Friday, October 31, 2014

The Fed's Term Deposit Facility comes of age

As discussed earlier (see post), the US monetary base had stopped growing in July and is now in fact lower than it was over the past few months.



Given that the securities purchases continued through October, the flattening of the monetary base was the result of the Fed "draining" some of the reserves. Most of that was due to the reverse repo program (RRP) as well as the Term Deposit Facility (TDF). The TDF is a tool that is quite similar to what the ECB used to sterilize its securities purchase program (SMP) - an initiative the European Central Bank recently terminated (see story). Here is how the Fed describes the purpose of this facility.
Federal Reserve Bank of Philadelphia: - In 2010, the Federal Reserve put in place another method for managing reserves, the Term Deposit Facility (TDF). The TDF works in reverse of the Term Auction Facility [see post from 2009]. In the TDF, the Fed is offering term deposits on an auction basis. When a depository institution purchases a term deposit from the Federal Reserve, the funds are removed from its reserve account at a Federal Reserve Bank, thereby reducing the amount of bank reserves for the specified term of the deposit. Both paying interest on reserves and the TDF provide the Fed with strong tools for reducing aggregate bank reserves and will be very useful when it comes time to tighten monetary policy and reduce the size of the Fed’s balance sheet.
The TDF is still in "experimental" stages but the Fed has recently ramped it up (h/t Econ Brothers) - which is part of the reason for the lower monetary base.



The latest version is a seven-day deposit with an early withdrawal penalty. While the TDF drains reserves, the primary goal of the program is to give the Fed another tool to control short term rates. In fact the TDF could potentially become a more actively used program than the RRP.

In addition to the Fed Funds Target Rate for overnight interbank lending (which has declined in recent years), the the Fed will be setting the rate it pays on excess reserves (IOER), on the reverse repo (RRP), and also on these term deposits (TDF). The rate change announcement will therefore be a complex set of procedures going forward.


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Thursday, October 30, 2014

Lower crude oil price in the US does not imply oversupply

Social media has been circulating this chart on US crude oil, that seems to indicate that the US is sitting on excessive inventories. That's simply not true. In fact US crude oil availability in storage, as measured in days of supply, is tighter than it was last year.

Source: EIA

The same holds true for gasoline.

Source: EIA

Furthermore, the WTI futures curve is in backwardation, indicating that the demand for physical crude in the US remains robust (this is not the case for Brent).




Sharply lower crude oil prices is a global phenomenon and is by no means an indication of slack demand or excessive inventories in the US.

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Wednesday, October 29, 2014

Distinguishing the Fed's securities purchases from monetary expansion

There has been a bit of confusion about what today's FOMC announcement means with respect to Quantitative Easing. The statement says that " the Committee decided to conclude its asset purchase program this month". It's important to point out that while this is the end of the Fed's bond purchases (for now), the US monetary expansion has ended this past summer. The outcome is visible in the the banking system's excess reserves, which flattened out around July.



That in turn resulted in the US monetary base leveling off at just below $4.1 trillion, as the so-called "money printing" effectively ended in July.



This begs the question: How is it that the excess reserves and the monetary base stopped growing this summer while the securities purchases and the balance sheet expansion continued through October? The answer has to do with some other balance sheet items that offset ("absorbed") reserve creation. The key item to consider here is the Fed's reverse repo position, which became more impactful as the securities purchases ebbed.



While the Fed's securities program is just ending now, the US monetary expansion was finished months ago. Therefore, other than its psychological effect, today's announcement should have a limited impact on the economy.

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How well does the CPI measure individuals’ health care burden?

Guest post by Jonathan Bernstein

Medical costs rose at an official rate of 1.7% year on year this past September, but the average increase in medical expenses individuals actually paid could easily be far larger. Most importantly, the CPI, as a pure price index, may not reflect the increased cost of living for families who lose employer paid health care coverage. That’s an all too common predicament, given the substantial fraction of part-time jobs created during the current economic recovery.

Nor does the CPI make it easy to see how reduced healthcare benefits raise the cost of living for those who still enjoy employer sponsored plans. As Aflac reports, 56% of employers offering health plans hiked the employees’ share of premiums or copays in 2013, and 59% expected to do so in 2014. Furthermore, the Affordable Care Act (ACA, or Obamacare) encourages this sort of cost shifting from employer to employee through its 40% excise tax on “Cadillac” plans.

