East Coast Economics

Posts Tagged ‘Fed

What I Missed, And What I Make Of It

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After having been blissfully unaware of any economic and market news since the end of March I am back in Boston, and it’s time  for me to get back into the game.  I’m still in the process of catching up, but here’s what I think the key developments over the last few months were:

1.  The market hit a (temporary) bottom in early March.  The Dow Jones is back at around 9,550, roughly 45% above its March 9 low of 6,547.05.  Similarly, the S&P500 is somewhere north of 50% above its March low.  At the same time, 30 year  Treasury yields are back in the neighborhood of 4.35% after having hit a bottom at 2.55% in late December 2008.

2.  Both Chrysler and GM declared bankruptcy; the two firms emerged from bankruptcy after no more than a few weeks each.  In addition to the troubled automakers there were 84 bank failures in 2009 through August, a full 63 of which occurred in between the end of April and now. 24 of those bankruptcies occurred in July, another 15 in August.

3. The US economy seems to recover, albeit slowly.  Unemployment stands at 9.4% but negative GDP growth slowed to -1.0% over the second quarter and durable goods orders were up.  Re-appointed Fed Chairman Ben Bernanke suggested in his speech last week that we have the worst behind us in this “most severe financial crisis since the Great Depression.”

But do we really?  Is the rally in the stock markets actually sustainable, especially without analogous interest rate increases?  What happens if the dollar crashes?  What if inflation picks up?  The futures markets do not seem particularly worried at the moment:  implied probability has the Fed Funds rate steady at 0.25% through the end of 2009 and then suggests and increase to 1.0% towards the end of the first quarter of 2010, suggesting steady progress on the course towards economic recovery.

My own conclusion at this point is simple: I’m at a loss.  I don’t see what should justify a stock market rally of the magnitude that we have seen.  I do see optimism that isn’t based on any real data (if you disagree please let us know!), and I believe that there’s a systemic problem lurking in the financial system that we prefer to ignore:  all the money that has been printed over the course of the last year.  When you look at the US monetary base and the level of excess reserves of depository institutions, the picture doesn’t look much different from seven months ago when I first wrote about it.

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Bernanke suggested last week that “the continuing provision of liquidity and a tightening of the regulatory framework are key” to keep financial markets functioning properly.  It’s blatantly obvious that the provision of liquidity remains a top priority of the Fed at the moment, and our monetary base and excess reserves are still at levels that are barely different from the end of 2008 when the crisis was in full swing.  Looking at these charts doesn’t make me confident that we have the worst behind us. Or maybe we do, and what we are looking at is a systemic change in the financial system.  What do you think?

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Written by eastcoasteconomics

August 31, 2009 at 12:52 am

The Stressfree Stress Test

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The Fed et al published their guidelines for the Supervisory Capital Assessment Program today, defining the parameters for the base case and adverse scenarios to be used in the bank stress tests.  As Paul Krugman points out the stress test scenarios are somewhat of a letdown.  The summary table below show the base case and adverse scenario assumptions for GDP growth, unemployment and home price appreciation over the next two years.  The original can be found here.

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I was under the impression that a stress test should be designed to take a look at possible outcomes under extreme scenarios.  To me, the above hardly seems extreme – especially when comparing the HPA and unemployment numbers to what some of the MBS  hedge fund managers I talk to on a regular basis tell me they are using as their “conservative” assumptions: -35% for home prices, unemployment in the mid teens.  Is the government putting the banks through a useless exercise?

Written by eastcoasteconomics

February 25, 2009 at 5:52 pm

The Fed & Bank Borrowing

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I’m currently doing some research on the (likely) Treasury bubble, and the charts I’m coming across are nothing but scary – one more so than the other.  Check out the following which shows the $$$ amount borrowed by US banks from the Fed through Dec 2007; the spike marks the Savings & Loan Crisis at the end of the 1980s with borrowing maxing out at $8b.

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Now take a look at the following chart.  It is the same graph as above, but updated through the beginning of November ’08.

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This might be less scary if the Fed wasn’t creating money out of thin air and at the same time accepting assets of questionable – and deliberately undisclosed – quality as collateral from banks.  As it stands, I am not surprised that 10 year CDS on US Treasuries are above 60bps (high of 72bps at the beginning of December vs. a pre-08 historical average of 2bps).

[The charts above are publicly available from the St Louis Fed; I first came across the idea of presenting the two graphs in progression in a letter by DK Matai.]

Written by eastcoasteconomics

January 7, 2009 at 10:23 pm

Posted in Monetary Policy

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