated projection in the next MPR on April 12.

Dr Sabine Mauderer, Member of the Executive Board of the Deutsche Bundesbank, gave a speech titled The return of inflation – here to stay?:

This also includes a solid resolution framework to deal with situations where shareholders and creditors of a troubled bank have to bear losses. On this matter, I would also like to reiterate what the ECB, the SRB and EBA have already pointed out earlier this week. In particular, common equity instruments are first in line to absorb any losses that occur.

Only after they have been fully used up would Additional Tier 1 (AT1) instruments be required to be written down. This approach has been consistently applied in past cases and will continue to guide the actions of the SRB and ECB banking supervision in crisis interventions.1 Additional Tier 1 – a market worth roughly EUR 250bn – is an important component of the capital structure of European banks.
…
In the short term, the policy focus is on bringing down cyclical inflation – largely deriving from the poly-crises of the past three years. However, there is another twist to the current challenge, which most of you will already be aware of and I will only briefly touch upon today.

Namely, is the era of structurally low inflation pressure coming to an end? After two decades of subdued price pressure, the tide may well have turned. Looking further ahead, changes in underlying trends could intensify inflationary pressures.

Some people refer to these challenges as the “three Ds”.

First, deglobalisation, driven by geopolitical tensions and a desire to reduce economic dependencies. Related processes have also become known as friendshoring or nearshoring.

Second, the decarbonisation of the economy, incentivised in particular through carbon pricing, could exert persistent upward pressure – and not just on energy prices.

Third, demographics – more precisely, the assumption that dwindling labour supply will continue to exert upward pressure on wages.

All these factors could turn out to be inflationary over the coming years. That is another reason why the Eurosystem must remain vigilant in this regard and ensure that inflation expectations remain well anchored around 2%.

DBRS has released its views on the implications of the Credit Suisse AT1 writedown. I have updated the post NVCC & Credit Suisse accordingly.

PerpetualDiscounts now yield 6.32%, equivalent to 8.22% interest at the standard equivalency factor of 1.3x. Long corporates yielded 4.93% on 2023-3-17 and since then the closing price has changed from 15.32 to 15.34, an increase of 13bp 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 a decline in yield of about 1bp since 3/17 to 4.92%, so the pre-tax interest-equivalent spread (in this context, the “Seniority Spread”) has narrowed substantially to about 330bp from the 350bp reported March 15.

TXPR closed at 549.00, up 0.65% on the day. Volume today was 848,480, third-lowest of the past 21 trading days.

CPD closed at 11.05, up 1.56% on the day. Volume was 129,960, fourth-highest of the past 21 trading days.

ZPR closed at 9.12, up 1.56% on the day. Volume was 152,100, below the median of the past 21 trading days.

Five-year Canada yields edged up to 3.00% today.

It was a good day all ’round:

Wall Street closed sharply higher on Tuesday as widespread fears over liquidity in the banking sector abated and market participants eyed the Federal Reserve, which is expected to conclude its two-day policy meeting on Wednesday with a 25-basis-point hike to its policy rate.

All three major U.S. stock indexes were bright green as the session closed, with energy, consumer discretionary and financials enjoying the most sizable gains.

Canada’s benchmark stock index also rose, closing at its highest level in a week, helped by gains in energy and financial shares after domestic data showed consumer prices easing more than expected in February.
…
Financial markets have now priced in an 83.4% likelihood of a 25 basis-point rate hike, and a 16.6% probability that the central bank will leave its policy rate unchanged, according to CME’s FedWatch tool.
…
Credit markets are continuing to bet an interest rate cut at the Bank of Canada is only months away. While they are currently pricing in only about a 12% chance of a cut next month, they are positioned for at least a quarter-point cut this summer, according to Refinitiv Eikon data late Tuesday.
…
Shares of First Republic Bank soared by 29.5%, the company’s biggest-ever one-day percentage jump as JPMorgan CEO Jamie Dimon leads talks with other big banks aimed at investing in the lender, according to the Wall Street Journal.

Canadian inflation is on the right path:

Canada’s annual inflation rate cooled more than expected in February, as a drop in gas prices and softer growth in shelter costs helped bring the consumer price index to its lowest level since January 2022, Statistics Canada data showed on Tuesday.

The annual inflation rate dropped to 5.2 per cent in February, beating economists’ forecast that it would fall to 5.4 per cent from 5.9 per cent in January. The annual rate deceleration from January to February was the largest in the headline CPI since April 2020, Statscan said.

