Aurelia Butler

NEW YORK (Reuters) -A U.S. lending program to stem deposit outflows in the wake of Silicon Valley Bank’s collapse gives the Federal Reserve scope to continue raising interest rates if needed to slow inflation without exacerbating losses on bonds held by banks.That said, Tuesday’s U.S. inflation news should not force the Fed’s hand on aggressive hikes, as was expected before the regional bank crisis unfolded in recent days.Under the Bank Term Funding Program (BTFP), aimed at shoring up liquidity in the sector, the Fed will provide banks with one-year loans at the rate of a one-year overnight index swap (OIS) plus 10 basis points (bps). Banks can use eligible government securities on their books like Treasuries and agency mortgage backed-debt to guarantee the loans. Crucially, the program values these at par rather than at mark-to-market which helped submerge SVB. The current one-year OIS rate on Tuesday was last at 4.73%. By comparison, a one-year loan from a Federal Home Loan Bank, a government state enterprise that provides low-cost lending to regional banks, is around 5.4%, according to market participants. The ability to pledge discounted bonds that have marked-to-market losses with the surge in interest rates should help banks considerably, as intended, analysts said, which should give the Fed some flexibility to continue to tighten monetary policy.”The net impact of the regional bank funding turmoil and the new lending program still means, on balance, less accommodative financial conditions than we were expecting a week ago,” said Lou Crandall, chief economist at money market research firm Wrightson in New York.”The Fed doesn’t want to stop tightening prematurely because of stability concerns. It wants to find stability tools. In essence, the bank lending program will allow the Fed to keep raising rates.”California regulators shut down SVB last Friday following a failed stock sale that took out $42 billion in deposits in a single day. SVB had to fill in a $1.8 billion funding hole after it sold a $21 billion portfolio of available-for-sale securities at a loss as rising interest rates eroded the value of U.S. Treasuries.With the new bank lending scheme, “banks will not be forced to liquidate bond portfolios at huge losses, even if they face funding pressures,” said Ryan Swift, bond strategist at BCA Research in Montreal.”Instead, banks can meet their liquidity needs by borrowing from the Fed. For the bond market, the structure of this facility means that the Fed can keep lifting rates without exacerbating the problem of unrealized bond losses in bank portfolios.”The latest Fitch Ratings report showed unrealized losses on bank securities portfolios stood at $690 billion as of Sept. 30, 2022, representing approximately 40% of U.S. banks’ tangible common equity. U.S. banks had raised their holdings of government securities during periods of ultra-low interest rates to defend falling interest net margins. Current U.S. bank holdings of government securities have ballooned to $4.4 trillion, or 19% of banking assets, Moody’s (NYSE:MCO) said in a report on Tuesday, citing Fed data. In 2005, those holdings were $1 trillion. Moody’s expects the Fed to continue tightening despite funding turmoil which should darken the outlook for banks this year.With SVB’s failure, the bond market has pulled back expectations of further rate increases, pricing in cuts this year as well. Major banks led by Goldman Sachs (NYSE:GS) and Barclays (LON:BARC) Bank have called for a pause from the Fed next week.”The Fed’s actions, backing up deposits, are to restore confidence in the system rather than to offer stimulus or loosen conditions, said Angelo Kourkafas, investment strategist at Edward Jones, in St. Louis. “But as we think about what’s played out, it’s resulted in tighter financial conditions. Even though yields have fallen credit spreads have widened. So in a way what transpired is doing some of the Fed’s work for the Fed.”The U.S. inflation data further eases the way for the Fed to keep tightening, although at a slower pace.The consumer price index (CPI) rose 0.4% last month after gaining 0.5% in January. Shelter, which includes rents as well as hotel and motel accommodations, accounted for more than 70% of the increase in the CPI.With inflation still strong, the Fed’s inflation-fighting credentials on the line and financial markets calmed for now by the new bank facility, U.S. rate futures have priced in a 25 basis-point hike at next week’s Fed policy meeting. The market has also priced the same increase in May. “The SVB failure has ripples that will need to be addressed, but full-on contagion does not seem the issue,” said Ellis Phifer, managing director of fixed income research at Raymond James in Memphis, Tennessee.”The Fed still wants to address inflation and they will continue to hike for now.” More

