Eric Rosengren
@EricSRosengren
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Former president and CEO of @BostonFed . Economist with interest in monetary policy, financial stability, and financial regulation. Visiting Scholar MIT
Joined June 2021
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Market overreacted to the CPI report. While above analysts expectation, monetary policy is not set to analyst expectations. Nothing in the report indicates anything other than a continued trend towards lower inflation. March cut was already off the table, little impact on May.
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The S&P 500 office reit sub index is down 25% last month and 50% last year. At the same time many bank lenders will be pulling back just as leases roll, with high office vacancies and high interest rates. Regional bank shock and troubled offices will be negatively reinforcing
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Expect a hawkish skip this week. FOMC participants will be providing their summary of economic projections. Those projections are likely to show a hawkish dot plot reflecting still sticky inflation and tighter labor markets - tighter than many had previously expected
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Financial crises create demand destruction. Banks reduce credit availability, consumers hold off large purchases, businesses defer spending. Interest rates should pause until the degree of demand destruction can be evaluated
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SVB was well capitalized by regulatory standards but markets felt otherwise. Well capitalized banks should not close quickly with no bidders. Market reacted to imbedded losses in held to maturity securities holdings. Time to rethink held to maturity for regulatory capital
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The H-8 provides weekly assets and liabilities of commercial banks and was just released. For the week from March 8 to March 15 (seasonally adjusted) small banks lost deposits of $120 billion and the top 25 banks grew deposits by $66.6 billion.
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ADP report seems to too strong relative to recent economic data. Best wait for the employment report which will give a much more comprehensive view of the labor market. Expect that by tomorrow market reaction to todays report will seem overstated.
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The 5 year CDS for Deutsche Bank is up 17 percent this morning. Weak banks are now experiencing the challenges created by the ease of payment and information transfers. Delays in mitigation, such as insuring all deposits, is likely to be costly. Not just isolated problems.
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After a significant shock from an earthquake should you immediately resume normal life? Prudent to wait to see if there are aftershocks and no stress fractures in buildings and bridges. Similarly with monetary policy after a financial shock - go slow, check for other problems
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Fed communication has been too focused on data dependence. It makes the markets unduly focused on small changes of high frequency high volatility data that would not impact an economic forecast of the path of the economy. Instead, the communication should be forecast focused.
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Some prominent economists have advocated focusing on inflation and ignoring financial instability for monetary policy. If you believe financial instability by definition slows down the real economy, setting rates on past inflation reports could lead to a serious mistake
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For those claiming the rate hikes are having no impact - they must pay off their credit card balances. Commercial bank rates on credit card plans are up. Student loans will need to start paying. Excess pandemic savings greatly diminished. Many consumers now being impacted
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Regional banks still face challenges. 1. Rates on many held to maturity securities likely below short-term rates 2. Deposit outflows to larger banks 3. Likely rise in npl for CRE tied to office 4. Likely higher regulatory compliance and more supervision 5. Potential recession
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Large regionals showing stress with PACW and WAL stock prices falling significantly. Deposit insurance ceilings need to be raised or eliminated. This steady attack on regional banks is destructive to financial markets and ultimately the economy.
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Too much euphoria over CPI report. Oil prices are up, Russia/Ukraine grain deal teetering, labor strikes may generate wage contracts significantly higher than 3.5 percent, and annual comparisons will get worse. Path to 2% likely bumpy and need softer labor markets.
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1 Strange 60 minute interview. Why would forward guidance be done in a voice over by a reporter who does not understand the nuance of monetary policy? Not sure the voice over was accurate, so it only increased uncertainty while taking March off the table.
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Several banks have dramatically increased their reliance on discount window borrowings, lending facility and FHLB advances. This is not an economic way to fund a balance sheet long-term. First Republic reported 106 Billion in short-term borrowing and FHLB advances. Challenging
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Chips are still distorting auto numbers. Went to a Honda and Toyota dealer - 0 inventory because of chips. One of the reasons new and used cars prices have not fallen more is that there are still shortages of popular fuel efficient cars - Toyota and Honda are significant shares
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Interesting sentence in statement:
Recent developments are likely to result in tighter credit conditions for households and businesses and to weigh on economic activity, hiring, and inflation
I agree. But it makes the case for a pause not a 25 bp tightening
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10 year Treasury at 4.8 percent with other long duration securities showing similar increases is a real problem for banks with significant held to maturity losses on Treasury and MBS securities. Q3 held to maturity losses for some banks will be uncomfortably high relative to K.