Month-over-month, the consumer price index was up 0.4 per cent, again lower than a forecast 0.5 per cent gain.
…
Excluding food and energy, prices rose 4.8 per cent compared with a rise of 4.9 per cent in January.

There’s talk of higher deposit insurance limits in the US:

Representative Ro Khanna, Democrat of California, and other lawmakers are in talks about introducing bipartisan legislation as early as this week that would temporarily increase the deposit cap on transaction accounts, which are used for activities like payroll, with an eye on smaller banks. Such a move would potentially reprise a playbook used during the 2008 financial crisis and authorized at the onset of the coronavirus pandemic in 2020 to prevent depositors from pulling their money out.

Others, including Senator Elizabeth Warren, Democrat of Massachusetts, have suggested lifting the deposit cap altogether.
…
Many lawmakers have yet to solidify their positions and some have openly opposed lifting the cap, so it is not clear that legislation adjusting it even temporarily would pass. While such a move could calm nervous depositors, it could have drawbacks, including removing a big disincentive for banks to take on too much risk.
…
And in 2008, as panic coursed across Wall Street at the outset of the global financial crisis, the F.D.I.C. created a program that allowed for unlimited deposit insurance for transaction accounts that chose to join the program in exchange for an added fee.

Peter Conti-Brown, a financial historian and a legal scholar at the University of Pennsylvania, said the 2010 Dodd Frank law ended the option for the agencies to temporarily insure larger transaction accounts the way they did in 2008.

TXPR closed at 545.46, down 0.75% on the day. Volume today was 1.16-million, near the median of the past 21 trading days.

CPD closed at 10.88, down 0.82% on the day. Volume was 105,510, well above the median of the past 21 trading days.

ZPR closed at 8.98, down 0.88% on the day. Volume was 161,860, below the median of the past 21 trading days.

Five-year Canada yields increased to 2.98% today.

Equities did OK today:

U.S. and Canadian stocks ended higher on Monday after a deal to rescue Credit Suisse and central bank efforts to bolster confidence in the financial system relieved investors, while participants also weighed the likelihood of a pause in rate hikes from the Federal Reserve this week.
…
All of the major S&P 500 sectors ended higher, and the Cboe Volatility index – Wall Street’s fear gauge – fell.
…
The Dow Jones Industrial Average rose 382.6 points, or 1.2%, to 32,244.58, the S&P 500 gained 34.93 points, or 0.89%, to 3,951.57 and the Nasdaq Composite added 45.03 points, or 0.39%, to 11,675.54.
…
Canada’s main stock index was helped by gains for resource and financial shares. The S&P/TSX composite index ended up 131.71 points, or 0.7%, at 19,519.43.

The financial sector, which accounts for nearly 30% of the TSX, added 0.5%.
…
The two-year U.S. Treasury yield, which often moves in step with interest rate expectations, rose 7.8 basis points to 3.924% after sliding to 3.635% in Europe.

The U.S. two-year yield has plunged since it peaked on March 8 at a 15-year high of 5.084% following hawkish congressional testimony by Fed Chairman Jerome Powell.

The Canadian 2-year bond yield saw a similar rise on Monday. Money markets are pricing in interest cuts at both the Fed and the Bank of Canada by this summer. The next scheduled BoC policy decision is set for April 12.

The most interesting news of the day is the demise of Credit Suisse. This has been given its own post, as the regulatory actions raise questions like ‘What does NVCC really mean?’. However, Powell and Yellen applauded:

The following statement was released by Secretary of the Treasury Janet L. Yellen and Federal Reserve Board Chair Jerome H. Powell:

“We welcome the announcements by the Swiss authorities today to support financial stability. The capital and liquidity positions of the U.S. banking system are strong, and the U.S. financial system is resilient. We have been in close contact with our international counterparts to support their implementation.”

But, holy smokes, a lot of people are going to get fired:

The combination of the two businesses is expected to generate annual run-rate of cost reductions of more than USD 8 billion by 2027.

It’s beginning to look like Silicon Valley Bank really didn’t have a clue:

Silicon Valley Bank’s risky practices were on the Federal Reserve’s radar for more than a year — an awareness that proved insufficient to stop the bank’s demise.

The Fed repeatedly warned the bank that it had problems, according to a person familiar with the matter.

In 2021, a Fed review of the growing bank found serious weaknesses in how it was handling key risks. Supervisors at the Federal Reserve Bank of San Francisco, which oversaw Silicon Valley Bank, issued six citations. Those warnings, known as “matters requiring attention” and “matters requiring immediate attention,” flagged that the firm was doing a bad job of ensuring that it would have enough easy-to-tap cash on hand in the event of trouble.

