Economy

(Reuters) -U.S. short-term financing markets saw a three-day spike in interest rates at month-end. That’s left Wall Street wondering whether the financial system is running out of cash. A spike in repurchase agreements, or repo, where investors borrow against Treasury and other collateral, can be a sign that cash is getting scarce. Markets need a minimum amount of liquidity to function smoothly.Eventually, the elevated level of the interest rate, called the Treasury GCF Repo Index, between Nov. 30 and Dec. 4 was explained by factors other than cash scarcity, such as month’s end book-closing by banks and hedge fund trading, interviews with more than half a dozen bank executives and market participants show. But it set Wall Street abuzz. The U.S. Federal Reserve is draining hundreds of billions from the financial system by selling bonds in a process called quantitative tightening (QT) to normalize monetary policy after the pandemic-era stimulus. That has caused concern that cash levels could be approaching a tipping point, the executives said.One problem for the market is that there is no consensus on how much cash in the system is too little, and so there is no telling when that level might be breached. Estimates vary widely, adding to the jitters. Tell Alessio, treasurer at regional lender Cadence Bank, said while they have access to ample liquidity they are watching for the threshold below which market functioning could be disrupted. “We actively monitor the repo markets for leading indicators of what that lower boundary is,” Alessio said in an email. The interviews with bank executives, some of whom requested anonymity to speak freely, also provide a flavor of a Fed survey of senior finance officers. The executives work at banks that combined oversee several hundred billion dollars of assets.In the survey, the Fed polls for information such as the lowest comfortable level of reserves (LCLOR), below which the financial system starts to get impacted. The Fed did the last survey in September but has not released results, leaving only data from May in the public domain. Two sources at a major U.S. bank said their LCLOR was up by 20% to 30% above what they were before the March banking crisis. Their reasons ranged from market volatility to tighter regulation.The May survey found that the crisis had led some banks to raise reserves. Three of four mid-sized bank executives said their cash levels have returned to normal after increasing many-fold in March and April, while one said it had higher levels. They all said they were being more conservative in business. Raj Singh, CEO of BankUnited (NYSE:BKU), said his bank had increased cash levels to $2 billion during the banking crisis, but had brought it down to pre-March levels of around $400 million by the summer. Amalgamated Bank (NASDAQ:AMAL) CFO Jason Darby said they had increased coverage of the riskiest portion of their uninsured deposits to over 200% from 185% after March. Such deposits come from its newer customers, who have been with the bank for less than five years.”It feels like the events of March are literally only yesterday,” Darby said. “That’s the way we’ve been thinking about trying to manage our business conservatively.”HOW MUCH IS NEEDED?Estimates of the minimum amount of bank reserves needed range from about $2.5 trillion to $3.3 trillion. Such reserves currently total nearly $3.5 trillion; another $820 billion or so is held by entities like money market funds.One treasurer at a mid-sized bank calculated the threshold to be around $2.9 trillion to $3 trillion, while an executive at a large bank said it might be in the middle- to higher-end of the range in the short term. The large bank executive said a survey of financial officers showed most expected to hit the threshold around the middle of next year. But it also underscored the uncertainty: Some expected it could be breached as early as February or March. Fed Chair Jerome Powell has said the bank sees no reason to change the pace of QT. “It’s hard to make a case that reserves are even close to scarce at this point,” he said last month.In broad strokes, financial system liquidity is the sum of reserves held by banks and money parked overnight with the Fed by money market funds and others, called a reverse repo. The levels are affected by the Fed’s balance sheet and the Treasury Department’s general account, where it keeps cash to pay the U.S. government’s bills.The last time the financial system found out liquidity had dipped too low was in 2019, when bank reserves hit around $1.5 trillion. The Fed had to step in.Since then, the threshold has likely increased, in part due to the growth in economic activity and tighter regulations, the executives said. AN ESTIMATEThe mid-sized bank’s treasurer said he looks at the ratio of cash held by domestic banks and their assets, setting his lowest comfortable level at around 9%. The treasurer draws from 2019, when the ratio fell well below that for a sustained period and markets