Reforms of problematic small and mid-sized financial institutions have made key progress and illegal financial activities have been curbed, the People’s Bank of China (PBOC) said in a statement after its annual meeting on financial stability.The central bank will continue to follow the guidance of “overall planning and coordination, differentiated policies and precise bomb disposal”, it said.”It is necessary to strengthen the financial risk disposal mechanism and capacity building, strengthen monitoring, early warning and evaluation,” the central bank said.The central bank will improve legislation and the financial stability guarantee fund system, and improve the role of deposit insurance, the central bank added.China’s economy showed a gradual though uneven recovery in the first two months, but statistics bureau spokesman Fu Linghui told a briefing on Wednesday that corporate and personal balance sheets damaged during the pandemic would need time for repair. Central bank chief Yi Gang told a news conference on March 3 that China has reduced the number of high-risk small- and medium-sized financial institutions to more than 300 from over 600 over the past three years.The government has unveiled plans to set up a new regulator – the National Financial Regulatory Administration – which will take over some regulatory responsibilities, including overseeing financial holding companies and investor protection, from the PBOC.”The revamp signals a shift in the government’s priority towards financial stability and de-risking the financial exposure of local governments and financial institutions,” ANZ analysts said in a note.”Local governments’ explicit debts have increased 16% year-on-year over the past five years. Their implicit debts may have reached 60 trillion yuan ($8.69 trillion), or half of China’s GDP, according to our estimates,” ANZ said.($1 = 6.9020 Chinese yuan renminbi) More

The list of those responsible for sky-high inflation grows ever longer: jammed supply chains, Putin’s invasion of Ukraine, sleeping central bankers, a dearth of workers, bolder pay demands . . . Now, a new culprit is at large: our own foolishness.Research by Vania Esady at the Bank of England — catchily titled Real and nominal effects of monetary shocks under time‑varying disagreement — provides a neat link between our struggles to make sense of the economic “polycrisis” we are in, and the persistence in price growth.At the heart of most macroeconomists’ models are rational economic actors. But how can anyone be straight-thinking when there is so much uncertainty? And what does that mean for inflation-fighting central bankers?Esady uses the range of GDP projections from the US Survey of Professional Forecasters as a proxy for high “information frictions” in assessing current economic conditions. In a Bank Underground blog post accompanying the paper:. . . because significant disagreement indicates that it is difficult to observe current economic conditions . . . If the ability to nowcast varies over time, this may affect agents’ ability to respond to various shocks, including monetary policy shocks.(NB: That’s a pretty conservative bar: if professional forecasters cannot agree, then you would expect an even higher level of confusion among business and households.)She finds that when disagreement is higher — ie when there are more difficulties in inferring current economic conditions — contractionary monetary policy brings down inflation at the cost of a greater fall in economic activity. Why? The answer could lie in “rational inattention”, or, our finite information-processing capacity. When there is more uncertainty and distractions abound it is time-consuming to find answers. It is also difficult to set a price when it is a challenge simply ascertaining how strong demand is or will be. So if, as a seller, you’re unsure whether to lower prices to get ahead of demand falling, it’s tempting to stick rather than twist:In periods where information frictions are severe, price-setting firms pay less attention to demand conditions. This implies that their prices will respond sluggishly to monetary policy shocks. The slower prices respond, the more ‘sticky’ prices appear. Stickier prices lead to smaller price adjustments. In conjunction with higher nominal rigidities, this inertia in price adjustments leads to a flatter Phillips curve, yielding larger effects of monetary policy on output.That is a pretty pertinent finding as economists try to dissect the current stubbornness in underlying inflation — and how much higher central bankers will need to take interest rates (now complicated by Silicon Valley Bank’s collapse). There is plenty of disagreement on the macroeconomic outlook today.Measures of uncertainty — like the global economic policy uncertainty index — are still elevated. In the UK, the Bank of England’s Decision Maker Panel Survey shows that uncertainty around the outlook for businesses’ expectations for their own-price growth remains at historically high levels.Clearly communications by central banks — and other institution’ — can help businesses and households to assess economic conditions. But that’ll be tough as SVB’s collapse clouds the outlook even further.Uncertainty may not be a driving factor behind inflationary persistence, but Esady’s research is a reminder that freakish economic outcomes cannot solely be explained by logical economic phenomena — particularly when economic agents at the heart of it cannot explain it themselves. More