But the bank did not fix its vulnerabilities. By July 2022, Silicon Valley Bank was in a full supervisory review — getting a more careful look — and was ultimately rated deficient for governance and controls. It was placed under a set of restrictions that prevented it from growing through acquisitions. Last autumn, staff members from the San Francisco Fed met with senior leaders at the firm to talk about their ability to gain access to enough cash in a crisis and possible exposure to losses as interest rates rose.
…
The picture that is emerging is one of a bank whose leaders failed to plan for a realistic future and neglected looming financial and operational problems, even as they were raised by Fed supervisors. For instance, according to a person familiar with the matter, executives at the firm were told of cybersecurity problems both by internal employees and by the Fed — but ignored the concerns.

Need to cheer up? Here’s a paper by Erica Xuewei Jiang, Gregor Matvos, Tomasz Piskorski and Amit Seru titled Monetary Tightening and U.S. Bank Fragility in 2023: Mark-to-Market Losses and Uninsured Depositor Runs?:

We analyze U.S. banks’ asset exposure to a recent rise in the interest rates with implications for financial stability. The U.S. banking system’s market value of assets is $2 trillion lower than suggested by their book value of assets accounting for loan portfolios held to maturity. Marked-to-market bank assets have declined by an average of 10% across all the banks, with the bottom 5th percentile experiencing a decline of 20%. We illustrate that uninsured leverage (i.e., Uninsured Debt/Assets) is the key to understanding whether these losses would lead to some banks in the U.S. becoming insolvent– unlike insured depositors, uninsured depositors stand to lose a part of their deposits if the bank fails, potentially giving them incentives to run. A case study of the recently failed Silicon Valley Bank (SVB) is illustrative. 10 percent of banks have larger unrecognized losses than those at SVB. Nor was SVB the worst capitalized bank, with 10 percent of banks having lower capitalization than SVB. On the other hand, SVB had a disproportional share of uninsured funding: only 1 percent of banks had higher uninsured leverage. Combined, losses and uninsured leverage provide incentives for an SVB uninsured depositor run. We compute similar incentives for the sample of all U.S. banks. Even if only half of uninsured depositors decide to withdraw, almost 190 banks are at a potential risk of impairment to insured depositors, with potentially $300 billion of insured deposits at risk. If uninsured deposit withdrawals cause even small fire sales, substantially more banks are at risk. Overall, these calculations suggest that recent declines in bank asset values very significantly increased the fragility of the US banking system to uninsured depositor runs.
…
Uninsured depositors represent a significant source of funding for commercial banks, accounting for about $9 trillion dollars of their liabilities, which can make runs a significant risk for these institutions.2 In fact, during the 1980s and 1990s, nearly one-third of savings and loan institutions failed due to losses incurred from long-term fixed-rate mortgages that declined in value when interest rates surged. This resulted in a substantial reduction in the net worth of the S&L industry.
…
We provide a simple analysis of U.S. banks’ asset exposure to a recent rise in the interest rates with implications for financial stability. The U.S. banking system’s market value of assets is $2 trillion lower than suggested by their book value of assets. We show that these losses, combined with a large share of uninsured deposits at some U.S. banks can impair their stability. Even if only half of uninsured depositors decide to withdraw, almost 190 banks are at a potential risk of impairment to even insured depositors, with potentially $300 billion of insured deposits at risk. If uninsured deposit withdrawals cause even small fire sales, substantially more banks are at risk. Overall, these calculations suggest that recent declines in bank asset values significantly increased the fragility of the US banking system to uninsured depositors runs (summarized in Table 1).

There are several medium-run regulatory responses one can consider to an uninsured deposit crisis. One is to expand even more complex banking regulation on how banks account for mark to market losses. However, such rules and regulation, implemented by myriad of regulators with overlapping jurisdictions might not address the core issue at hand consistently (Agarwal et al. 2014).10 Alternatively, banks could face stricter capital requirement, which would bring their capital ratios closer to less regulated lenders, as documented in Jiang et al (2020). Discussions of this nature remind us of the heated debate that occurred after the 2007 financial crisis, which many might argue did not result in sufficient progress on bank capital requirements (see Admati et al. 2013, 2014 and 2018).

Frankly, I find the paper somewhat unsatisfying, using non-standard terms and using somewhat alarmist language. But it’s interesting enough!

First Republic is now in the crosshairs:

First Republic, which has drawn potential suitors like Morgan Stanley, should sell itself or raise more capital quickly, after a $30 billion cash injection by bigger banks failed to assure markets. But its management still thinks it is worth more than the market does, while buyers believe they could get it for even less.