were affected. It again breached 9% ahead of the March crisis.The ratio is now above 10%. Roughly $200 billion to $230 billion of cash drain would bring it down by a percentage point, the treasurer estimated. But before bank reserves get hit, the system has a buffer in the Fed’s reverse repo facility, leading to questions about whether that can be drained to zero. A New York Fed survey shows Wall Street expects the Fed to stop QT when the facility hits $625 billion. Meanwhile, more tests to liquidity are likely in the coming weeks, keeping Wall Street on edge. Year-end cash needs still have to be sorted. Early next year, the Treasury will lay out plans for debt issuance that would eat into cash. Then, the tax season will be upon us with more cash needs, said John Velis, forex and macro strategist for the Americas at BNY Mellon (NYSE:BK).”That’s another thing to keep in mind as a wild card,” he said. More

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Unlock the Editor’s Digest for freeRoula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.China’s President Xi Jinping lauded Beijing’s security and commercial ties with Vietnam on Tuesday, as he kicked off a state visit to a country that has become a critical global supply hub not only for western companies diversifying out of China but also for Chinese manufacturers. The trip, the Chinese president’s third since he became Communist party general secretary more than a decade ago, also sought to counter growing ties between the US and Vietnam, with president Joe Biden visiting the country in September. “China has long been Vietnam’s largest trading partner, and Vietnam is China’s largest trading partner in Asean [the Association of Southeast Asian Nations],” Xi said in a “signed article” published in Vietnamese state media ahead of the visit and reported by China’s news agency Xinhua. Xi also took pains to emphasise relations with China’s neighbour, despite their history of conflict. “Only when all countries develop together can they jointly build an Asian homeland of peace, tranquility, prosperity, beauty, and friendly coexistence,” Xinhua quoted him as saying.The visit was Xi’s first in six years and came amid differences between the two sides over competing claims in the South China Sea. Commercial ties have grown rapidly between the two countries, with Asean, the regional grouping that also includes countries such as Indonesia, Singapore and Thailand, becoming China’s largest trading partner, surpassing the US and the EU. Biden signed a “comprehensive strategic partnership” with Vietnam in September, raising the bilateral relationship to a status Hanoi had previously reserved only for China, Russia, India and South Korea. Vietnam had long avoided the move for fear of upsetting Beijing. “Vietnam fought wars with both US and China, and now has comprehensive strategic partnerships [the highest level] with both of them — that is a masterclass of diplomacy,” said Huong Le Thu, deputy programme director, Asia for the International Crisis Group. Vietnam state media reported that the two countries were expected to sign “dozens” of agreements covering national defence and security, co-operation at sea, trade, investment, agricultural exports and other areas. Xinhua reported that Xi listed China’s areas of commercial co-operation with Vietnam, including Hanoi Light Rail Line 2, a project that reportedly received loans under Beijing’s Belt and Road infrastructure scheme. Xi also highlighted the launch of cross-border trains between the two countries, the construction of ports and the building of a “photovoltaic industry cluster” by Chinese companies in Vietnam. He sought to emphasise Vietnam’s support for Beijing’s other geopolitical campaigns, including the global security and the global civilisation initiatives, which seek to erode what China calls US “hegemony” by rallying support among non-aligned countries for a more multipolar world. “The visit comes at an interesting time when China is trying to get more support behind the Belt & Road Summit, the Global Security Initiative that seem to have lost their shine,” said Le Tru. “Xi Jinping will play on Communist party affinity, which Vietnam’s Party Secretary General Trong seems to value,” she said. She said recent tensions between China and the Philippines over competing South China Sea claims offer Beijing “yet another reason to play it nice with another Southeast Asian neighbour to present a more unified south-east Asia”.The warming ties come as analyst reports show that Vietnam is becoming a crucial hub for manufacturers diversifying out of China to beat US sanctions on Chinese goods or to reduce geopolitical risk. This applied to western and Chinese owned companies, a paper by National Bureau of Economic Research academics Laura Alfaro and Davin Chor said.The paper said while nearly a quarter of Vietnam’s exports were shipped to the US, Vietnam was also importing more from China. Analysts believe many Chinese imports are processed and re-exported from Vietnam. Imports from China had risen from 9 per cent of its total imports in 1994 to about 40 per cent in 2022, the paper said. The main imports included integrated circuits, telephone sets, and textiles, the paper said. More

