The Fed’s Job Gets Tougher and Tougher

Central Bank

Summary:

Another unenviable FOMC meeting.

Already facing uncharted territory, the Federal Open Market Committee’s job is only getting tougher. It faces innumerable conundrums: assessing the economic outlook and how recent financial turmoil impacts that, the rate decision, financial stability considerations and communicating decisions. This FOMC meeting from 21-22 March will come with a new dot plot – it may end up heightening confusion.

What to make of the economic outlook?

In the period prior to Silicon Valley Bank developments, the US economy was running hotter than expected. Continued strong labour markets underpinned growth relative to expectation, with forecasts of a US recession often being pushed towards end-2023. Inflation, despite having come down for months, was proving stickier than expected on the downside – getting to 2% was viewed as a more difficult and protracted task. Expectations about the terminal rate had shifted to 5.5% from around 5%, and the Fed Funds rate – after peaking – was viewed as on hold for the remainder of 2023.

Will financial turmoil impact this outlook?

Then along comes the SVB upheaval, major deposit shifts, a collapse in US Treasury yields and plummeting market expectations regarding the Federal Funds rate outlook for the rest of the year. But will the turmoil persist and how might it affect the real economy? This is obviously a huge unknown.

If markets steady in time without much real impact, the FOMC’s outlook for the rest of the year could revert to its pre-SVB thinking on inflation/labour market dynamics. But if volatility persists, including deposit flight from community and regional banks, credit contraction might be in the offing. The FOMC’s timing is smack in the middle of peak volatility and uncertainty and it has little more insight than anybody else.

What to do with the Fed Funds rate?

While a few weeks ago a 50-basis point hike seemed a good bet, now it appears the FOMC faces a coin toss between not hiking and raising by 25bp. Good arguments can be put forward for both.

No rate hike would give the FOMC time to assess the situation, without precluding action when more information becomes available. A pause would further allow authorities to assess the lagged impact of the rapid rate hikes that have already taken place.

In contrast, a 25bp hike would respond to sticky price data. The Federal Reserve must keep its eye on inflation. If the FOMC pauses now, will it be harder to explain resumed rate hikes if needed? Moreover, while financial stability concerns are relevant to the macro outlook, especially if credit contracts, financial stability per se is not part of the Fed’s dual mandate of maximum employment and price stability.

Financial stability considerations and the Fed

Fed officials have long emphasised that monetary policy and financial stability considerations should be separated. Monetary policy should be guided by the dual mandate. Financial stability should be tackled with strong micro and macro prudential policies. Of course, if the financial stability upsets the growth and employment outlook, it relates to the attainment of the dual mandate.

Separation is nice in theory, but it may come up short in practice. Rate cuts/hikes and financial stability are interrelated. The US’s financial stability tools are inadequate. The Financial Stability Oversight Council is weak and overpopulated. The Dodd-Frank ‘designation’ process has been gutted. The US does an inadequate job overseeing non-bank financial intermediation, particularly given the labyrinthian regulatory structure that undermines accountability. The SVB collapse shows again that a ‘small’ bank can potentially trigger systemic contagion and it appears that on-the-ground banking regulators missed obvious red flags.

How to communicate amid the confusion?

Fed Chair Jerome Powell will have the unenviable task of explaining the FOMC’s decisions. Whatever those may be, the case for acting one way or another is arguably balanced and actions will easily be second-guessed. If the Fed pauses, it may be accused of paying too little attention to inflation. If it hikes, given the circumstances, it will be accused of overdoing it, as Senator Elizabeth Warren has already charged.

Powell faces the challenge of how to position the Fed for forthcoming meetings when the outlook faces so many unknowns. He may be pressed on whether the Fed failed in its supervisory role, whether blanket deposit guarantees should be issued and the deposit cap upped and whether quantitative tightening should proceed. While trying to maintain options and keep the Fed’s eyes on inflation fighting, the potential for missteps and market volatility will be even greater than usual, which is the last thing the Fed wants.