… with more detail available:

Just one day after the biggest U.S. banks gave it a $30 billion infusion, First Republic Bank was in talks to sell a piece of itself to other banks or private equity firms, three people with knowledge of the process said, an indication that the imperiled lender is far from conquering its troubles.

The deals under discussion, which would involve selling new shares, represent a fresh level of urgency for a bank that has been under mounting pressure since last week’s collapse of Silicon Valley Bank. First Republic had been working with advisers all week, exploring possible deals, and a transaction could still result in a full sale of the company. All the while, customers have been pulling deposits and the bank’s market value shrank to $4 billion on Friday from around $22 billion at the beginning of March.

But hope’s not helping much:

The most imperiled bank on Wall Street, First Republic, slid closer to the precipice on Monday as its shares fell 47 percent, down nearly 90 percent since its close on March 8, the day Silicon Valley Bank’s woes incited a financial panic.

The calamitous drop in First Republic’s stock price, even as shares of many of its peers steadied, highlights the fears that threaten to consume it. Until recently, the bank, based in San Francisco, boasted $176 billion in deposits and an enviable list of wealthy clientele.
…
The urgency only increased on Monday, after shares of First Republic fell so much that the New York Stock Exchange automatically halted trading 11 times to prevent a free fall. Monday’s rout also dealt a blow to the bank’s executives because, as recently as Sunday evening, senior leaders and board members were convinced that the bank had enough leeway and money from its own clients to weather further tumult, according to two people familiar with the bank’s discussions.

At the very least, they assumed First Republic had weeks, not days, to solve its problems, by either raising new capital or selling itself, one person with knowledge of the matter said.
…
First Republic lost roughly $70 billion in deposits in recent weeks — nearly half of its total depositor base as of the end of last year — said two people with knowledge of the matter.
…
First Republic has also seen several downgrades of its credit in recent days. On Friday, Moody’s said it was downgrading the bank because of its increased reliance on short-term borrowing, including from the Federal Reserve and the consortium of banks. Repaying interest on loans can be expensive for a bank that is trying to shore up its cash.
…
Standard & Poor’s, in its own downgrade on Sunday, said the bank continued to face “substantial business, liquidity, funding and profitability challenges.”

But at least Signature Bank is off the books:

The Office of the Comptroller of the Currency (OCC) announced today that it has conditionally approved Flagstar Bank, N.A., Hicksville, New York, to purchase assets and assume certain liabilities of Signature Bridge Bank, N.A., New York, New York.

The transaction includes the purchase by Flagstar Bank of certain loan portfolios from Signature Bridge Bank, N.A., that total $12.9 billion and the assumption of $34 billion in deposits. The OCC imposed conditions on the approval, including to require Flagstar Bank to allocate appropriate resources to the assets and liabilities acquired, and to require a supervisory non-objection prior to paying a dividend to shareholders.

And you know what’s back? USD swap lines!

The Bank of Canada, the Bank of England, the Bank of Japan, the European Central Bank, the Federal Reserve, and the Swiss National Bank are today announcing a coordinated action to enhance the provision of liquidity via the standing U.S. dollar liquidity swap line arrangements.

To improve the swap lines’ effectiveness in providing U.S. dollar funding, the central banks currently offering U.S. dollar operations have agreed to increase the frequency of 7-day maturity operations from weekly to daily. These daily operations will commence on Monday, March 20, 2023, and will continue at least through the end of April.

The network of swap lines among these central banks is a set of available standing facilities and serve as an important liquidity backstop to ease strains in global funding markets, thereby helping to mitigate the effects of such strains on the supply of credit to households and businesses.

It’s been a while since we saw those!

TXPR closed at 549.90, up 0.54% on the day. Volume today was 926,050, below the median of the past 21 trading days.

CPD closed at 10.97, down 0.72% on the day. Volume was 49,780, third-lowest of the past 21 trading days.

ZPR closed at 9.06, down 0.22% on the day. Volume was 88,280, second-lowest of the past 21 trading days.

Five-year Canada yields plummetted back down to 2.92% today.

Equities were hit again; pundits blamed, basically, uncertainty:

Wall Street closed sharply lower on Friday, marking the end of a tumultuous week dominated by an unfolding crisis in the banking sector and the gathering storm clouds of possible recession.

All three indexes ended the session deep in negative territory, with financial stocks down the most among the major sectors of the S&P 500.

Canada’s main stock index also fell, dragged down by losses in financial and energy stocks as fears of a global banking meltdown continued to plague investors. But losses were a little more modest.