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No econometric model would show a significant inflation difference between pausing now and tightening an equivalent amount in six weeks would result in a major difference in inflation relative to a tightening cycle that ignores financial stability concerns and tightens now.
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The Fed dots have continued to have the long-term federal funds rate at 2.5. However, immigration has increased, AI and machine learning have raised many expectations of productivity, and federal debt continues to grow. While I expect this dot to rise, why has it taken so long?
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ECI, a better measure than average hourly earnings of wages and salaries is also showing gradual declines to levels more consistent with 2 percent inflation. Not sure why the Fed would not still gradually reduce interest rates barring big surprises in inflation reports.
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New York Community Bank is a 116 billion dollar bank. Its market value has declined more than 20 percent so far today. It calls into question whether it should have been the winning bid for assets of signature bank. Risk management should be in shape before crossing 100 bil.
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In the Fed minutes the staff baseline forecast was for a recession later this year. It is unusual for staff to forecast a recession. I agree with the staff that the most likely outcome will be a recession later this year given high rates and less credit availability from banks
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Once again there is a disconnect between fed interest rate projections and that of the market. The Fed projects the fed funds rate to be 5-5.25 by the end of the year while the market expects 4.5-4.75. The market may be assuming greater tightening of bank credit conditions
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Some have argued that Fed credibility is lost if monetary policy does not tighten. Credibility is created by sensible policy decisions. The ECB did not gain monetary policy credibility by tightening the summer before the GFC because of a spike in oil prices.
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Non-performing real estate loans are currently low, they will not be low at the end of the year. This is a slow-moving problem that is predictable. As non-performing loans rise, particularly in this political environment, credit availability will be reduced.
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One topic almost all economists agree on, The policies that Arthur Burns, chair of the Fed during the Nixon administration, followed to "consult" with the president were a disaster - leading to prolonged period of inflation. I hope today's WSJ article on the Fed are not serious.
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Japan never returned to its growth path after the stock market and land prices peaked in 1990. Particularly challenging was banks misallocated capital making stimulus difficult. China may now be facing the same challenge from its over-investment in housing and attacks on tech.
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No reduction in the bank term lending program yet. These loans are much more expensive than core deposits and are likely at a higher rate than the underlying securities. This implies that banks are trading off reductions in NIM to show they have cash to meet deposit redemptions
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Are a handful of medium-sized banks uniquely poorly positioned for rapidly rising rates, unlikely. Banks of all sizes checking their liquidity. Insurance firms hold long-term securities. Many hedge funds hold long-term securities. Too soon to be confident the problem is over
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First Republic Bank reported total cap/risk weighted assets went up from 3/22 (12.6%) to 3/23 (12.7%). Similarly common equity tier 1 ratio also increased. Yet the stock price plummeted. The disconnect between healthy capital ratios and solvency concerns is very problematic.
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Takeaways from Jackson Hole
1. Proceed cautiously - unlikely to change policy in September
2. No change in inflation target - 2 means 2
3. Still expect SEP outcome - Rising unemployment, growth below 2 percent, gradual decline in nominal wages
4. Focus on core - still too high
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From the H-8, weekly commercial real estate loans from small commercial banks turned down in the middle of march. Small in this case is not one of the top 25 banks. Given the role of regional banks in financing commercial real estate, potential first sign of less credit to CRE
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2. While I would not increase rates without more information about credit availability, without more banking problems (which could be generated with earnings announcements), I expect an inflation focused Fed to raise one more time to get the fed funds rate over 5 percent
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The rise in initial claims for unemployment of 264,000 may be the first signs that higher interest rates and banking turmoil may be causing a labor market slowdown. While this will help with inflation, banking problems could lead to more of a labor slowdown than desired.
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NYCB continues to struggle. Very difficult to do a capital raise when the value of the CRE portfolio would be very difficult to ascertain given the well documented problems with rent controlled apartments in NYC and offices, and could change dramatically after an exam.
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Spoke at the 2023 RECM conference sponsored by Goodwin and Columbia. Most common adjective attached to office real estate was "frozen". A lack of transactions, except fire sales, are a problem for private valuations and for bank supervisors who will be assessing value of loans.