Sean Hagan is former general counsel of the IMF. He is currently professor from practice at Georgetown Law and an adviser to Rothschild & Co.A crucial feature of corporate insolvency law is the “trigger” — when should a proceeding begin? Sadly there’s no insolvency law for sovereigns, so for better or for worse it is the IMF that in practice acts as the trigger.Why? Because when a country cannot service its debts, it will typically ask the IMF for money. That’s not an easy decision for any finance minister. Although they know IMF support will come with painful strings, a default and debt restructuring can result in the loss of hard-earned creditworthiness, kybosh the economy and may very well cost the minister their job.But the IMF also has to make a difficult decision. It too prefers to avoid a restructuring, given the economic and financial risks. However, if the IMF concludes that the country’s debt burden is so high that it cannot repay creditors in full under any feasible scenario it will make a restructuring a condition for its assistance.This is why the IMF’s “Debt Sustainability Analysis” is the de facto trigger for government restructurings. To say that DSAs are difficult is an understatement. A company is insolvent when its liabilities exceed its assets. Trying to assess the value of a country’s “assets” is complicated when its taxing capacity is, at least theoretically, inexhaustible. As a result, the IMF’s assessment involves a number of projections around things like economic growth and the maximum achievable budget surpluses.This is particularly tricky. There comes a point where tax increases become counterproductive, since it chokes growth. Spending cuts can hit the economy instantly. Also, not all governments have the same political capacity to sustain fiscal surpluses over an extended period. Argentina is not Latvia. Finally, the IMF assesses the country’s overall financing needs and the projected cost of future borrowing.If all of this seems a bit judgmental, it’s because it is. Notwithstanding the sophistication of the Fund’s DSA methodology, the bottom-line assessments of debt sustainability are, as the economists say, “probabilistic”. An IMF determination that the debt is not sustainable is pretty consequential. A restructuring is no longer a question of “if” — it is now a question of “when” and “how”. In addition to kick-starting the debt restructuring process, it shapes crucial features of the IMF program, including the pace of “fiscal adjustment”. Moreover, because a vital objective of the program is to restore debt sustainability, it effectively determines the size of the “restructuring envelope” — ie, the overall amount of debt relief needed.At this point, delays are costly. While this may seem obvious for the country — a government “gambling for resurrection” will, in desperation, inflict unnecessary pain on the economy in a futile attempt to service a debt level that is unserviceable — it is also true for creditors. Why? If the debts are unsustainable and the IMF continues to provide financing to repay maturing obligations, it will effectively be replacing these creditors. Because of the IMF’s preferred creditor status, the remaining creditors will have to contribute more to secure the necessary debt relief.Unsurprisingly, creditors often argue vociferously over DSAs, which basically dictate how much money they can get back. And admittedly, the IMF’s record on the accuracy of its macroeconomic projections is hardly unblemished. Indeed, some feel that DSAs should therefore be a subject of “negotiation” between the IMF and a country’s creditors. This would be . . . problematic. As long as DSAs are made in the context of the IMF’s lending decisions, they must be the product of IMF’s independent judgment. The DSA is a crucial anchor of the entire process. Despite its shortcomings, subjecting DSAs to negotiation would compromise their legitimacy. An already uncertain process could become chaotic. As has been noted of the role that Supreme Courts play: they are not final because they are right; rather, they are right because they are final.But the IMF could and should take steps to improve the transparency of the process. Private creditors typically only see the DSA after the IMF’s executive board approves of the programme and the full documents are published. This is in contrast to other government creditors, who normally receive at least certain important elements of the DSA on a confidential basis at an earlier stage. This lag creates delays. Private creditors cannot begin negotiations unless they have clarity as to what the restructuring envelope is. As is the case in the corporate bankruptcies, once a sovereign debt restructuring process has been launched, everyone just wants to get it done quickly. The government is anxious to regain market access. Private creditors are eager to see the recovery in the market value of their claims that will occur once the restructuring has been completed and debts are sustainability again.The IMF should therefore speed up the process by publishing key elements of the DSA when the staff level agreement is reached, so official and private creditors receive this information at the same time. It’s a small thing, but given the mess the sovereign debt restructuring process is in right now, every little bit helps. More