Unlock the Editor’s Digest for freeRoula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.This article is an on-site version of our Unhedged newsletter. Sign up here to get the newsletter sent straight to your inbox every weekdayGood morning. All quiet to start the trading week. With the holidays imminent, Unhedged’s idea hopper is running on empty. Help us replenish it: [email protected] and [email protected] we would ask Powell at Wednesday’s presserUnless today’s inflation data is ferociously hot, the market consensus on a soft landing and 2024 interest rate cuts should remain intact. But even though some observers think the hard part is over, the Federal Reserve does not. Its job, in many ways, is harder now. In the words of chair Jay Powell, risks have become “more balanced”, Fedspeak for “the job market deteriorating is now a similarly scary prospect to inflation re-accelerating”. When inflation was running wild, smashing the higher-rates button with maximum vigour was the clear call. Now, more finesse is needed to secure the soft landing.Signalling has a powerful impact on markets, so the Fed is understandably tight-lipped about how rates might fall, with one exception. As we discussed at the time, Fed governor Chris Waller said in late November:If we see disinflation continuing for several more months — I don’t know how long that might be, three months, four months, five months . . . you could then start lowering the policy rate just because inflation’s lower . . . It has nothing to do with trying to save the economy. It is consistent with every policy rule. There is no reason to say we will keep it really high.This sort of policy normalisation, lowering nominal rates to hold real rates steady as inflation falls, makes sense. But there are loads of questions around how it will work in practice. Here are three we are thinking about.As inflation falls, what principles will guide policy normalisation? The Fed’s nightmare is stop-and-go rate increases reminiscent of the 1980s. That is the biggest reason to wait to normalise rates. In the milder case of the mid-1990s, the central bank cut rates after an uptick in unemployment, and eventually had to raise them again when the economy strengthened. In a note over the weekend, Morgan Stanley’s Seth Carpenter called that episode a “cautionary tale”. But equally, it is possible to put off cuts for too long, as the Fed did in 2007. Unemployment is non-linear; once it’s rising unambiguously, it’s often too late.In a recent report, Skanda Amarnath and Preston Mui of Employ America offer three principles for rates normalisation: once cuts start, they should be front-loaded, proportional to inflation and data-dependent. Front-loading delivers a powerful dose of looser financial conditions right away, doing the most to counteract the risk of rising unemployment. Proportionality (eg, 1 per cent lower inflation rate = 1 per cent lower policy rates) gives the Fed and markets clear guidance for how fast to proceed. Lastly, data-dependence lets the central bank maintain optionality, in case inflation resurges or falls faster than expected.What sort of inflation counts? Fed officials have said they want to see moderation in each of three inflation categories: goods, rents (the biggest category) and non-housing services. The reality of falling inflation and/or rising unemployment might change that. Prices of non-housing core services make up less than a quarter of the total inflation basket, and some, such as auto insurance, have been unusually, persistently hot. Would inflation in a few services categories keep the Fed from lowering rates even if unemployment was inching up and core inflation falling? Either way, “we have to have more clarity about what [types of inflation the Fed] is comfortable with”, says Kevin Gordon at Schwab.Is it really full-steam QT for ever? Quantitative tightening (shrinking the Fed’s balance sheet) is a form of normalising monetary policy, Powell has said, meaning that rate cuts and QT could well go together. This has not always been the case. In 2019, while it was cutting rates, the Fed was forced to restart bond purchases because of chaos in the repo market. That came just months after Powell said QT was on “autopilot”. Some money-market watchers think the Fed will slow the pace of QT pre-emptively to buy itself time. Serious market dysfunction could kill off QT. A recession could, too, or perhaps even a slowdown threatening to become a recession. Deutsche Bank’s US rates strategists argue that if the central bank is bent on “actively easing policy, it will end QT. This view is driven primarily by the communications challenges the Fed confronted in 2018-2019 around the prospect of having its two tools work at cross-purposes — that