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Percent change in auto loans by banks dropped in the beginning of July and is negative for the first time since the pandemic. Combination of higher prices, higher interest rates and tightening bank credit likely generate slower sales later this year.
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The real question after 1 week of banking headlines is will consumers alter their spending, will businesses wait before investing, and will banks tighten their lending conditions to reflect the impact of recent events. Only if these effects are immaterial would you ignore them
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1 Why the 10 year Treasury has gone up so rapidly matters. While recent economic data has been stronger than expected, higher rates, geopolitical challenges, labor unrest, higher student loans, make forecasts weaken next quarter. More likely a reflection of fiscal challenges.
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Employment report consistent with slower growth in other economic data. Inflation is coming down too slowly to avoid another increase in July, but expect more evidence of cooling in the economy and inflation will make it less likely we see the second increase in Fed dot chart.
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If long rates continue to rise we are not out of the woods for additional banking problems. In addition, office and other challenged CRE will be harder to refinance, raising non-performing loans at the same time of large held to maturity securities losses.
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As I expected, the ADP was a head fake. Payroll employment at 209K is below expectations and consistent with the economy growing more modestly. Expect markets to reverse yesterday's over reaction to the adp data. The economy appears to be slowing, but slower than many expected
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Auto loan rates and car prices have risen significantly. Bank-financed auto loans have not been this high since before the financial crisis. I would expect that the financing challenges will start to make in-roads into car demand for low- and moderate-income consumers
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Like SVB, landlords can hedge the risk of interest rate rises with interest rate swaps or straight hedges. However, like SVB many borrowers did not hedge, resulting in higher profits initially but significant problems now. Raising rates quickly has costs.
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Consistent with the last two posts, the implied probability of a cut in March is now only 20% with the first cut of 25 basis points in May now a 60% probability. While I expect a cut in May, that is because I expect weaker incoming labor and wage data later this quarter.
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While the PCE inflation in today's release was viewed positively by the markets, I am not sure how comforting it should be. Core pce is coming down quite slowly and not currently on a trajectory to the low 3's by the end of this year.
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Things to watch as banks report. 1. Deposit changes, in particular which banks lost deposits and in what categories 2. Non-performing loans in real estate and are loan loss reserves growing 3. Commercial lending for possible changes in credit conditions and in which categories
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2. The decreases in bank deposits from higher rates and banking turmoil have implications. Banks will need to raise deposit rates which shrinks net interest margins or shrink assets. The latter is why we should be concerned about credit availability over this year.
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1) Inflation is too high and labor markets are too tight to achieve 2 percent inflation quickly. However, credit is being tightened by debt ceiling uncertainty, imbedded losses in bank securities holdings, and future losses from secular changes in office and poorly hedged loans
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Employment report is consistent with expectations. However, the labor market is still quite tight with unemployment at 3.5 percent and payroll growth of 236k. This report is probably strong enough that a Fed focused on inflation will likely see the need to raise 25 bp in May
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2) Forward looking monetary policy should treat the tightened credit, which is hard to quantify, as nonetheless a restraint on future growth. Waiting to see if the economy slows more over the summer before tightening rates would reduce the risk of unintended consequences.
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Total and core pce rose 0.4 (percent change from preceding month) and the percent change for April was 4.4 percent total, 4.7 percent ex food and energy. This is strong enough to make it unlikely the Fed is done raising rates, though they may skip a June increase.
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Strong jobs report. Continued strong growth in payroll but low-skilled jobs no longer need to pay outsized wages to get employees in construction, retail, or leisure and hospitality. As the chart shows, continued gradual decrease in average hourly earnings.
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The office credit problem is slow moving. Leases are staggered. However, as vacancies rise with interest rates, landlords must decide to invest more or turn the property over to the lender (these are non-recourse loans) Increasingly this will be a bank problem over 2023
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Senior loan officer survey shows credit tightening. The chart below indicates that spreads relative to cost of funds is above the peaks in several recessions and was only higher during the GFC. Note the cost of funds have risen from Fed tightening and borrowing wholesale funds
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It is too early to declare victory on a soft landing. Tightening of commercial and industrial loans of this magnitude have signaled recessions in the past. Rapid rise in rates impacting borrower and bank balance sheets makes credit tightening a reasonable strategy for banks
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Since the Fed began raising rates the deposits at the largest 25 banks have been declining steadily. Many of the deposits are from large firms with Treasury functions that can seek higher returns as deposit rates lag market rates. Implies more costly or less available loans
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Things to watch with FOMC SEP - Has the forecast changed? Relative to last SEP, expect new SEP to have 2024 real GDP to be somewhat higher, unemployment to be somewhat lower, PCE and core PCE in the low 2's. Forecast consistent with easing relatively soon.
