Interest Rates Spike on News From Banks

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.

While the big Tuesday rally in stocks got all the media attention, the big selloff in U.S. Treasuries that accompanied it went largely unnoticed. Good news for banks apparently means much higher interest rates and bad news for consumers.

Yields on U.S. treasuries were not that far above historical lows before the boondoggle accompanying the Federal Reserve's stress test announcements. When JP Morgan jumped the gun and other banks followed on March 13th, stocks mounted a spectacular rally in the last hour of trade. No one asked however where the money to fund all of that stock buying was coming from. Even a casual analysis shows that it came from the selling of U.S. Treasuries (which continued into the next day). 

The two-day rise in yields from the bond selloff was sizeable to say the least, with the longer-end of the curve having the biggest gains in absolute terms. Yields were up 26 basis points on the 30-year, 25 basis points on the 10-year, and 26 basis points on the 7-year (a basis point is one hundredth of a percent). Even the 5-year yield rose 21 basis points. Essentially, interest rates rose a quarter of a percent on treasuries with maturities of 5 years or more — and it all happened literally overnight. 

Since interest rates were at such low levels, the spike in yields represented a big increase on a percentage basis. This was most pronounced at the middle part of the curve. Yields on the 7-year went from 1.43% to 1.69%, for a gain of 18%. Yields of the 5-year went from 0.92% to 1.13%, and this represented a 23% increase. An even bigger jump took place in the 3-year, with yields up 28%when rates rose from 0.47% to 0.60%. The two-year though was up only 18% after going from  0.33% to 0.40%. The percentage increase in the 10-year, where yields went from 2.04% to  2.29%, and the 30-year, where yields went from 3.17% to 3.43%, were modest in comparison.

Treasury bills were less affected with yields on the 3-month and 6-month unchanged. The one-year rate rose from 0.18% to 0.21%. The one-month yield (which went negative in late 2008 and late 2009) went from 0.05% to 0.08%.  Yield information for treasuries can be found at: http://www.treasury.gov/resource-center/data-chart-center/interest-rates/Pages/TextView.aspx?data=yield.

The Fed's Operation Twist, a plan to sell $400 billion of shorter-dated Teasuries and buy an equivalent amount of longer-dated paper is still ongoing. By the end of March, a switch of $268 billion will have taken place. The purpose of this operation is to keep rates for the 10-year yield low in order to stimulate the economy. Apparently, it wasn't working so well this week. The Fed publishes the schedule for its Operation Twist sales and purchases and these can be found at: http://www.newyorkfed.org/markets/tot_operation_schedule.html.

The rise in interest rates is not just important to investors, but to consumers. as well. Consumer loans are frequently based on some formula using the 10-year Treasury yield. If this goes up a quarter of a percent, so will the rates on consumer debt. This will be a drag on the economy. While rates have been kept artificially low by the central bank for the last three years (they have gone down during the "recovery", when they should have been going up), the sudden rise in yields this week indicates the Fed may be losing its ability to hold them down.

Disclosure: None

Daryl Montgomery
Author: "Inflation Investing - A Guide for the 2010s"
Organizer, New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. There is no intention to endorse the purchase or sale of any security.

Market Rallies on Bungled Stress Test News Release

 

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.

The Federal Reserve released its stress test results of 19 banks two days early yesterday. JP Morgan Chase forced its hand by making a public announcement that it had passed the test. Although the news was not particularly good, nor the results completely believable, U.S. stocks had their best day all year.

The Fed said on Tuesday that 15 of the 19 banks tested would have enough capital, even if they suffered a financial shock.  Citigroup (C), Ally Financial, SunTrust (STI) and MetLife (MET) failed the test. It should be considered shocking that any bank would fail a stress test after all the lavish government bailout and support programs that have funneled considerable amounts of money to them.  The U.S.  government had to semi-nationalize Citigroup and owned 27% of its stock by the time the Credit Crisis was over. Citi received approximately $45 billion in TARP funds alone and when it started paying them back, it got a $38 billion federal tax credit. And it still can't pass a stress test?