Source:Mark Sobel

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Justin

Central Bank

Economic

Taken by surprise by the resurgence of inflation, the European Central Bank started raising rates last summer and is still in the process of doing so. At her press conference on 16 March, President Christine Lagarde started her remarks with: ‘Inflation is projected to remain too high for too long.’ She then announced a 50 basis point increase in interest rates, the seventh in a row.

This firm stance, after a week of tremors in the global banking sector, was supported by an overwhelming majority of governing council members; only ‘three or four’, she said (out of 26), voted against her proposal. This was a remarkable demonstration of consensus and resolve by a very large committee.

Out of the spotlight, meanwhile, there is a huge elephant in the monetary policy room: the central bank’s balance sheet. Years of massive expansion have deposited a staggering €4tn of idle liquidity in the pockets of euro area banks. Until that stash of cash goes away, the ECB can only raise rates by subsidising the deposits it receives from banks. The remuneration on its deposit facility was raised from minus 0.5% last July to 3%, on a riskless basis. It will probably go beyond that. This is a hefty subsidy to bank shareholders: except for them, nobody today can access a risk-free rate of 3% in the open market.

This is a dangerous course. The assets the central bank holds against these deposits yield returns far below the funding cost. Calculations by Daniel Gros, a senior fellow of the Centre for European Policy Studies, show that this is enough to wreck the accounts of the ECB and its constituent national central banks in the years ahead. Bundesbank President Joachim Nagel must have felt some embarrassment recently as he announced to the German public that the losses of the German central bank last year do not cover provisions. This is an accounting euphemism to say that the central bank may need financial support from the government, and indirectly from the national taxpayer.

Economic textbooks say that central banks cannot go bankrupt, but this is another euphemism. It is easy to think of situations where the central bank and the money it issues – the euro in this case – loses support and reputation among public opinions and political circles, some of which in Europe edge towards populism. When this happens, the loss of central bank independence is just around the corner.

The only way for the ECB to stay clear of danger is to keep its deposit facility rate low. But this is compatible with the intended monetary policy course only if the bank liquidity and the central bank’s outright portfolio of securities – two amounts which are roughly equivalent – are reduced in parallel, and fast. The ECB has started scaling down its securities holdings at a pace of €15bn a month on a net basis. This is not sufficient. Other things being equal, it would take some 27 years to reabsorb all the liquidity that is around through this channel alone. The ECB cannot afford to wait that long.

One way to accelerate the process is to re-activate a long-term liquidity-management instrument introduced by the ECB in 2014, the so-called ‘targeted long-term financing operation’, but in reverse. The new reverse long-term operation would auction out rights to swap central bank deposits for long-term securities on a long-term basis according to the maturity of the bonds. Auction participation would be voluntary but incentivised. Banks deciding not to swap out their central bank deposits would be penalised by a lower deposit rate. Swap rights could be calibrated by taking into account the balance of each bank at the deposit facility

Calculations suggest that an auction mechanism so designed would induce profit-maximising banks to swap away large amounts of their deposits in exchange for temporary (but long-term) government bond holdings.

Regardless of the specific mechanism chosen, one thing is clear: a coherent package of measures and incentives lowering the deposit rate and reducing bank liquidity alongside the central bank’s portfolio is the only way the ECB can maintain monetary control and salvage, together with its own accounts, its operational flexibility and independence. The issue is urgent. Most national central banks of the euro will soon present their accounts for 2022. At that time, the monetary policy elephant and its impact on European taxpayers will be apparent. The ECB would be better off having answers when this happens.

Source:Ignazio Angeloni

To stay updated on all economic events of today, please check out our Economic calendar

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Justin

Central Bank

Economic

Slower inflation boosts the case for a 4.5% peak in rates

Headline inflation in Canada rose 0.4%MoM, below the 0.5% expected, resulting in the annual rate of consumer price inflation falling sharply to 5.2% from 5.9%. The core measures of inflation broadly performed as expected but are now below 5%YoY. Gasoline prices were the main downward influence, falling 1 %MoM, meaning that the YoY rate for this component is now -4.7%. The main upward influences were clothing prices, which jumped 1.9%MoM after three consecutive monthly declines, while “household operations” saw prices rise 1.1%MoM, but again this follows three months of relatively soft or negative price changes.