is, easing by cutting rates while tightening through balance sheet run-off”. In any case, we need a better sense of the Fed’s QT reaction function.We’ll be keeping an ear out as Powell speaks on Wednesday. (Ethan Wu)Are we in a profits recession?A little while ago Bloomberg published a short piece which has stuck in my mind ever since. The article, “Without top five stocks, S&P 500 is deep into profits recession”, contained this passage:Without its five largest names, the S&P 500’s quarterly EPS has fallen 1.5% in 3Q y/y, according to Bloomberg Intelligence — even with better than expected results. Compare that with the index’s overall growth rate of 4%I was a little surprised by this, given how strong the economy was through the end of the third quarter. And it got me thinking about how much we should care if we are in a profits recession. The point of the Bloomberg piece, as I understood it, was that outside of the five biggest companies by market capitalisation (Apple, Microsoft, Amazon, Alphabet and Nvidia) S&P 500 profits are falling, and this should make us wonder about the sustainability of the current rally. But it also has implications for the economy: it likely reflects something about the ability of companies to raise prices, pay workers, invest in new projects and so on. I did a little measuring myself, but differently from Bloomberg in two ways. First, I used sequential rather than year-over-year changes in earnings. I wanted to match the way we talk about economic recessions, for which the common narrow definition is two quarters of sequential declines in output. Sequential change is also a more immediate measure of economic momentum (though it does create the risk of seasonal distortion). And I also used net income, or more precisely net income adjusted for unusual items, rather than net earnings per share (my numbers come from S&P Capital IQ). I wanted to look past the effects of stock buybacks on EPS, so I could see changes in companies’ underlying profitability without the impact of changes to capital structures.Looking in terms of sequential changes in net income, we are not in a profits recession, but we are close. While earnings fell 4 per cent in the third quarter, they rose 1 per cent in the second. Following Bloomberg, what about taking out the five biggest companies? That does appear to put us into a recession, with earnings growth down 8 per cent in the third quarter and 1 per cent in the second. But this, it turns out, is a distortion: in the third quarter, the eighth largest company in the index, Berkshire Hathaway, reported a big net loss because of changes to the value of its investment portfolio (Berkshire likes to put these changes aside when talking about its profitability). Take Berkshire and the top five companies out, and S&P earnings grew a plump 6 per cent in the third quarter; adjust for a large non-cash charge at Walmart, and growth is a point or two better still.The data is fiddly, and there is not a canonical answer to the question “is US corporate profitability rising or falling?”. The closest thing is probably the national accounts compiled by the Bureau of Economic Analysis; these also show modest but positive sequential growth in profit after tax in the past few quarters.That said, another way to see that we are not in a profits recession: only 68 companies in the S&P had profits fall sequentially in both of the past two quarters. The list of companies in “profit recession” contains companies from 10 of the 11 major sectors (communications services was the exception), but there was not an obvious or menacing macroeconomic pattern to be found in the list, other than a few sectoral trends (eg, transport companies are struggling; liability-sensitive regional banks are under margin pressure).Profits, like the economy, are slowing. But we are not, however you slice it, in a profits recession.One good readOne of the FT’s best takes his bow.FT Unhedged podcastCan’t get enough of Unhedged? Listen to our new podcast, hosted by Ethan Wu and Katie Martin, for a 15-minute dive into the latest markets news and financial headlines, twice a week. Catch up on past editions of the newsletter here.Recommended newsletters for youSwamp Notes — Expert insight on the intersection of money and power in US politics. 