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2. In contrast to the large banks, the smaller bank deposits (below the top 25) were less sensitive to fed tightening. Smaller firms have lower deposit beta's and deposits did not decline until the SVB banking turmoil. Deposit outflows primarily a large regional bank problem.
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In the week ending March 22 deposits at the top 25 banks decreased by almost $90 billion while banks below the top 25 banks increased deposits marginally by almost $6 billion (seasonally adjusted). Good news for regional and community banks that deposits are stabilizing for now
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The FOMC minutes and Fed speeches seem more consistent with the first cut in May. The markets FF path would be consistent with significant concerns of a recession, requiring lower FF. While the fourth quarter will be slower than the third, too much pessimism about 2024 GDP.
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Most bank failures are addressed by assumption of all deposits including large deposits - because it is the least cost resolution for FDIC. Normally large depositors are made whole - what is different this time is that they were told that before the acquisition was finalized
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The challenge getting back to 2 percent over the forecast horizon depends largely on services. Core CPI rose 4%, with goods prices near 0 but services much higher as a result of shelter 6.5% and transportation 10.1%. Not expecting ff rates to come down as fast as market expects
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The H41 release indicates bank stress is not being relieved quickly. On March 1 there were 4 billion in discount window lending. On April 19 there were 70 billion in discount window lending and 74 billion in bank term lending. Likely implies credit availability pressures.
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Even with deposits stabilizing, imbedded losses in securities holdings are a continuing problem that will only improve as securities roll off or interest rates decline. Losses on securities and, over time, real estate, could generate a potential solvency risk for some banks
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Payroll employment 187k in August but the two previous months were revised down so that the average of the past three months is now 150k. Unemployment 3.8 percent. Now seeing a clear cooling of the labor market - if it continues, we are likely at the peak of the interest cycle
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Banks borrow at blended market and deposit rates, fin techs borrow at market rates. As long as deposit rates are below market rates, higher rates will over time provide a competitive advantage for banks over fin techs.
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CPI was good news but core CPI is still a long way from 2 percent. Expect FF rates have peaked. Good time to lock in some duration. While still plenty of data before December meeting (including PCE and u), How many participants have no more increases will be shown in SEP.
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The path of the federal funds may become less data dependent and more risk management dependent. A low risk strategy would be to be patient once inflation falls below 3 (opportunistic disinflation). A high risk strategy (for real GDP) would be try to drive inflation to 2.
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1. With Fed staff forecasting a mild recession the odds of another 25 bp hike in May is a coin flip in the FF futures. However, while inflation is coming down, both core CPI and core PCE are not yet on a trajectory for low 3 percent inflation by the end of the year
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Average hourly earnings was up 4.2 percent. Earnings for leisure and hospitality was up 6.1 percent. Good for low wage workers, but indicates service wages still rising to draw people into the labor force. Challenge for bringing inflation down more quickly.
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Demand destruction is beginning to be priced into commodities markets. Crude oil is down more than 7 percent, copper prices are down significantly over the last day. A slower economy going forward would be consistent with these price shifts
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The exuberance in markets after the press conference seems overdone. The comments from the NY Fed are consistent with the three cuts in the SEP possibly beginning around May rather than where the market started pricing of five cuts beginning earlier than May.
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Interest rate risk for banks is not just in securities holdings. Commercial real estate are normally floating rate loans. Particularly for offices, higher interest rates are occurring as vacancies rise and values fall. It will appear as a credit issue but related to higher r
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Earnings calls for banks with significant uninsured deposits and large imbedded securities losses will be particularly important for whether there is another round of banking concerns. Too soon to be confident that other banks are not at risk
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Were the imbedded capital losses on securities held by banks forced to be marked to market and flow through income and capital accounts, banks would be much less likely to hold long duration securities in a low interest rate environment, particularly as Fed raised interest rates
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2. In contrast, there continues to be declines in deposits at large banks (shown below) with elevated ff which would seem to imply much more interest sensitivity of deposits at large banks than small banks.