At the 8 March Bank of Canada policy meeting, officials outlined their view that “weak economic growth for the next couple of quarters” and increasing “competitive pressures” will bear down on inflation and allow it to “come down to around 3% in the middle of this year”. Today’s data should give them more confidence in this happening and reinforce the market view that 4.5%, reached in January, will be the peak for the policy rate.

Headline annual inflation rates (YoY%)

Rates to move lower before year-end

Back in January, the BoC indicated that “it expected to hold the policy interest rate at its current level, conditional on economic developments evolving broadly in line with the MPR outlook”. This guidance is likely to remain in place at the next BoC meeting on April 12, with the BoC likely to sound even more cautious in the wake of US and European banking woes. Canadian banks are looking relatively resilient right now, but they too are likely to become increasingly wary given the fallout from what has happened. We should expect to see some modest tightening of lending standards which means access to credit will become more restricted throughout the economy.

We still think the next move in the BoC policy rate will be downwards and that the first cut is likely to come before the end of the year. Canada’s greater exposure to interest rates rate hikes via a high prevalence of variable rate borrowing means consumer activity should slow through 2023. High household debt levels in Canada - equivalent to more than 180% of disposable income versus 103% in the US – mean that Canada is especially exposed to the risk of a housing market correction in a rising interest rate environment. Falling inflation rates will give the BoC the room to respond with looser monetary policy, especially with the Finance Minister Chrystia Freeland suggesting her upcoming budget will “exercise fiscal restraint” to help in the battle against inflation.

Source:ING

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Thomas

Political

Thailand dissolved its parliament on Monday, paving the way for what could be a bitterly-fought election in May between rival political forces at the heart of a tumultuous 18-year struggle for power.

Below are some key issues around the election.

Which parties are the main contenders?

The opposition Pheu Thai party, controlled by the billionaire Shinawatra family, will go up against parties aligned with the Thai establishment and with the military that ousted Pheu Thai's last government in a 2014 coup.

Prime Minister Prayuth Chan-ocha, who led that coup as army chief and has been in power ever since, will run with the new United Thai Nation party, while another retired general, Prawit Wongsuwan, a well-known political dealmaker, will lead the Palang Pracharath party, which has headed the ruling coalition since 2019.

Other parties that could be central to alliance-building after the election are the opposition Move Forward party and coalition members Democrat Party and Bhumjaithai.

Which will win most seats?

Pheu Thai is the favourite to win the most of the 400 constituency and 100 party-list seats available and has scored well in pre-election opinion polls.

Pheu Thai and its earlier incarnations have won every election since 2001 and remain popular among the urban and rural working classes in the north and northeast, largely due to populist policies like minimum wage hikes, rural micro loans and cheap healthcare.

Though successful in winning millions of votes, the policies have been hugely controversial, considered wasteful by many Thais and among the pretexts for coups and judicial rulings that removed three Shinawatra-backed governments.

Who are the top candidates for prime minister?

The frontrunner is Pheu Thai's Paetongtarn Shinawatra, the daughter and niece respectively of two former Thai premiers toppled in military coups. Though Paetongtarn, 36, has limited political experience, she has led opinion polls since last year, with more than twice the backing of her nearest contenders.

Others include Prayuth and three deputy prime ministers, Prawit, Bhumjaithai leader Anutin Charnvirakul, who is also health minister, and Democrat Party leader Jurin Laksanawisit, who is also commerce minister.

What are the election issues?

Most parties are promising welfare programmes like a minimum wage increase, better payments for the poor and elderly and price guarantees for agriculture goods.

A lively debate around cannabis is likely to play out during the campaign after Thailand became the first Southeast Asian country to decriminalise its use last year. Cannabis has been promised as a cash crop for a country where about a third of the labour force works in agriculture.

However, new rules had to be rushed to rein in recreational use because regulations restricting it were not in place. A cannabis bill failed to pass before parliament was dissolved, leaving the issue in legal limbo as recreational use surged, benefiting quick-acting businesses but angering some conservatives.

