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Archive for the ‘Interest rates’ Category

Saving money is usually pushed to the background in a debt induced economy built around spending.  Marketing firms are designed with the intention of parting you from your hard earned dollar.  The housing bubble was a manifestation of a system permeated by easy access to debt and promises to repay current purchases with future dollars.  Even the modest historical down payments of 20 percent were removed to introduce new no money or low money down payments.  It was as if money grew on trees.  Credit cards sit in the wallets of many, right next to cold hard cash.  Although not synonymous, people think of access to debt as if it were access to a permanent piggybank.  Many thought of their home equity as trapped income needing to get out instead of a safety net.  I used to hear so many throw in their home equity line of credit into their net worth equation.  You have to pay debt back!  That somehow escapes many and in this low rate environment, the Federal Reserve is punishing savers to get them off the fence and spend every little penny they got.

Many feel trapped because they see their incomes going nowhere or even worse, down and being eaten up by real world inflation:

Source:  Census

From 2000 to 2010 we experienced a decade where the median household income actually went down in real terms.  The only reason things seemed like they were booming in the early 2000s was due to the irrational debt spending brought on by the debt bubble.  Anyone could get a loan for a home, car, college education, or credit card.  It is easy to feel rich when all you need to do is have a pulse and a pen to sign on the dotted line.  The problem was that someone was going to have to pay for the giant mess at some point.  It was only a matter of time that it would burst but now, we are left relearning the ways of past generations where savings is actually an acquired art.  This is difficult in a society that is essentially designed and built to spend.  We have shipped off a large part of our manufacturing base and consumption is a giant key to our GDP growth.  So you can see how this becomes a problem when people have less access to debt and less money to spend.

It used to be the case that really conservative savers could put their money into a bank account and earn 5 percent at the lower end.  This was common for many years for those of you with some perspective and an active memory.  Let us look at the average 5-year Treasury Bill rate since the 1960s:

Since the early 1960s the average rate for a 5-year Treasury Bill was 6.54 percent.  Today it is 1.98 percent.  That means you would have to lock in your money for five years to earn 1.98 percent.  Since the Consumer Price Index actually hides real inflation any cost of living adjustments are being pushed aside and consumers are seeing the real impact of a depreciating dollar.  The Federal Reserve would like to push cash off the sidelines so people can go back to speculating in the casino known as Wall Street.  Keep in mind that nothing has changed since the financial crisis hit.  We have yet to have any explanation for the one day “flash crash” yet people are being cajoled into putting their hard earned money into what amounts to a glorified roulette table.  Red or black?  Even or odd?

A small percentage point can make a world of a difference for someone.  Take for example a 1 percent bank rate versus a 5 percent bank rate.  Let us assume you have $5,000 in your savings account and sock away $300 per month.  Let us run this analysis under two scenarios, the first being under 1 percent:

After 30 years this account will total up to $132,643.  Let us run the same scenario but at 5 percent which is below the average 5-year Treasury Bill rate since the 1960s:

This slight percentage change makes all the difference.  It virtually doubles the account with the same amount of savings.  Keep in mind that 43 million Americans are on food stamps and don’t even have the ability to save.  Half of Americans only have $2,000 allocated to their retirement so we are making the assumption that you actually have some money to save after the necessities are paid for.  So where can you put your money?  Take a look at these savings account rates:

Source: Bank Rate

Keep in mind that the above was sorted for the highest APY.  The highest rate we can find is 1.1 percent for high yield money market accounts.  Given the dollar decline and hidden inflation your savings erode simply by storing it in this account.  So what are your options?  Given the current market instability and the fact that there has been little reform on Wall Street, actually losing a little on your savings account isn’t such a bad thing.  Wealth preservation is the key in today’s market.  The Federal Reserve is punishing savers by keeping interest rates low.  The purpose of course is to save the too big to fail banks hoping that inflation will simply wipe the slate clean with their massive balance sheet sinkholes.  Yet inflation is never the solution to an economic crisis.  If inflation was the easy way out why don’t we just give every household in the U.S. $1 million to spend?  I’m sure that will get things going.

My Budget360

Ten Year Bond Breakout!

Posted by Karl Denninger

Borrowing costs are going up, and this chart says they’re going up a lot – like 200 basis points within the next year or so on mortgages and 10yr Treasuries.