The S&P/TSX composite index was down 152.83, or 0.77%, at 19,387.72, its second straight week of losses. For the week, it was down 1.8%.

While the benchmark S&P 500 ended higher than last Friday’s close, the Nasdaq and the Dow posted weekly declines.
…
Over the last two weeks, the S&P Banking index and the KBW Regional Banking index plunged by 4.6% and 5.4%, respectively, their largest two-week drops since March 2020.

First Republic Bank plunged 32.8% after the bank announced it was suspending its dividend, reversing Thursday’s surge which was sparked by an unprecedented $30 billion rescue package from large financial institutions

Among First Republic’s peers, PacWest Bancorp fell 19.0% while Western Alliance slid 15.1%.

U.S.-traded shares of Credit Suisse also closed sharply lower, down 6.9%.
…
At last glance, financial markets have priced in a 60.5% likelihood that the central bank will raise its key target rate by 25 basis points, and a 39.5% probability that it will let the current rate stand, according to CME’s FedWatch tool.

Uncertainly over what the Fed will do at its policy meeting next week and beyond, and the overall volatile credit markets, also have investors betting interest cuts are in the cards at the Bank of Canada. As of late Friday, money markets were placing 45% odds the bank will cut its trend-setting overnight rate next month by a quarter of a percentage point. Markets are pricing in more than 50 basis points of easing by July.

Bond market volatility is high:

In 2008, and again in early 2020 during the shocking early days of COVID-19, bond yields collapsed as investors braced for tumbling interest rates.

This time, however, traders are torn between two scenarios. They can bet on rates continuing their historically fast upward march to combat inflation, as U.S. Federal Reserve chair Jerome Powell suggested last week was still necessary, and that the European Central Bank reinforced this week by hiking its own benchmark rate by half a percentage point.

Or fixed income investors can decide the contagion effects of regional bank failures in the United States and the near-collapse of Credit Suisse in Europe will spawn a broader economic crisis requiring interest rates to fall back toward zero.
…
The Merrill Lynch Option Volatility Estimate, or MOVE Index, which tracks the implied volatility of U.S. Treasury bonds, hit its highest level since 2009 this week.

And with respect to US banks:

The shares of many banks resumed their dizzying slide, erasing gains from Thursday that had provided a brief moment of calm during a tumultuous week. First Republic, the beleaguered regional lender, lost a third of its already beaten-down value on Friday alone. The S&P 500 stock index fell about 1.1 percent — the week’s worst day of trading.

President Biden asked Congress on Friday to grant financial regulators broad new powers to punish the executives of failed lenders. A day earlier, data showed that banks in the United States borrowed record amounts from the Federal Reserve this week to meet short-term needs, another sign of acute stresses in the financial system.
…
The KBW bank index, which tracks the performance of 24 US banks, skidded more than 5 percent and has lost over 20 percent of its value this year, versus a small gain in the broader market over that period.
…
Other signs of anxiety also persisted. Data from the Federal Reserve released on Thursday showed that banks borrowed record amounts of emergency funds from the central bank in recent days, tapping both existing facilities and a new program to shore up liquidity that was announced after the seizure of Silicon Valley Bank and Signature.

How much at the discount window?

Banks took an all-time high $152.9 billion from the Fed’s traditional lender-of-last resort facility known as the discount window as of Wednesday, while also taking $11.9 billion in loans from the Fed’s newly created Bank Term Lending Program. The discount window jump crashed through the prior record of $112 billion in the fall of 2008, during the most acute phase of the financial crisis.
…
Including more than $140 billion in other funding provided to the new bridge banks for Silicon Valley Bank and Signature Bank established by the Federal Deposit Insurance Corp, the central bank’s total balance sheet mushroomed by roughly $300 billion in the last week. That reverses a substantial portion of the balance sheet reduction accomplished since last summer.

To put that in perspective:

And what does Biden want additional rules for?

One plank of the proposal would broaden the F.D.I.C.’s ability to seek the return of compensation from executives of failed banks, in response to reports that the chief executive of Silicon Valley Bank sold $3 million in shares of the bank shortly before federal regulators took it over a week ago. Regulators’ current clawback powers are limited to the largest banks; Mr. Biden would expand them to cover banks the size of Signature and Silicon Valley Bank.
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The president is also asking Congress to lower a legal bar that the F.D.I.C. must clear in order to bar an executive from a failed bank from working elsewhere in the financial industry. That ability currently applies only to executives who engage in “willful or continuing disregard for the safety and soundness” of their institutions. He is similarly seeking to broaden the agency’s ability to impose fines on executives whose actions contribute to the failure of their banks.
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The chair of the Senate Banking Committee, Sherrod Brown of Ohio, said in a statement emailed to reporters that regulators needed “stronger rules to rein in risky behavior and catch incompetence.”