The BLS does not measure insurance costs directly when compiling CPI-MED, the CPI’s health care component (h/t Doug Short). Instead BLS assumes that insurance costs rise commensurately with the prices of medical goods and services, plus or minus a margin for profit and administrative costs. Since CPI-MED measures changes in medical prices faced by consumers, it calculates changes in net prices charged to consumers after insurers, if any, have paid their share. As individuals and families pay an increased percentage of their healthcare costs, the BLS will account for that by increasing the weight of CPI-MED within the overall CPI; currently CPI-MED accounts for 5.825% of the overall CPI. Increases in the share of medical expense paid by individuals (as opposed to their insurers), will not affect CPI levels.

Therefore, when the BLS re-benchmarks the CPI this coming February, we can probably expect CPI-MED to carry a larger weight than in the past. An increase in the weight would then tell us how much BLS estimates that the average consumer’s medical care expenses increased as a percent of his or her total expenses.

 To state the obvious: when a family loses their coverage, they could easily go from paying a $300 monthly share of an employer’s plan, to paying $1,200 or more monthly for a “gold” plan, depending on the parents’ ages and number of children. Alternatively, the family could buy a less expensive plan (or no plan at all), and consequently pay more of their medical bills out of pocket. Again, that shock, if experienced by enough people, will eventually show up in weight changes, but not in the CPI level.

Either way, for many if not most families, the resulting increase in health care costs works out to a double digit percentage increase in total monthly expenses. Increases in deductibles, premiums or copays for those who have employee coverage presumably hurt less, but would also boost the employee’s health care costs over and above this year’s 1.7% increase in CPI-MED. And let’s not talk about those who lose employer paid coverage but whose income is low enough to qualify for the Obamacare insurance premium subsidy. In that situation, one can’t afford the out of pocket cost for much non-emergency treatment, and emergency treatment cost may put one at risk for bankruptcy.

In sum: while the BLS tells us how fast medical costs are rising, the CPI’s headline numbers may not reflect how healthcare costs actually affect the cost of living. If you want to know why many people feel that they are falling behind despite benign official statistics, here’s one place to look.



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Sunday, October 26, 2014

The Saudis have the staying power to undercut the competition

According to Deutsche Bank, the Saudi government can sustain itself for almost 8 years with Brent crude at $83/bbl. The nation's government has accumulated sufficient "rainy day funds" to withstand a prolonged period of budget deficits driven by low oil prices.

Source: DB

Armed with such staying power, Saudi Arabia is undercutting the competition in order to expand market share. They know they have the funds to outlast most of the competitors. The goal is to pressure OPEC cheaters as well as to shake out US "tight oil" producers. The Saudis could presumably deal with the notion of US "energy independence", but having Americans export large amounts of crude (currently being debated in the US) and compete head on with OPEC is not acceptable. While Saudi Arabia cannot entirely stop the growth of North American production, it is going to try slowing it.

The Saudis launched their attack with the comment that the nation "will accept oil prices below $90 per barrel, and perhaps down to $80, for as long as a year or two". With energy markets already soft, the selloff acceleration ensued.

Another recent development shows that the Saudis are also willing to back their statement with action. With OPEC already producing 700-900K bbl/d above its quota, Saudi Aramco started undercutting the competition by lowering prices.
Deutsche Bank: - ... we can observe that the differential of Saudi Arabia’s Arab Light blend versus the Oman/Dubai average for Asian deliveries has fallen sharply from a premium of USD1.65/bbl for September loadings to a discount of USD1.05/bbl for November loadings. This suggests that Saudi Aramco is determined to maintain current levels of exports at the expense of sales prices achieved. This represents the sharpest discount since the -USD1.25/bbl level observed in December 2008, during a quarter in which global oil demand contracted by 3.0 mmb/d, in contrast to the current quarter when we still expect oil demand to grow by 0.8 mmb/d.
Source: DB

The November OPEC meeting is expected to be tense, with a number of nations pushing for production cuts. But ultimately the Saudis will prevail and the pressure on high-cost crude producers will continue. Pain will be felt in Iran, Russia, Venezuela, as well as across the North America's energy sector.

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The "Save our Swiss gold" initiative is incompatible with the EUR/CHF peg

This is every gold bull's dream. The Swiss just might force their central bank to begin accumulating massive amounts of gold via the so-called "Save our Swiss gold" referendum. The Swiss National Bank (SNB) unwound a large portion of its gold holdings prior to the financial crisis and now it could be forced to buy it back over the next five years. Here is what the accumulation is likely to look like assuming the rest of the balance sheet stays constant.