Key to the thesis of Bernanke (and essentially everyone else) that this “V-shaped” recovery could take hold and be sustainable – instead of being a false dawn – is the premise that mortgage rates would behave.

Bernanke’s thesis, in fact was that he could cap 30 year money at 4% or less to prevent home price devaluation.

Well, now the 10 year bond is back where it was before the collapse.  That’s good, right?  Well, not really – because it means that 30 year money (mortgages) will start backing up shortly and prices on existing Fannie and Freddie (along with other long-duration) paper will start falling.

The target on this breakout of the inverted head-and-shoulders is 6% on the ten year treasury, and approximately 7% on 30 year mortgages.  As of today’s pricing (about 5% on that same money) we can back into the home price impact quite simply; the hypothetical $200,000 house will be devalued to $161,644.55.

That is, the same payment that today pays down a $200,000 mortgage will only pay down a $161,644.55 one.

The time on the full expression of this target is one to two years hence, although it can occur sooner.  The reliability of this sort of pattern is extremely high, and remains valid conditionally even with a drop back to 3%, and is not invalidated unless the ten year were to get down to 2.03%.  Neither is likely.

The entire premise of the so-called “recovery” not only requires stabilization of the housing market but a resumption in home price appreciation.  With the cost of mortgage money nearly-certain to rise toward the 7% range over the next year this is simply impossible.

The market will not ignore this for long, once it begins to express itself in actual rates and prices – and it will. 

If you’re one of the trapped underwater homeowners who as of today has an opportunity to short-sale your house, take it – while it still is available. 

Consider that The Fed is holding a literal trillion of this paper which is likely to come under extreme valuation pressures as rates back up.

Additionally, the sentiment in the market today is positively giddy – those who claim that retail is “not in” need to look at the ISE index, which hit an all time high today.  That’s all retail call buyers – they sure are “in”, and now the shears can come out of the drawer.

Parabolic moves like this always go further than you’d expect or believe possible.  But the math always wins, and the sort of rate environment we’re seeing now is quite similar to what happened in 1987.

No, this is not predicting a 1987-style crash – at least not today or tomorrow.  But with both rates and oil headed up hard the effective tax this presents to the economy is going to hit home immediately and hard, with no evidence that this very same backup in oil is in commodities generally (look at wheat lately?)

That’s not inflation, it’s financial speculation in a blow-off top.

Real job creation and a healthier economy?  We’ll see.

Here It Comes (You Were Just Warned Folks)

Posted by Karl Denninger

Good Credit Score Not Good Enough Anymore

by Melissa Ezarik
Tuesday, December 29, 2009provided by

Submitted by James Bianco of Bianco Research

•    The Wall Street Journal – Fed Proposes Tool to Drain Extra Cash
The Federal Reserve on Monday proposed selling interest-bearing term deposits to banks, a move the U.S. central bank would make when it decides to drain some of the liquidity it pumped into the economy during the financial crisis. The new facility is intended to help ensure that the Fed can implement an exit strategy before a banking system awash with Fed money triggers inflation. Fed Chairman Ben Bernanke has described term deposits as “roughly analogous to the certificates of deposit that banks offer to their customers.” Under the plan, the Fed would issue the term deposits to banks, potentially at several maturities up to one year. That would encourage banks to park reserves at the Fed rather than lending them out, taking money out of the lending stream.The central bank said the proposal “has no implications for monetary policy decisions in the near term.” “The Federal Reserve has addressed the financial market turmoil of the past two years in part by greatly expanding its balance sheet and by supplying an unprecedented volume of reserves to the banking system,” it said. “Term deposits could be part of the Federal Reserve’s tool kit to drain reserves, if necessary, and thus support the implementation of monetary policy.” Michael Feroli, an economist at J.P. Morgan Chase, said “it’s another step forward in the exit-strategy infrastructure, but it’s been well flagged in advance, so it’s not a surprise.” When Fed officials decide to tighten credit, they would likely use the term-deposits program ahead of — or in conjunction with — adjusting their traditional policy lever, the target for the federal funds interest rate at which banks lend to each other overnight. The Fed also said Monday that its balance sheet rose slightly to $2.2 trillion in the week ending Dec. 23. The Fed’s total portfolio of loans and securities has more than doubled since the beginning of the financial crisis. As part of its efforts to fight the downturn, the central bank is buying $1.25 trillion in mortgage-backed securities, a program it says will end in March. The Fed now holds $910.43 billion in mortgage-backed securities, it said Monday.