He added that in addition to executives who had failed at their duties, there should be a way to hold accountable the “regulators tasked with overseeing them.”

The good old American puritanical streak. If anything goes wrong, it must be somebody’s fault and they must be punished!

There are more mechanical complications, which I fail to understand:

I am concerned by reports of retail investors being unable to exercise options they purchased on Silicon Valley Bank and Signature Bank stock.[1] I am hopeful that broker-dealers and clearing agencies will make efforts to assist retail investors in exercising their options if the investors wish to do so, including by exploring possible cash settlements. In addition, I hope that FINRA and my colleagues at the SEC will move forward with efforts to establish a comprehensive regulatory framework around complex products, including options, which are risky and can expose an investor to sudden and severe losses.[2]

Huh?:

Retail options traders who thought they hit the jackpot with their wagers against the stock of Silicon Valley Bank and Signature Bank are now finding themselves in a world of hurt. Despite the collapse of the banks, the traders are unable to cash in on their put options after brokers halted trading in the stocks, leaving them with worthless contracts set to expire Friday.
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“On expiration day, Interactive Brokers will allow customers to manually exercise any of their expiring option positions in SIVBVB -2.3% and SBNY, as long as their account is sufficiently funded and has the permissions required to carry the stock position that will result from the exercise,” the broker’s statement read. “Per OCC, no options in those series will be automatically exercised.” The OCC would be the Options Clearing Corporation. They’re the biggest equity derivatives clearinghouse in the world, serving as the middleman between buyers and sellers tasked with making sure that everyone is playing by the rules and set to get paid what they’re entitled.
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Of course, if the stock doesn’t start trading again by Friday, there won’t be much point in exercising the options. That’s because the stock prices they’re tied to won’t reflect the current reality — that they’re worthless — but rather the price before trading stopped.

And:

There are about 7,660 put options on SVB Financial worth a notional $114 million due to expire Friday and another 22,347 worth $178 million on Signature, according to Bloomberg calculations based on the last trading session for each stock. Assuming the banks’ shares are now worthless, they all represent winning bets.

The Options Clearing Corp., which provides clearing and settlement services for derivatives, announced Tuesday that its usual process of automatically exercising options would not happen for contracts tied to Signature and SVB. That’s because when shares aren’t trading, there’s technically no way to value them and determine which options are in-the-money.
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Meanwhile, margin risk is adding a further complication, according to Steve Sosnick, chief strategist at Interactive Brokers. That’s because the amount of collateral a trader needs to deposit in an account is tied to the last closing price of the underlying stock.

For SVB that was $106.04, and for Signature it was $70. In other words, even if a trader sold a $30 put on SVB, they’d still need to have sufficient funds in the account to cover the position as if it was valued at $106.04.

“You may find yourself in margin deficit as the short position is immediately marked to the last traded price,” Sosnick said. “And that position will persist until the Depository Trust Company or the Options Clearing Corp. make a determination of the final value. That could take some time.”

I can’t believe that there’s no established procedure for this. There’s a regulatory failure, if you’re looking for one!

The IMF has published several articles on monetary policy:

Soaring prices were a surprise from the perspective of precrisis policy frameworks, especially for advanced economies. Empirical evidence suggested that inflation rose by only a small amount when unemployment declined, consistent with a very flat Phillips curve. This evidence was reinforced by the pre-pandemic experience of inflation that remained tepid even as monetary stimulus pushed unemployment to very low levels.

However, these models embedding a low Phillips curve slope did a poor job of explaining the pandemic-related surge in prices. Most inflation forecasts based on these models, including ours at the IMF, significantly underpredicted inflation.

While high inflation partly reflects unusual developments, some forecast errors likely reflect our misunderstanding of the Phillips curve and the supply side of the economy.

While the standard Phillips curve links inflation to the unemployment gap, the rapid employment recovery may have played a significant role in driving inflation, implying that “speed effects” matter more than previously thought. There may also be important nonlinearities in the Phillips curve slope: price and wage pressures from falling unemployment become more acute when the economy is running hot than when it’s below full employment. Finally, surging goods inflation during the recovery—when constraints on supply and demand for services meant massive stimulus fell heavily on goods—suggests the importance of capacity constraints at the sectoral, as well as aggregate, level.

