Did The Fed "Pull A Homer"?

In an early episode of The Simpsons, “Homer Defined,” Homer saves the nuclear plant from meltdown by randomly pushing a button on the control panel. Soon “to pull a Homer,” meaning to “succeed despite idiocy," becomes a popular catchphrase.

Is that what happened last week? Did Jerome Powell and the Federal Reserve inadvertently “pull a Homer” by helping to create a bank panic that actually might accelerate their desire to slow down the economy? That might not have been their intention, but it sure looks like it.

At least it does to former White House adviser and Goldman Sachs President Gary Cohn (although he didn’t reference The Simpsons).

"We're almost getting to a point right now where he's outsourcing monetary policy," Cohn told CNBC, referring to Powell. “I don't believe they [the banks] are going to loan money, or as much money, and therefore we're going to see a natural contraction in the economy.”

Minneapolis Fed president Neel Kashkari said basically the same thing on CBS’s Face the Nation Sunday.

"It definitely brings us closer [to recession]," Kashkari said. "What's unclear for us is how much of these banking stresses are leading to a widespread credit crunch. That credit crunch ... would then slow down the economy.”

Now, I sincerely doubt that the Fed deliberately phonied up a banking panic in order to put the brakes on the economy.

Just the same, though, it certainly did play a major role in creating one not just through monetary policy — by raising interest rates so high and so fast — but also through neglect.

Just as it did in the road leading up to the global financial crisis, the Fed allowed problems at several banks it regulated to reach the point that generated an electronic run on deposits and the banks’ eventual failure. Continue reading "Did The Fed "Pull A Homer"?"

ETFs For Rising Consumer Debt

According to The New York Federal Reserve, consumer debt is at record highs.

At the end of 2022, U.S. consumer debt across all categories totaled $16.9 trillion. That was an increase of $1.3 trillion from one year ago. What's more alarming is that in 2019, the total U.S. consumer debt was $14.14 trillion.

So, while higher interest rates likely fueled some of the increase from 2021 to 2022, increasing consumer debt had occurred even before the Federal Reserve began its rate hikes.

What is concerning about the increasing consumer debt is what it says about the future of our economy. In 2017, the International Monetary Fund released a report that showed a correlation between rising consumer debt and the economy's health. The IMF concluded that rising consumer debt was good for the economy in the short term.

For example, the more consumers take out auto loans, the more the automotive industry, from the auto parts manufacturers to the big auto manufacturers to even the auto dealers, will experience an increase in labor needs. This increase reduces unemployment, which increases overall economic activity and spurs the economy.

Consumer debt rises related to the housing industry have the same effect but on an even larger scale. It's been reported that for every new home built in the U.S., 1.5 new jobs are created.

The IMF study clearly says that while consumer debt is increasing, there are economic benefits. But, in three to five years, those positive effects are reversed. The report states that growth is slower than it would have been if the debt had not increased, and more importantly, the odds of a financial crisis increased.

The IMF went into detail about how much consumer debt needs to grow in order to raise the likelihood of a financial crisis. Their calculations indicate that a five percent increase in the ratio of household debt to the gross domestic product over a three-year period forecasts a 1.25 percentage point decline in inflation-adjusted growth three years in the future. Continue reading "ETFs For Rising Consumer Debt"

What to Do When Interest Rates Rise

Last year, when the Federal Reserve realized that the inflation, which was earlier thought to be “transitory,” might be feeding on itself and soon spiral out of control, it acted swiftly to respond with an aggressive interest rate hike cycle, one of the quickest on record.

As a result, we have gone from living in a world of virtually free money, marked by a target federal funds rate of 0% to 0.25%, for more than 12 years since the global financial crisis to a world of constricted credit, with a target rate at 4.50% to 4.75%, the highest since 2007.

Right on cue, the market and economy responded to the end of the era of easy money with withdrawal tantrums. Although the Fed has been able to bring down CPI inflation from a 40-year high of 9.1% in June 2022 to 6.4% in January 2023, it has come at the cost of increased market volatility, stressed margins due to increased borrowing costs, and bank runs due to bond price devaluations.

Given that the federal funds rate appears to be nothing short of a force of nature for the capital markets and the economy at large, its deeper understanding would serve market participants well.

What is the Federal Funds Rate?

The federal funds rate is the interest rate that banks charge other institutions for lending excess cash to them from their reserve balances on an overnight basis.

Legally, all banks are required to maintain a percentage of their deposits as a reserve in an account at a Federal Reserve bank. This mandated amount is known as the reserve requirement, and compliance of a bank is determined by averaging its end-of-the-day balances over two-week reserve maintenance periods.

Banks, which expect to have end-of-the-day balances greater than the reserve requirement, can lend the surplus to institutions that expect to have a shortfall.

The Federal Open Market Committee (FOMC) guides this overnight lending of excess cash among U.S. banks by setting the target interest rate as a range between an upper and lower limit. This target interest rate is called the federal funds rate. Continue reading "What to Do When Interest Rates Rise"

What Will The Fed Do In March?

The Federal Open Market Committee meets next week, at which time it is expected to raise its benchmark interest rate another 50 basis points, to a range of 4.75% to 5.00%, if we correctly interpret Fed Chair Jerome Powell’s testimony to Congress last week, when he said “the ultimate level of interest rates is likely to be higher than previously anticipated.”

Before that, the market had expected a 25-basis point increase, equivalent to its most recent hike at the Jan. 31-February 1 meeting. As we know, his comments sent stock and bond prices sharply lower.

Since then, though, we’ve had some serious news coming out of the banking system, namely the failure of SVB Bank and the closure of Silvergate Capital (both regulated by the Fed!) and worries that some of the largest U.S. banks (also regulated by the Fed) are sitting on some huge, unrealized losses in their government bond portfolios.

In this atmosphere, is a larger than expected rate increase next week—i.e., 50 bps rather than 25—justified?

Or should the Fed maybe show a little restraint and raise the fed funds rate only a quarter point?

And if it does, what will be the likely market reaction?

In his Capitol Hill testimony, Powell focused – as you would expect – on the U.S. economy, namely its stronger than expected recent performance, particularly in the jobs market, which in February gained another 311,000 jobs even as the unemployment rate rose slightly to 3.6%.

The Fed seems hellbent on making up for its past errors of overly long, overly loose monetary policy by ramming through rate increases no matter how much harm they might cause.

Ignoring the second component of its Congressional mandate, namely promoting full employment, the Fed is instead totally focused on slaying inflation as fast as possible, even though getting from the current rate of inflation – 6.4% in January — back down to its 2% target will no doubt take some time.

After all, the Fed only started raising interest rates back in March 2022, when the fed funds rate was at or near zero. Continue reading "What Will The Fed Do In March?"

"50 Cent" Profits From 3-Letter Acronyms

In February 2023, the US economy produced 311,000 jobs, surpassing market expectations of 205,000, and revised down from 504,000 in January. This indicates a labor market that remains tight, with an average of 343,000 jobs added per month over the previous six months.

This is another upbeat NFP report following last month's even stronger data. The Fed now has more ammunition to potentially raise rates by 0.5% at their next meeting.

Let's take a look at how the market reacted to this report.

1 Day Futures Performance

Chart Courtesy: finviz.com

The top three winners last Friday, when the jobs report was published, were VIX, which gained +9.42% in just one day, heating oil futures, which rose by +4.22%, and the Swiss franc, which increased by +2.75%. Continue reading ""50 Cent" Profits From 3-Letter Acronyms"