Asset Neutral

Published on July 24, 2023 by Premium

Net interest margins for many banks remain healthy, but have notably shrunk as deposit funding costs rose more quickly than anticipated. The first aggressive hike cycle in decades is revealing widely held assumptions on deposit behavior to be false. The surprising rate sensitivity of deposits appears to be due to both aggressive loan growth in the preceeding years, as well as a persistent reduction in system wide deposits via quantitative tightening. However, the largest banks

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A Beautiful Replenishment

Published on July 17, 2023 by Premium

The Treasury successfully replenished the Treasury General Account with minimal market disruption by draining the RRP through aggressive bill issuance. Treasury announced its intention in early June to refill the TGA by aggressively issuing short dated bills, which are particularly attractive to money market funds. The surge in issuance pushed bill yields above the expected path of the RRP and enticed money funds to move money out of the RRP and into bills. The rapid

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Labor Inelasticity

Published on July 10, 2023 by Premium

Even as demand for labor continues to increase with economic growth, the supply of labor in the U.S. is stagnate absent ever larger wages increases. The working age population of the U.S. plateaued a few years ago, so increases in labor supply have largely come from attracting those outside the work force using high wages. At the same time, demand for labor appears to persist with steady economic growth and a growing population of retirees.

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Excess Wealth

Published on July 3, 2023 by Premium

Excess pandemic savings are better thought of as a component of household wealth, which remains far above trend and can continue to fuel consumption. Financial savings do not all just sit in a bank account, but can be used to purchase assets that appreciate in value. The excess pandemic savings of households are only a small part of an overall boom that has kept household wealth far above trend. The wealth boom was broad and

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Long Live SOFR

Published on June 26, 2023 by Premium

The move away from a credit sensitive reference rate implies that credit concerns can now only manifest in price, potentially amplifying volatility during times of financial stress. USD LIBOR will officially be replaced on June month-end by SOFR, a reference rate based on overnight Treasury repo transactions. SOFR is very different from LIBOR in that it is both credit risk free and is not forward looking, though forward looking versions have been calculated using derivatives.

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Business Interest Channel

Published on June 20, 2023 by Premium

Business debt is a transmission mechanism of monetary policy, but its effectiveness can be blunted by inflation. In theory, Fed rate hikes can dampen economic activity by raising business interest expenses and reducing the availability of financing. But inflation works against this channel by increasing business revenues and the value of business assets, which can be used as collateral to raise financing. The Fed's hikes appear significant, but are muted when contrasted with the surge

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It’s Not Working

Published on June 12, 2023 by Premium

Central banks are beginning to realize that things are not as they thought, so their policy stance is also not as restrictive as intended. Both the Reserve Bank of Australia and the Bank of Canada embarked upon aggressive rate hike campaigns, paused only to see resilient inflation, and then began hiking again. The impact from the Fed's aggressive hikes also thus far seems to be muted, with inflation stubborn and typical policy transmission channels unexpectedly

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Reserves and Asset Prices

Published on June 5, 2023 by Premium

A rapid decline in bank reserves is a headwind to all asset prices, but it need not be significant. In our two-tiered monetary system, a decline in bank reserves means both banks and non-bank investors have less cash and thus potentially less demand for financial assets. Banks may have less demand for high quality liquid assets like Treasury securities and non-bank investors may have less demand for riskier assets. In addition, while a decline in

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Back to 2019

Published on May 30, 2023 by Free

The hedge fund community appears to have returned as the marginal buyer of cash Treasuries through a resurgence of the cash futures basis trade. The recent surge in Treasury repo volumes and record short Treasury futures positioning by hedge funds strongly suggest a revival of the trade, which was popular prior to 2020. This would indicate steady demand for cash Treasuries even as the Fed and commercial banks moved from large net buyers to net

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Probing LCLoR

Published on May 15, 2023 by Free

Bank reserves are on track to approach a common estimate of the Lowest Comfortable Level of Reserves (“LCLoR”) within a few months. At the moment, reserves sit around $3.2t and a common Fed estimate places LCLoR at around $2.2t (8% of GDP). In addition to quantitative tightening, two events may soon reduce bank reserves to around $2.2t. First, the RRP is likely to steadily increase as MMF assets continue to rise and FHLB debt issuance

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