And HOOPP did very well:

The Healthcare of Ontario Pension Plan (HOOPP), long a top performer among Canada’s big pension plans, swung to a loss in 2022, its first in 14 years.

HOOPP said Friday it posted a loss of 8.60 per cent on its investment portfolio, cutting its assets to $103.7-billion at year end.

The plan, which serves 435,000 active and retired Ontario health care workers at more than 630 employers, dipped to its lowest level of funding since 2014 – but that funding ratio, which compares its assets with the future benefits it owes members, still stood at 117 per cent, down from 120 per cent at the end of 2021.
…
[Chief Investment Officer] Mr. Wissell said despite the overall loss, HOOPP beat its benchmark – what a similar portfolio should have been expected to return – by 4.61 percentage points. And each investment department outperformed its benchmark, “across the board,” he said.

HOOPP’s 10-year annualized return as of the end of 2022 was 8.35 per cent.

“What we say here is, we’re in the pension delivery business. We’re not in the money-management business, so against that backdrop, we’re pleased that we remain fully funded,” Mr. Wissell said.

TXPR closed at 546.67, up 1.39% on the day. Volume today was 1.06-million, near the median of the past 21 trading days.

CPD closed at 11.05, up 2.13% on the day. Volume was 177,600, second-highest of the past 21 trading days.

ZPR closed at 9.08, up 1.68% on the day. Volume was 181,000, near the median of the past 21 trading days.

Five-year Canada yields roared up to 3.08% today.

First Republic got a huge deposit infusion from its rivals:

Less than a week after the sudden collapse of a trio of smaller banks dented the confidence of depositors across the country, a group of 11 banks reached a $30 billion deal to prop up another lender caught in the turmoil.

First Republic Bank, which has been at the center of the crisis engulfing a sliver of the banking industry, will receive a huge injection of deposits from other lenders in a bid to stave off a collapse, the banks said on Thursday.

Four of the country’s biggest banks — JPMorgan Chase, Bank of America, Citigroup and Wells Fargo — agreed to contribute $5 billion each. Goldman Sachs and Morgan Stanley will contribute $2.5 billion each and BNY Mellon, PNC Bank, State Street, Truist and US Bank will each add $1 billion.

The deposits are uninsured, the banks said — effectively making them votes of confidence in First Republic’s future. In announcing the deposits, the banks said recent events did nothing to undermine the banking system but that they were deploying their financial strength “where it is needed the most.”

Apparently:

The plan for the rescue deal first emerged on Tuesday during a coordination call between Treasury Secretary Yellen and Jerome H. Powell, the chairman of the Federal Reserve, according to a person familiar with discussions.

The idea was first proposed by Yellen, who believed that bringing banks to inject money into First Republic would be a strong sign of private sector support and confidence in the banking system, this person said.

Shortly after Jamie Dimon, the chief executive of JPMorgan Chase, called Yellen to check in and she proposed the idea. He started wrangling bank executives while she called with business leaders and regulators.

Over the next 48 hours, the group of interested banks grew. On Thursday morning, Yellen – before she was scheduled to testify before the Senate Finance Committee – convened a call with the regulators and bank CEOs to finalize the deal.

Following the hearing, Dimon came to meet Yellen in her office to finalize things ahead of the announcement.

I don’t get it. What’s in this deal for the depositing banks? Can it really be that the show of confidence will calm conditions so that their profits grow in the forseeable future? Or is this just arm-twisting by the feds as the world moves deeper into State Capitalism territory?

Credit Suisse got more traditional support:

Credit Suisse said it would borrow up to 50 billion Swiss francs ($53.7 billion) from the Swiss National Bank, taking advantage of a lifeline offered by the central bank late Wednesday after the lender’s stock had crashed as much as 30% to a new record low. It also said it would buy back some of its own debt.
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Credit Suisse’s shares soared 32% at the open but erased some of those gains to close up 19% in Zurich. The cost of buying insurance against the risk of default by the bank eased back from record highs hit Wednesday.

The bank has lost about a quarter of its stock market value since the start of 2023, and more than 70% in the past 12 months, as a series of scandals, missteps and compliance failures have steadily undermined the confidence of investors and clients.
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Customers withdrew 123 billion Swiss francs ($133 billion) from Credit Suisse in 2022 — mostly in the fourth quarter — and the bank reported in February an annual net loss of nearly 7.3 billion Swiss francs ($7.9 billion), its biggest since the global financial crisis in 2008.