•    Bloomberg.com – Fed Proposes Term-Deposit Program to Drain Reserves
The Federal Reserve today proposed a program to sell term deposits to banks to help mop up some of the $1 trillion in excess reserves in the U.S. banking system.  The plan, subject to a 30-day comment period, “has no implications for monetary policy decisions in the near term,” the central bank said in a statement released in Washington. Fed Chairman Ben S. Bernanke is preparing tools and strategies to shrink or neutralize the inflationary impact from the biggest monetary expansion in U.S. history. Central bankers are also conducting tests of reverse repurchase agreements and discussing the possibility of asset sales. Term deposits may help the central bank “assert operational control over the federal funds rate” once officials decide to lift the overnight bank lending rate from the current range of zero to 0.25 percent, said Lou Crandall, chief economist at Wrightson ICAP LLC in Jersey City, New Jersey. Excess cash “would be locked up” rather than put downward pressure on the federal funds rate, he said.The Fed won’t begin raising interest rates until the third quarter of 2010, according to the median estimate of 62 economists surveyed by Bloomberg News in the first week of December.

•    The Financial Times – Fed to offer term deposits to banks
The US Federal Reserve plans to offer term deposits to banks as part of its “exit strategy” from the exceptionally loose monetary policy used to fight the recession. In a consultation paper released on Monday the Fed said it planned to change its rules so that it could pay interest on money locked up at the central bank for a defined period. The Fed added that the well-flagged rule change – designed to allow it more influence over the $1,100bn in excess reserves held by banks – was part of “prudent planning. . . and has no implications for monetary policy decisions in the near term”. It is one of a number of measures that has been outlined over the past few months by Ben Bernanke, chairman of the Fed, as an option to drain liquidity from the financial system in a manner that protects the economic recovery while heading off the threat of inflation.

•    The Federal Reserve – Notice of proposed rulemaking; request for public comment.
The Board is requesting public comment on proposed amendments to Regulation D, Reserve Requirements of Depository Institutions, to authorize the establishment of term deposits. Term deposits are intended to facilitate the conduct of monetary policy by providing a tool for managing the aggregate quantity of reserve balances. Institutions eligible to receive earnings on their balances in accounts at Federal Reserve Banks (”eligible institutions”) could hold term deposits and receive earnings at a rate that would not exceed the general level of short-term interest rates. Term deposits would be separate and distinct from those maintained in an institution’s master account at a Reserve Bank (”master account”) as well as from those maintained in an excess balance account. Term deposits would not satisfy required reserve balances or contractual clearing balances and would not be available to clear payments or to cover daylight or overnight overdrafts. The proposal also would make minor amendments to the posting rules for intraday debits and credits to master accounts as set forth in the Board’s Policy on Payment System Risk to address transactions associated with term deposits.

Comment

We believe the proposal of this new tool signals the Federal Reserve is still flailing around trying to look busy so everyone is assured they have a plan.  The fact is they have no plan and are still throwing everything on the wall to see what sticks. From the November 4 FOMC minutes:

Participants expressed a range of views about how the Committee might use its various tools in combination to foster most effectively its dual objectives of maximum employment and price stability. As part of the Committee’s strategy for eventual exit from the period of extraordinary policy accommodation, several participants thought that asset sales could be a useful tool to reduce the size of the Federal Reserve’s balance sheet and lower the level of reserve balances, either prior to or concurrently with increasing the policy rate. In their view, such sales would help reinforce the effectiveness of paying interest on excess reserves as an instrument for firming policy at the appropriate time and would help quicken the restoration of a balance sheet composition in which Treasury securities were the predominant asset. Other participants had reservations about asset sales–especially in advance of a decision to raise policy interest rates–and noted that such sales might elicit sharp increases in longer-term interest rates that could undermine attainment of the Committee’s goals. Furthermore, they believed that other reserve management tools such as reverse RPs and term deposits would likely be sufficient to implement an appropriate exit strategy and that assets could be allowed to run off over time, reflecting prepayments and the maturation of issues. Participants agreed to continue to evaluate various potential policy-implementation tools and the possible combinations and sequences in which they might be used. They also agreed that it would be important to develop communication approaches for clearly explaining to the public the use of these tools and the Committee’s exit strategy more broadly.