Source: SNB

If the proposal passes in November, the SNB will also need to repatriate its physical gold holdings stored abroad (particularly in the US and the UK) back to Switzerland. The most difficult part of the law is that once the SNB buys any gold, it would no longer be permitted to sell the holdings at any time.

The law would require the SNB to hold at least 20% of its assets in gold (from less than 8% currently), likely forcing the central bank to unwind some of its foreign reserves.

Source: SNB

To understand why the SNB would need to sell its FX reserves, let's start with a bit of background. The reason the SNB's foreign reserves are so elevated is to a large extent the result of the 2008 financial crisis and more importantly the Eurozone crisis. Since the default of Lehman and through the euro area debt turbulence, depositors/investors moved assets out of the Eurozone into Switzerland. They feared a potential collapse of EMU banks, haircuts on euro-denominated deposits (which is what ultimately happened in Cyprus), and even the breakup of the euro - followed by redenomination back to pre-euro currencies and devaluation of the lira, drachma, escudo, etc.

Many moved assets to the relative safety and independence of the Swiss franc, which resulted in Swiss currency's sharp appreciation against the euro (the chart below shows the euro depreciating against the franc).



The currency spike made Swiss products/services much more expensive in the Eurozone, driving Switzerland toward recession.


Moreover, the currency strength had generated deflation in Switzerland that was as severe as what we saw right after the financial crisis.


The Swiss National bank had to arrest the franc's appreciation, which it did by imposing a currency peg to the euro. But in order to maintain the peg while everyone wanted to buy the Swiss franc, the SNB was forced to do the opposite - sell the franc and buy the euro. That's why the SNB foreign reserves spiked during the eurozone crisis (see post from 2012) - with nearly half the reserves in euro.

Now back to the situation with the SNB's gold holdings. It's unlikely that the SNB would use Swiss francs to buy gold if forced to do so.  That's because the SNB would need to "print" the currency (similarly to the Fed buying treasuries via QE), which would result in the central bank's balance sheet expanding. But gold reserves would have to stay at 20% of total assets, forcing the SNB to buy more gold than planned due to larger balance sheet.

That means the central bank would need to sell something and replace it with gold in order to avoid unwanted balance sheet expansion. The SNB is therefore likely to sell foreign currencies, particularly the euro. And that could potentially put pressure on the EUR/CHF peg discussed above by weakening the euro.

Furthermore, if there is another "run on the euro" and the SNB is forced to defend the peg by buying more euros, the central bank would be also forced to buy more gold (by selling the euros). Such downward pressure on the euro is actually quite possible, should the ECB embark on a new QE effort on order to arrest disinflationary pressures.

In such a situation, large market participants would simply go long gold while shorting massive amounts of euro against the Swiss franc (possibly via options). If the SNB buys a great deal of euros to keep the peg fixed, it would also be forced to buy gold. In such a scenario the traders win on the gold appreciation. If the SNB gives up the peg and no longer buys gold, the euro falls sharply against the franc and the traders win - again. The peg becomes unsustainable.

The "Save our Swiss gold" initiative is therefore simply incompatible with the longer term EUR/CHF stability objectives.

Over the long run, the inability to sell any gold could in theory force the SNB's balance sheet to be 100% gold. If the central bank assets for example grow to 5 times the current size (with the 20% rule in place), and then shrink back to their original size, the Swiss National Bank would be holding nothing but gold. It would no longer have the ability to do much of anything, especially address deflationary pressures. 

What's the likelihood that the "Save our Swiss gold" proposal passes? According to the GFS Bern poll for the November 30th referendum, 44% of respondents currently support it, 39% are against it and 17% are not yet decided. This is obviously too close to call, but the possibility of a "yes" vote is now quite real.


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Thursday, October 23, 2014

Gap between wages and rents continues to grow

Here is a quick follow-up to the discussion on the looming rental crisis in the US. The gap in growth rates of rental costs vs. wages continues to widen. This divergence is creating a drag on the GDP growth by suppressing household formation, consumer spending, and labor mobility. Over time this trend will also increase homelessness.




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Tuesday, October 21, 2014

Last week's volatility and the economy

US consumers remain jittery. As expected, households actually paid attention to last week's market volatility and the Ebola fears. As many have pointed out, some of what we've heard last week was blown out of proportion. But any increased uncertainty, perceived or real, can have an immediate and a very real impact on the economy these days.

Source: Investing.com


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