Will the monarchy be a campaign issue?

Youth-led protests that began in 2020 broke a longstanding taboo around questioning the role of the monarchy in Thailand, where the constitution states the king is "enthroned in a position of revered worship".

The Move Forward party has campaigned on reforming a law that punishes royal insults with up to 15 years in jail. Activists have urged opposition parties to scrap it, but the topic remains sensitive among many Thais and most parties oppose or want to avoid talk of reform.

How will the PM be elected?

A party with at least 25 seats can nominate a prime ministerial candidate to be put to a vote of both lower and upper houses. The winner must receive more than half of the 750 votes from the bicameral legislature.

That will include 250 senators appointed by the military after the 2014 coup, who are expected to support candidates backed by the military or its allies.

Source: Reuters

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Devin

Political

With Brexit, the devil is always in the detail.

New legislation published Monday enacting British Prime Minister Rishi Sunak's much-heralded Windsor Framework makes clear that unionists in Northern Ireland will be able to object to new EU laws — but won't hold the power to veto them.

Careful reading of the draft regulations enacting into law the so-called Stormont Brake shows that the power to block the introduction in Northern Ireland of any new EU goods standards — essential for Northern Irish exporters to observe if they want to maintain barrier-free trade with neighboring Ireland and the wider EU — will lie exclusively with London, not Belfast.

And the legislation shows the U.K. government ultimately reserves the right to override any unionist objections, citing "exceptional circumstances."

Such caveats have proven a dealbreaker for some unionists already highly skeptical of the prime minister's claims to have allayed their chief concerns over the much-maligned Brexit trade protocol that keeps Northern Ireland subject to EU goods rules.

"These opt-outs render the Stormont Brake useless," said hardline Democratic Unionist MP Sammy Wilson.

He complained previous U.K. assurances that the Stormont Brake would deliver an effective "unionist veto," promoted particularly by Northern Ireland Secretary Chris Heaton-Harris, have been proven "totally incorrect" now that he's had a chance to read the published rulebook.

The Democratic Unionists announced Monday they would vote against the Windsor Framework (Democratic Scrutiny) Regulations when they are put to a U.K. House of Commons vote Wednesday, ending weeks of speculation about their intentions.

The DUP, with only eight votes in a 650-seat House of Commons due to give overwhelming support to the regulations, cannot stop the law from being enacted — though its opposition may prove influential in convincing Euroskeptic Tory MPs to follow suit.

But Democratic Unionist leader Jeffrey Donaldson, eyeing the need to minimize internal party splits and potential losses in local council elections in May, emphasized that his party would not indefinitely block the revival of power-sharing at Stormont — and hopes in coming weeks to coax the U.K. government to deliver more of the DUP wish list.

Donaldson stressed that a Wednesday vote against the Stormont Brake did not mean that the DUP was rejecting the wider Windsor Framework, merely maintaining a critical stance in hopes of edging the U.K. government closer to unmet DUP demands.

Under the new regulations, unionists — a minority in the mothballed Northern Ireland Assembly — would have sufficient numbers to file a formal objection against the local introduction of any new EU law changing goods standards. The regulations specify that 30 members from at least two parties will be sufficient for any "petition of concern" to the U.K. government to be heard.

This means, in practice, that lawmakers from the Democratic Unionists (25 seats) and the moderate Ulster Unionists (nine seats) must file any objection jointly. Given that the Ulster Unionists, unlike the DUP, opposed Brexit and are more positive on maintaining barrier-free trade with the EU, even attaining this two-party, 30-signature threshold can't be presumed.

Any successful unionist petition would trigger a review of the proposed law's local impact in Northern Ireland in the U.K.-EU Withdrawal Agreement Joint Committee. It meets regularly to manage and resolve post-Brexit trade tensions.

While any EU law challenged by a unionist petition wouldn't go into immediate force in Northern Ireland pending these few weeks of deliberations, the London-Brussels dialogue might well result in an agreement that the law doesn't risk sufficient disruption to Northern Ireland trade to merit a British government veto.