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The Federal Reserve’s dilemma over whether to press ahead with its campaign of raising interest rates after bank failures has been further complicated by the release of strong inflation data.Officials of the US central bank are set to gather next week for a two-day policy meeting at which they will decide how substantially to alter their plans for monetary tightening in light of the turmoil in the banking system triggered by last week’s implosion of Silicon Valley Bank, which was followed by that of Signature Bank.But following the release of data on Tuesday showing a 0.5 per cent rise in “core” consumer price growth in February despite a slower annual pace, the Fed must now thread a delicate needle of continuing to root out persistent inflation while also ensuring the smooth functioning of the financial system.“They’re stuck between their inflation objectives and their financial stability objectives, and that’s really what they’re evaluating here,” said Nathan Sheets, global head of international economics at Citigroup and a former US Treasury official.In the days before SVB’s collapse, which forced the Fed and other government authorities to intervene to limit contagion, chair Jay Powell had floated the idea that the central bank might consider reverting to half-point rate rises, as data showed renewed strength in the labour market and rebounding consumer spending.That followed a historic, months-long campaign of supersized rate rises intended to tame rampant price pressures, which the Fed had only wound back down to a more typical quarter-point pace in February.At the time, Powell said forthcoming data — including Tuesday’s inflation report and the latest jobs report, which showed employers added a robust 311,000 positions in February — would be closely scrutinised before a decision was made.But economists say the collapse of SVB has fundamentally changed the policy outlook, muddying the central bank’s path forward and raising concerns over the level of interest rates the financial system can withstand.Late on Sunday, economists at Goldman Sachs switched their expectations from a quarter-point increase in March to no rate rise at all, noting “considerable uncertainty about the path beyond” that point.Julian Richers, an economist at Morgan Stanley, said “uncertainty had blown up” in the aftermath of the bank failures, and the Fed would be “attentive” to further signs of stress.February’s inflation report has complicated the picture further. Over the past three months, “core” consumer price growth — which strips out volatile food and energy prices and homes in on services-related costs — has increased at a 5.2 per cent annualised rate, the highest reading since October 2022.

“In the absence of what’s happening in financial markets, this is the type of data that likely would have motivated a 50 basis point rate hike next week,” said Matthew Luzzetti, chief US economist at Deutsche Bank. While he described the inflation data as “unrelenting”, Luzzetti said he expects the Fed to proceed with a quarter-point rate rise this month and signal that the federal funds rate will peak just above 5 per cent.Richers added the CPI figures meant officials should not stop rate rises altogether, even in light of the SVB fallout. “There certainly seem to be concerns about market functioning, but it’s not something that a pause will necessarily ease,” he said.Economists say the Fed must also contend with broader questions of how financial instability stemming from SVB’s failure will effect demand and economic activity.Speaking with the Financial Times on Friday — following the jobs report and SVB’s collapse — Thomas Barkin, president of the Richmond Fed, said he was chiefly focused on demand in determining the future of the central bank’s tightening campaign, adding this was an area in which financial stability “may or may not have an impact”.“Even if the Fed is to stem this and we see no other bank failures, there’s been tightening in credit conditions [and] there’s been tightening in financial conditions,” said Priya Misra, head of global rates strategy at TD Securities, adding that this could lead to an “earlier recession or a deeper one” than previously expected. More