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1. Changes in deposits at commercial banks have have shown unusual pattern. First the buildup of deposits from the pandemic and then the rapid shedding of deposits as the Fed tightened unusually quickly coupled more recently with turmoil in regional banks.
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Completely agree with Treasury Secretary Yellen that prime money market funds remain a risk to disrupt short-term credit markets. They needed Fed facilities in the pandemic and GFC, the financial stability concerns remain unaddressed.
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The CME currently has a coin flip for whether the Fed tightens at the May meeting by 25 basis points. With the focus on bringing inflation down, and the downplaying of risk management concerns, in the absence of more banking headlines, this pce report is consistent with higher r
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The CME fed funds futures now has a 25.9 percent probability of a rate cut at the May FOMC meeting. Declines in stock prices at European banks, continued weakness at regionals could validate those expecting the next action is lower rates to combat too much demand destruction
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Yesterdays move up in Treasury rates more closely tied to a difficult 30-year Treasury auction, than remarks by the chair - that were consistent with earlier statements. Highlights the challenges issuing long duration Treasury as supply is large and banks/foreign buyers pull back
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A long period of elevated interest rates will apply increasing pressure on bank's Interest Margins. Banks will need to make their deposit rates more competitive, thus rising deposit betas. Moody's downgrades reflect pressure on NIM, CRE reserves rising, and imbedded r losses
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Fed chatter does seem consistent with a skip, assuming employment data does not indicate economy is picking up stream. More open ended policy would be better at this juncture - less forward guidance and requiring higher data threshhold for policy changes
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2 Treasury rates rose as it became clear that there was no clear path forward to getting fiscal agreement. Divergent views on taxes vs spending makes no action the most likely outcome, forcing Treasury to issue more at auction as Fed/banks/foreigners are less active purchasers.
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Surprised FF futures does not have a lower probability for a March cut. The statement that risks "moving to better balance" would be just "balanced" if March cut was likely and during the press conference a March cut "is probably not the most likely case" is surprisingly clear
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A legal movement to reduce discretion for the administrative state has hampered the use of discretion in bank supervision. Bank supervision should not be a compliance exercise, it should be limiting unsafe and unsound practices and closing banks that continue those practices
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The employment report still shows leisure and hospitality growing (72). Services, particularly food services still growing (50). Delayed challenges in hiring in this area post-covid probably indicates services wages and prices likely to be too strong for inflation-focused Fed
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It will be interesting to observe in the next FOMC Summary of Economic Projections whether more participants start raising their long-run estimates for the real interest rate. High continued fiscal deficits along with investment opportunities from higher productivity raise r*
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A much higher r* has implications for financial stability. Are borrowers and lenders appropriately positioned for interest rates remaining higher than anticipated even after the economy has normalized? Higher for longer may not just refer to tight monetary policy.
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Financial tightening does not just affect the economy by increasing the cost of borrowing. Take office buildings. Large vacancies because of work from home, and future earnings (if positive) are now discounted by a much higher discount rate. Real problem for future valuations.
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Countries that have experimented with political "consultation" on monetary policy have experienced prolonged periods of inflation. The most recent example is Turkey, whose inflation rate is currently 68 percent - the result of politics driving Turkey's monetary policy decisions.
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CPI inflation numbers consistent with a pause in September. However, elevated core and recent increases in food and energy prices probably makes November increase in the FF rate still a possibility - though I expect incoming data likely will make future hikes unnecessary
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1 New York Community Bank reduced their dividend to 5 cents and significantly increased their provision for credit losses to $552 million (from $62 million Q3). Historically, dramatic declines in dividends and significant increases in provisions indicate supervisory intervention
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Employment report consistent with a slowdown. Unemployment gradually rising and currently 3.9 percent. Payroll slowing with 150k jobs in Oct. Average hourly earnings falling gradually, now 4.1 %. Expect Fed is done unless the economy picks up - which I do not expect in Q4.
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2 Answr Jobs Act, Inflation Reduction Act and Chips Act have provided huge fiscal incentive for construction. y/y from January manufacturing construction is up 36.5 percent, highway construction is up 22 percent, power construction is up 16.2 percent while commercial up only 3.2
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The other risk is financial stability. Tightening into a financial stability problem created by rapidly raising rates could have unpredictable results. Particularly while several banks are being resolved. Risk management would argue for a pause now
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