Any joint U.K.-EU agreement to proceed with rolling out that EU law would then be subject to a formal vote at the Northern Ireland Assembly at Stormont.

Passage would require "cross-community consent" — Stormont jargon for a vote that fails unless both the British unionist and Irish nationalist camps agree.

But this stipulation doesn't mean the unionist minority would wield a veto over U.K. decision-making. Instead, as the regulations detail, the U.K.'s secretary of state for Northern Ireland would not be legally bound by the Stormont vote.

The Stormont Brake rules specify that the secretary of state could announce in the House of Commons that the EU law will apply despite unionist objections. In this scenario, the U.K. government could justify its decision by citing "exceptional circumstances," or its own judgment that the EU law "would not create a new regulatory border between Great Britain and Northern Ireland."

The regulations state that such a barrier must be seen to "materially divert trade or materially impair the free flow of goods."

"For weeks, the Windsor Framework has been oversold," Wilson said. "Now the wildest assertions are being laid bare as its details are examined and publicly revealed."

Source: POLITICO

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Kevin Du

Cryptocurrency

As crisis stalks the traditional world of stocks and bonds, bitcoin is suddenly looking like a safe haven.

The infamously volatile cryptocurrency seems positively hale and hearty, just as a banking meltdown drives markets into the arms of a recession.

Bitcoin has risen 21% this month, while a choppy S&P 500 has lost 1.4% and gold has gained 8%.

"If you were going to describe an environment where there were successive bank runs because central banks are trying to fight inflation with fast rate increases, that is pretty close to as spot-on a thesis for owning bitcoin as you've ever heard," said Stéphane Ouellette, CEO at digital asset investment platform FRNT Financial.

The cryptocurrency has, for now, severed its ties with stocks and bonds and tagged on to a rally in gold, fulfilling at least one part of creator Satoshi Nakamoto's dream - that bitcoin can serve as a refuge for suffering investors.

Bitcoin's 30-day correlation with the S&P 500 has slid to negative 0.12 over the past week, where a measure of 1 indicates the two assets are moving in lock step.

A selloff in banks has wiped out hundreds of billions of dollars in market value and forced U.S. regulators to launch emergency measures. The past couple of weeks has seen Silicon Valley Bank and crypto lender Silvergate go under, while Credit Suisse has teetered on the brink.

'Return to core ethos'

Let's not carried away, though. This is bitcoin.

"The bearish argument would be that these dynamics are temporary, and ultimately this rally is not going to sustain," said Ouellette.

It remains to be seen if bitcoin's bullishness will endure as attention shifts to the Federal Reserve's policy meeting this week where the U.S. central bank must walk a fine line as it fights inflation and bank stresses.

Furthermore, the cryptocurrency's allure hasn't all been about safety.

The rapid price rise has forced some short-sellers to cut their bets and buy coin back. Data from Coinglass shows traders liquidated $300 million worth of crypto positions on Monday, with most of that total - $178.5 million - short positions.

Nonetheless, bitcoin is resurgent.

It now commands nearly 43% of the total crypto market, its highest share since last June, according to CoinMarketCap data, while the total cryptocurrency market's capitalization has jumped 23% to $1.1 billion since March 10.

"We're seeing a return to bitcoin's core ethos, that of a financial asset independent from the opacity and meddling of the centralized financial system," said Henry Elder, head of decentralized finance (DeFi) at digital asset investment manager Wave Digital Assets.

The mainstream bank crisis has also fueled some interest in DeFi, with the total value of tokens linked to such platforms rising to $49 billion from $43 billion over the past week, according to DappRadar.

Bitcoin In a Bank Crisis

Not all areas of the digital world have been immune to the banking fallout, though. The no. 2 stablecoin Circle USD or USDC lost its 1:1 peg to the dollar after disclosing its reserves were parked at the shuttered Silicon Valley Bank.

As worries spread over USDC's ability to maintain its peg, its market cap slid to $36.8 billion last Friday from $43.8 billion a week earlier, even as leading stablecoin Tether gained around $4 billion.

Market participants said some USDC withdrawals were likely reinvested in bitcoin as well, helping fuel the rally.