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Unlock the Editor’s Digest for freeRoula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.The European Central Bank only stopped its most aggressive ever series of interest rate increases in October. But already pressure is mounting from investors to start lowering borrowing costs.When the ECB governing council meets in Frankfurt on Thursday, it is expected to leave rates unchanged, even though eurozone inflation is falling much closer to its 2 per cent target.Rather than consider relaxing policy, the central bank is instead preparing to push back against market bets on a cut as early as March by pointing out they still see upside risks on prices, particularly from rising wages.With official forecasts for eurozone growth and inflation expected to be cut and investors watching for any clues on when rates may be reduced, these are the main questions for the ECB:Are rate-setters behind the curve on falling inflation?Eurozone inflation has been slowing throughout 2023, as energy prices retreated from last year’s surge caused by Russia’s full-scale invasion of Ukraine. Yet ECB policymakers have continued to warn of the risk that price growth could yet get stuck above its 2 per cent target.However, this scenario of the “last mile” of disinflation being the hardest looks much less likely after euro area inflation dropped to 2.4 per cent in November — far lower than expected and tantalisingly close to target. Given the ECB forecast in September that inflation would remain above 3 per cent until the fourth quarter of next year, monetary policymakers seem to have underestimated the pace of disinflation. Krishna Guha, vice-chair of Evercore ISI, said: “The data suggests the ECB has overtightened.”Deutsche Bank economists expect the ECB on Thursday to cut its 2024 forecast for core inflation — which excludes energy and food to give a better picture of underlying price pressures — from 2.9 per cent to 2.1 per cent.Lorenzo Bini Smaghi, a former ECB executive who now chairs French bank Société Générale, said that after badly underestimating the rise of inflation last year, central bankers “may once again be late in adjusting their policies” as price pressures fade.Is the market right that rate cuts are imminent?Isabel Schnabel, the most hawkish member of the ECB board, signalled last week that the “encouraging” fall in inflation had shifted sentiment among policymakers by repeating a quote often attributed to John Maynard Keynes: “When the facts change, I change my mind. What do you do, sir?”But the only concrete change in Schnabel’s position is that she no longer thinks a rate rise is still a realistic possibility. She was careful not to discuss the timing of cuts and stressed the central bank had to be more cautious than the market. “We still need to see some further progress with regard to underlying inflation,” she said. “We must not declare victory over inflation prematurely.”Inflation is expected to bounce back up again to near 3 per cent in December as German energy prices will rise from a year ago when the government paid most households’ gas and electricity bills, according to the Bundesbank. “That rebound in inflation will give the ECB some breathing room before they need to cut,” said Frederik Ducrozet, head of macroeconomic research at Pictet Wealth Management, adding he thinks rate cuts could start in April. “Having failed to appreciate the rise in inflation two years ago, it is natural they are reluctant to declare victory too early.”What could prevent rate cuts in March?Wages are the biggest factor. Eurozone unit labour costs per hour worked rose 6.8 per cent in the third quarter from a year earlier, the fastest pace since Eurostat records started in 1995. Daniel Vernazza, an economist at Italian bank UniCredit, said this rise reflected “a fall in labour productivity — strong employment and weak output — and high wage growth”.ECB president Christine Lagarde said last month she still wanted to see “firm evidence” that tight labour markets were not causing another inflationary surge.Wages are a key input to prices for labour-intensive services, which make up 44 per cent of the euro area inflation basket and are still rising at an annual rate of 4 per cent. The ECB will want to see the results of collective bargaining agreements with unions in early 2024 and a further squeezing of profit margins to judge if services prices will continue to slow.“They are likely to say there is more work to be done,” said Konstantin Veit, a portfolio manager at investor Pimco. “Core inflation is still at 3.6 per cent in the euro area, the ECB needs unit labour costs and profit margins to come down in line with its target and the jury is still out on this, so they will wait to have more clarity next spring.”Will the ECB stop buying bonds early?The ECB ended much of its bond-buying last year. But it is still reinvesting the proceeds of maturing securities in the €1.7tn portfolio it started buying in response to the pandemic. It has set out plans to continue these reinvestments until at least the end of next year, which would entail buying some €180bn of bonds in 2024.Several of the more hawkish members of the ECB have called for these reinvestments to end early. Lagarde said last month the matter would be discussed “in the not too distant future” and many observers expect it to start reducing the purchases as early as April.Schnabel said it did not seem “such a big deal” because these purchases were going to end anyway and the amounts are “relatively small”. But some policymakers say the flexibility to focus ECB reinvestments on any country is useful to counter a potential surge in borrowing costs for a highly indebted country like Italy. “It is not clear why the ECB has brought up this topic of ending reinvestments early — it risks incoherence with the shift towards cutting rates,” said Katharine Neiss, a former Bank of England official who is now chief European economist at US investor PGIM Fixed Income. More