Of course, if Citi did pass a stress test, it might bring too much attention to the test's credibility. The Fed claims it set tough conditions and major banks complained that the tests were made too rigorous by considering a scenario where unemployment reached 13% and housing prices dropped 21% (presumably the Fed meant the official unemployment rate being 13% and not the actual rate). While these conditions sound tough, they aren't comprehensive, nor where the attention should be focused.

What prevented hundreds of U.S. banks from failing in 2008 and 2009 was a government willing to provide an effectively unlimited amount of money to keep them afloat.  The feds also propped up the housing market with minimal interest rates and mortgage relief programs and kept the unemployment rate (at least officially) out of double digits by running trillion dollar deficits. It should be expected that these policies will continue, so how could there be any risk to the U.S. banking system?

The policies themselves are creating the risk. Easy money is inflationary and always has been (and no, things will not be different this time). Inflation devalues financial assets and destabilizes banks.  The Fed however denies that inflation exists and that it will exist, so it is not politically tenable for it to do ever include any realistic inflation scenario in its bank stress tests.

Stress tests do not exactly have an unblemished record as is. The ECB tests in Europe passed Dexia bank with flying colors. Only three months later, it was in serious trouble and then it collapsed. Major Irish banks also passed the test, although Ireland itself had to be bailed out shortly thereafter to prevent its financial system from collapsing. Central bank stress tests are essentially public relations gambits meant to tell the public how good things are regardless of the actual state of affairs.

The release of the U.S. stress test also inadvertently revealed the true relationship between the Federal Reserve and the banking system that it supposedly regulates.  Even though the Fed was scheduled to release the stress test results after the market closed on Thursday, Jamie Diamond  announced that JP Morgan Chase (JPM) has passed the stress tests while the market was still open on Tuesday. He also stated that his bank would be raising its dividend and doing a stock buyback. Shortly thereafter, U.S. Bancorp (USB) and American Express (AXP) raised their dividends and announced stock buybacks. Wells Fargo (WFC) and BB&T (BBT) announced that they would be raising their dividend. 

Diamond's announcement forced the Fed's hand and it had to take emergency measures to move its own announcement up. The imbroglio was described by the mainstream media as a "miscommunication" between the Fed and Jamie Diamond. Oh really?  This is quite difficult to accept considering Jamie Diamond sits on the Board of Directors of the New York Fed. A more plausible scenario is that the big banks do what they want and the Fed follows their lead.  This nicely explains how the Credit Crisis came about in 2008 and why the banks will get into trouble once again.

The market rallied strongly on the news starting around 3:00PM with the Dow Jones industrials closing up more than 200 points. Anyone who knew that the accidental "miscommunication" was going to take place made a lot of money.


Disclosure: None

Daryl Montgomery
Author: "Inflation Investing - A Guide for the 2010s"
Organizer, New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. There is no intention to endorse the purchase or sale of any security.

Is Dexia Bank the Bear Stearns of the Current Credit Crisis?

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.

Over the weekend French President Sarkozy and German Chancellor Merkel said they had come to an agreement on recapitalizing EU banks. No details of their mystery plan were released. Plenty of details were forthcoming however on how Dexia bank was going to be bailed out and they indicate that it's time for EU leaders to stop talking and to start acting. 

Before its recent failure, Dexia bank was described as one of the strongest banks in Europe. It had no trouble passing the recent EU stress tests for banks (so much for the accuracy of those tests, which I have maintained for some time are nothing but a meaningless public relations gambit). Its Greek debt exposure was cited by the mainstream media as a primary reason for Dexia's demise. Dexia though had only 5.4 billion euros of Greek debt on its books out of an asset base of 518 billion euros according to Bloomberg. So, Greek debt was a little over 1% of Dexia's loans. Apparently this was enough for wholesale funding for the bank to dry up. Like most banks, consumer deposits were not enough to maintain Dexia's operations, it needed to continually borrow in the interbank market.

Dexia was a Franco-Belgium bank created 15 years ago by a merger of banks from the two countries. It also operates in Luxembourg and owns a 75% stake in Denzibank AS in Turkey, which it purchased in 2006. The Belgium government agreed to buy Dexia for 4 billion euros.  The French and Luxembourg units will be sold. Together, the three European governments will guarantee 90 billion euros of interbank and bond funding for 10 years. Belgium's share will be about 15% of its GDP. Guaranteeing bank debt has its risks and this is why Ireland required an EU bailout. Could Belgium be next?