Nonetheless, DBRS downgraded Credit Suisse:

DBRS Ratings Limited (DBRS Morningstar) downgraded the Long-Term Issuer Rating of Credit Suisse AG (the Bank) to ‘BBB’ from ‘A (low)’ and the Long-Term Issuer Rating of Credit Suisse Group AG (Credit Suisse, CSG or the Group), the top-level holding company to ‘BBB (low)’ from ‘BBB (high)’. The Bank’s Short-Term Issuer ratings was downgraded to R-2 (high), and CSG’s Short-Term Issuer ratings was downgraded to R-2 (middle). The trend is Negative on all ratings. The Intrinsic Assessment (IA) for the Bank is ‘BBB’, and the Support Assessment is SA1. The Group’s Support Assessment is SA3. See the full list of ratings in the table at the end of this press release.

KEY RATING CONSIDERATIONS

The downgrade of Credit Suisse AG’s Long-Term ratings to BBB takes into account DBRS Morningstar’s view that CSG continues to report missteps and compliance failures, resulting in a visible weakening of the franchise as evidenced by the high level of deposit outflows in Q4 2022, alongside high costs. Today’s rating action reflects DBRS Morningstar’s increasing concerns over the Group’s ability to restore stakeholders’ confidence. The current market volatility affecting the financial sector globally has added to the negative impact resulting from CSG’s recent compliance failures, and this has led to a significant decline in Credit Suisse’s market capitalisation. In addition, the Wealth Management division, Credit Suisse’s core franchise, has not been as resilient as expected and this weakness appears likely to continue.

There has been a lot of talk that bank-sector market chaos might cause the Fed to pause. Well, maybe, but here’s what Christine Lagarde had to say:

Good afternoon, the Vice-President and I welcome you to our press conference.

Inflation is projected to remain too high for too long. Therefore, the Governing Council today decided to increase the three key ECB interest rates by 50 basis points, in line with our determination to ensure the timely return of inflation to our two per cent medium-term target. The elevated level of uncertainty reinforces the importance of a data-dependent approach to our policy rate decisions, which will be determined by our assessment of the inflation outlook in light of the incoming economic and financial data, the dynamics of underlying inflation, and the strength of monetary policy transmission.

We are monitoring current market tensions closely and stand ready to respond as necessary to preserve price stability and financial stability in the euro area. The euro area banking sector is resilient, with strong capital and liquidity positions. In any case, our policy toolkit is fully equipped to provide liquidity support to the euro area financial system if needed and to preserve the smooth transmission of monetary policy.

The new ECB staff macroeconomic projections were finalised in early March before the recent emergence of financial market tensions. As such, these tensions imply additional uncertainty around the baseline assessments of inflation and growth. Prior to these latest developments, the baseline path for headline inflation had already been revised down, mainly owing to a smaller contribution from energy prices than previously expected. ECB staff now see inflation averaging 5.3 per cent in 2023, 2.9 per cent in 2024 and 2.1 per cent in 2025. At the same time, underlying price pressures remain strong. Inflation excluding energy and food continued to increase in February and ECB staff expect it to average 4.6 per cent in 2023, which is higher than foreseen in the December projections. Subsequently, it is projected to come down to 2.5 per cent in 2024 and 2.2 per cent in 2025, as the upward pressures from past supply shocks and the reopening of the economy fade out and as tighter monetary policy increasingly dampens demand.

The baseline projections for growth in 2023 have been revised up to an average of 1.0 per cent as a result of both the decline in energy prices and the economy’s greater resilience to the challenging international environment. ECB staff then expect growth to pick up further, to 1.6 per cent, in both 2024 and 2025, underpinned by a robust labour market, improving confidence and a recovery in real incomes. At the same time, the pick-up in growth in 2024 and 2025 is weaker than projected in December, owing to the tightening of monetary policy.

The decisions taken today are set out in a press release available on our website.

I will now outline in more detail how we see the economy and inflation developing and will then explain our assessment of financial and monetary conditions.
…
Summing up, inflation is projected to remain too high for too long. Therefore, the Governing Council today decided to increase the three key ECB interest rates by 50 basis points, in line with our determination to ensure the timely return of inflation to our two per cent medium-term target. The elevated level of uncertainty reinforces the importance of a data-dependent approach to our policy rate decisions, which will be determined by our assessment of the inflation outlook in light of the incoming economic and financial data, the dynamics of underlying inflation, and the strength of monetary policy transmission. We are monitoring current market tensions closely and stand ready to respond as necessary to preserve price stability and financial stability in the euro area.

In any case, we stand ready to adjust all of our instruments within our mandate to ensure that inflation returns to our medium-term target and to preserve the smooth functioning of monetary policy transmission.

We are now ready to take your questions.