The Federal Reserve first hinted at term deposits almost two months ago, although exactly what they were talking about was left vague until now.

Remember that the Federal Reserve has to withdraw over a trillion dollars of excess liquidity.  The easiest way to do this is to sell hundreds of billions of MBS, Treasuries and agencies.   As the bold highlighted passage above implies, they are scared to death of doing this, so they propose complicated schemes to withdraw liquidity like reverse repos and now term deposits.

We have argued that these schemes will not work.  They cannot be done in the sizes necessary or enough to even matter.  The Federal Reserve could possibly drain tens of billions of dollars via these schemes, but collectively that will amount to a rounding error when the goal is to withdraw over a trillion in excess reserves.

The Federal Reserve does not want to admit defeat, so they continue pursuing these strategies that will not make a difference.  We believe they also do it to “look busy” as they are taking measurements and notes as to how to withdraw all the liquidity they have pumped in.  They think this will give the market comfort that someone is on the case and that inflation expectations will not get out of control.  The market is not buying this.  Inflation expectations, s measured by TIPS inflation breakeven rates, are going vertical.

Reinvestment Risk

As to term deposits, the Federal Reserve is proposing an illiquid short term instrument for banks to invest in.  Banks would buy these instruments and “lock up” the excess reserves they now have.  This would have the same effect as draining excess reverses.  The maturities of these instruments would be as long as one year.

It is unclear if there will be a secondary market for these instruments, and if so, how liquid it will be.
Without a secondary market, buyers of these instruments face huge reinvestment risk.  The future course of short term interest rates is arguably to the most uncertain it has been in decades.  Will the Federal Reserve stay near zero until 2012 or will they be forced to raise rates in the first half of 2010?  Given all this uncertainty, who wants to lock up money in something that cannot be sold before maturity?  This is especially true given the Federal Reserve’s statement that the “maximum-allowable rate for each auction of term deposits would be no higher than the general level of short- term interest rates.”

The general level of short-term interest rates is set on known instruments that have generations of history and active secondary markets.  If the Federal Reserve wants to introduce a new, and wholly unknown instrument with an uncertain secondary market and offer no interest rate premium, then we cannot see how this will work beyond a token amount after some arm twisting to get them sold.  The Federal Reserve will have to offer a premium for uncertainty and illiquidy to make this fly in any major way, something they said they will not do.

Complicated Is Simple

The Federal Reserve owns 80% of AIG.  With each passing day it looks like the Federal Reserve is adopting AIG Financial Product’s business practices.  That is, when faced with a financial problem, they create complicated tools (like CDS).  When critics says these new products will not work, tell them they do not know what they are talking about and create even more complicated tools to dazzle everyone.  Once the tools are so complicated that no one understands them, you will be hailed as an expert with no peer.  You might even be named TIME’s Person of the Year.

For some reason Zero Hedge is prone to take a great deal of heat (both directly radiated and reflected) whenever we opine on the (rather obvious to us) prospect that interest rates might actually (quelle surprise) rise in this environment.  Today, rather than engage in “we told you so” gloating, or endure the repetitive pleadings of commentators that this or that Treasury auction was really a success if you just look a little deeper at the figures, we’ll just quote Bloomberg quoting other fixed income observers on today’s auction of two years, in an article “ambiguously” titled “U.S. 2-Year Yields Highest Since October After $44 Billion Sale.”

Treasury two-year note yields reached the highest levels since October as an investor class that includes foreign central banks bought the least of the debt in five months at today’s record-tying $44 billion auction.

Indirect bidders purchased 34.8 percent of the notes, the lowest amount since July, and below the average for the past 10 sales of 45 percent. Treasuries of all maturities have fallen 3.6 percent this year, according to Bank of America Merrill Lynch indexes. That would be the worst performance since at least 1978, when Merrill began collecting the data.

We aren’t really sure how this will be spun into a “good thing,”™ but we are sure that someone will find a way.  Back to you, CNBC.