If Dexia can fail, what EU bank is safe?  Moreover, the failure happened without a default by Greece, so it is clear many more bank failures are possible regardless of the outcome of the Greek debt crisis.
It can also be assumed that default will make the situation much worse. There are reports from German news agency DPA that Eurozone finance ministers are working on a plan involving a 60% reduction in Greek debt (previous reports indicated a 50% reduction).

The recent Dexia failure just like Bear Stearns failure in March 2008 happened because confidence from lenders in the interbank market disappeared. This can happen overnight. The monetary authorities patched things together temporarily after Bear Stearns demise, but the overall situation continued to deteriorate until Lehman Brothers failed six months later. A Greek default is likely to be the Lehman moment for the current credit crisis and Dexia's sudden collapse is similar to Bear Stearns. More bank failures in the EU will be a warning that the current crisis is escalating out of control.

Disclosure: None
Daryl Montgomery
Organizer, New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. Like all other postings for this blog, there is no intention to endorse the purchase or sale of any security.
 

Stock Rally in Beginning of Month Ignored Economic Reality

The 'Helicopter Economics Investing Guide' is meant to help educate people on how to make profitable investing choices in the current economic environment. We have coined this term to describe the current monetary and fiscal policies of the U.S. government, which involve unprecedented money printing. This is the official blog of the New York Investing meetup.


U.S. stocks had an impressive rally the first four days of the month and this is generally a bullish indicator.  The rally took place with a backdrop of really ugly economic news however and that is not bullish. Weakness has a way of coming back to haunt the market as European bank news is demonstrating today.

U.S. economic reports for the last few months have been generally bad to awful. Nothing changed last week. While the ISM manufacturing index went up, this supposedly occurred because of a big increase in manufacturing jobs (the inflation component of the report was the actually the biggest gain, but the mainstream media somehow didn't report this negative news). This gain was not corroborated by the government's August employment report, which showed a drop in manufacturing jobs, nor by anecdotal evidence or anything else taking place on the planet earth. The stock market of course rallied strongly on the news.

The ISM non-manufacturing index, which measures the almost four times bigger service sector, didn't get nearly as much media coverage. It barely remained in positive territory. The inflation component, also the highest number in this report, was chiefly responsible for the number not going negative and indicating contraction.  Two components of the report were clearly in contraction however - exports and employment. The service sector losing jobs is a big negative for the overall U.S. economy.

Also lost in the stock buying frenzy was August car sales. They were down 21% year over year. This followed the 27% monthly drop in existing home sales in July and the 33% drop in new home sales in May. Last August was the peak of the Cash for Clunkers program. The numbers for car sales and home sales both demonstrate what happens when government incentives are no longer available in a market. While new homes sales fell to the lowest level ever recorded, August car sales were only at a 28-year low. For those who don't recall, 1982 was when the previous double-dip recession took place.

Government stimulus programs didn't fix the housing and car markets, but merely made them look better. This works for a while, but reality eventually rears its ugly head. A report from Europe today said that "the continent's major banks have more potentially risky government debt on their books than was disclosed during stress tests earlier this year." This wasn't exactly a piece of information that required the skills of Sherlock Holmes to uncover. At the time of their release, the stress tests were roundly criticized as being a phony PR gambit that set the bar so low that any bank not declaring insolvency in the next week would pass. Stocks of course went up on the news back then and today they are going back down.

Economic reality will eventually be reflected in the stock market. As I have said many times however, it's not the economy that drives the stock market in the short term, but liquidity. The Fed obviously kept pushing the 'flood the financial system with liquidity' button in early September. What happens when they stop doing this? See the homes sales and car sales numbers for a hint of how stimulus withdrawal impacts a market.

Disclosure: No positions.

Daryl Montgomery
Organizer, New York Investing meetup
http://investing.meetup.com/21

This posting is editorial opinion. There is no intention to endorse the purchase or sale of any security.