Unlock the Editor’s Digest for freeRoula Khalaf, Editor of the FT, selects her favourite stories in this weekly newsletter.The writer is director of the Center-Left Renewal project at the Progressive Policy Institute and former Labour executive director of policy 2020-22As the Labour party looks increasingly likely to form the next UK government, it would do well to heed the warnings as well as the successes of the Biden administration’s investment programme unfolding in America. Undoubtedly ambitious, the programme can reasonably claim to have contributed to the relatively strong growth and jobs rate in the US — hence Labour leader Keir Starmer’s desire to set out an economic plan that follows in its wake. Wages are up in America and inflation is coming down. With less than a year until the election, the US administration should have cause for optimism.But the polling for President Joe Biden is dire, with the latest surveys placing him behind former president Donald Trump in key swing states that will determine the outcome of the overall contest. There are loud murmurings about a Democrat challenger to be the “next generation” figure. The party’s problems don’t start and end with a judgment on Biden, however. Their economic policies — much heralded by the centre-left worldwide, not just in the UK — are just not landing with the voters the Democrats need. Not yet, anyway.Despite the headline economic performance, less than a third of US voters say the nation’s economy is good. When asked which president from the past 30 years has done the most for working families, just 12 per cent of working-class voters polled by YouGov for the Progressive Policy Institute chose Biden; 44 per cent said Donald Trump, well ahead of any rival including Bill Clinton, Barack Obama and George W Bush. The Republicans outperform the Democrats on which party is trusted to manage a growing economy and to keep public debt and deficits under control. So Democratic strategists hoping that the headline performance will filter through to voters before the next election are taking a big gamble.Labour has long looked across the Atlantic for inspiration, and this new generation is no exception. There have been overt references to Biden’s policies in pronouncements by Starmer and Rachel Reeves, shadow chancellor, and the Labour party has its own infrastructure investment programme, gestating in opposition. It’s already under attack from the Conservative chancellor. (Jeremy Hunt rejects Biden-style policies as “some distortive global subsidy race”.) Battle lines are being drawn, and Labour needs to arm itself.So why aren’t Americans more favourably disposed to an economic approach that seems, on the face of it, to be delivering the goods? The individual components of the Biden administration’s policies are actually quite popular with voters who back the Inflation Reduction Act by 46 per cent compared with 32 per cent who oppose it. Certainly, they are more popular than the abstract framing of “Bidenomics”, which has no positive associations for a population stung by higher prices and named after a president they associate with tough times. However, working-class voters in particular are sceptical that they will be the ones to benefit from the White House’s investments, not helped by Biden’s choice to write off $127bn of student debt. The survey shows they actually attribute stimulus spending to overheating the economy.US voters have a clear preference for government policies to bring down rising prices, reduce the high cost of essentials and provide affordable training programmes to boost skills and earnings. Households everywhere are feeling the pinch, and they want to know that the government is on their side with pragmatic solutions. They are doubtful that more trade wars will bring greater economic prosperity, favouring stronger trading relationships with allies and more resilience in domestic supply chains. There is no reason why a Trumpian economic agenda should prevail if the Democrats can translate the economy’s positive headline data into the money in people’s pockets, and get the message out that this holds hope for a brighter future.Labour also should not shy away from an active state that steers the economy to greater prosperity. Investing in the US has been good for America’s workers and businesses, just as investing in Britain would be good for workers and businesses — if it is done well. But the lesson is that big plans are no substitute for policies that bring direct benefits to people’s everyday finances. Only then will the electorate feel they will be better off voting for change.Video: How Biden’s Inflation Reduction Act changed the world | FT Film More