"It's too soon to say that bitcoin has proven the narrative that it's an alternative in a banking crisis," cautioned Ed Hindi, Chief Investment Officer at Tyr Capital in Geneva.

But he added: "The rally we are currently witnessing in bitcoin will be looked back at as the point in time where its main property as a decentralized non-sovereign asset was stress tested."

Source: Yahoo

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Cohen

Central Bank

From Washington to Zurich to London, central bankers need to make a pivotal decision in coming days: whether their biggest immediate fear is financial or price stability.

The Federal Reserve on Wednesday will set the tone as Chair Jerome Powell gathers with his colleagues to consider whether the banking turmoil that erupted less than two weeks ago is so concerning that an interest-rate hike should be abandoned.

The UK, Swiss and Norwegian central banks are among more than a dozen others that also will be setting rates this week. And while the European Central Bank opted to pull the rate trigger last Thursday, the downfall of Credit Suisse Group AG — and default on its bondholders — since then poses fresh questions for policymakers.

Tilting toward safeguarding finance by keeping rates on hold could reassure investors that regulators will do what it takes to ensure contagion from three US bank collapses, and now Credit Suisse's demise, will be contained.

Trouble is, above-target inflation remains stubborn, and Powell and his peers are well aware of the history of the 1970s, when insufficient tightening helped to entrench outsize price gains.

"Financial crises tend to move in fits and starts and we're still far from a full resolution from this one," said Diane Swonk, chief economist at KPMG LLP. For the Fed, "we're looking for a pregnant pause given the uncertainty about what tightening is in the credit markets already," she said.

Speaking to how quickly things have changed, Swonk earlier this month, had penciled in a 50 basis-point hike for March 22.

Communication Challenge

Central bankers face "a choice between 'a dovish hike' versus 'a hawkish hold,'" Geoffrey Yu, a senior market strategist at Bank of New York Mellon, wrote in a note Monday.

In other words, policymakers could boost rates further while assuring the public that they are attuned to risks in the banking system and will act appropriately to avert any broader meltdown.

Or they could stand pat for now to buy time to see how financial developments unfold, while pledging to resume the inflation battle swiftly once stresses subside.

Futures markets show odds-on bets for a 25 basis-point move by the Fed on Wednesday. For the Bank of England — which started hiking months before the Fed — there's less than a 50-50 chance of an increase on Thursday, when the Swiss National Bank also must make a call, just days after helping oversee Credit Suisse's takeover by UBS Group AG.

Regardless of what they do this week, markets see central banks much closer to being done with tightening than it appeared just days ago.

For the Fed, traders were betting on another 110 basis points of hikes before the troubles at Silicon Valley Bank escalated — implying a peak rate of almost 6%. As of Monday, they were pricing in just another 35 basis points. Further out the curve the market is betting on cuts.

It's a similar picture in Europe, where traders have repriced their terminal-rate expectations for the ECB by an entire percentage point, to 3.2%. The BOE is now seen raising rates to at most 4.25%, compared with 5% previously.

The markedly more-dovish outlook has also helped fuel a strong bond rally. The yield on two-year German and US government bonds — those most sensitive to policy — have fallen 100 basis points or more since March 8.

Policy Divergence?

Both now sit at or below their respective central bank key rates, another sign for many traders that policymakers are quickly nearing the end of their rate-hike cycles.

Central banks may well decide to make different calls.

In Switzerland, economists predict a half-point rate rise to 1.5% as the SNB plays catch-up with the neighboring euro zone in its first decision of 2023. However, at 3.4%, Swiss inflation is low compared with much of the advanced world.

A day before the BOE decides, official inflation data is expected to show a slowing from 10.1% to 9.9%.

ECB President Christine Lagarde, in overseeing a half-point rate hike last week, insisted that price stability and financial stability "are two different stabilities addressed by different tools."

But rate increases have been blamed for contributing to the banking crisis that's now erupted.

"Recent economic momentum and inflation have been overshadowed by banking system risks, sharply repricing the Fed's path," as Bank of America rates strategist Mark Cabana said in a note.