Cumberland Advisors Market Commentary – Inflation and Capacity Utilization

At Cumberland, we continuously have internal strategy discussions. We decided to make one such discussion, on the subject of inflation and US capacity utilization, available in the form of a commentary to clients, consultants, and all readers. Below you’ll find a summation of our discussion, written by Bob Eisenbeis, Cumberland Advisors Chief Monetary Economist. -David Kotok


Inflation, Deflation, and Capacity Utilization

by Bob Eisenbeis

During the pandemic we have seen both a drop in aggregate demand as well as a shutdown in supply, resulting in a precipitous drop in capacity utilization. To many economists, this convergence means that inflation will be benign in the foreseeable future. We know that excess demand serves to bid up prices, but is there reliable information on the supply side in terms of capacity utilization that also conveys meaningful information about price pressures as well? To address this question, it is useful to look at the long-run relationship between capacity utilization (blue) and inflation (red). In the 1970s, capacity utilization appeared to increase, followed by an increase in inflation. The pickup seemed to start when capacity utilization exceeded 80%.

Inflation and capacity utilization chart 01

The idea is that, as demand increases, businesses expand their productive capacity; increase labor hours; and then, ultimately, increase prices and invest to expand capacity to meet the increased demand.

However, in the period following the two recessions in the early 1980s, the relationship appears to have broken down, and that breakdown continued up to almost the current period, when capacity utilization declined to slightly below its low point in late 2009. To investigate the capacity utilization-inflation relationship, we computed linear regressions for the entire 1967–2020 period as well as for the shorter 1967–1983 period, when there appeared to be a strong relationship between capacity utilization and inflation. Interestingly, for the entire period, the strongest regression incorporated a three-month lag between changes in capacity utilization and inflation; but even for this regression, changes in capacity utilization explained only about 18% of the variation in inflation. For the shorter period, the regressions were much weaker, explaining at most 1.5% of the variation in inflation.

The large drop in capacity utilization in 2008 and 2009 was accompanied by a drop in inflation, but it is unlikely that there was a causal relationship between the two trends, since we know that the problems were in the housing and financial sectors. You will also note a slight downward trend in capacity utilization from about 1995 to the present. It becomes a bit clearer when we look only at the period from 1988 to the present, in the following chart.

Inflation and capacity utilization chart 02

Again, we need to remember that this was a period of low inflation and steady growth. In general, if businesses expect growth to continue, they will invest and expand capacity in anticipation of that growth, thereby contributing to lower measured capacity utilization in the short run. Business investment from late 1985 through 2007 averaged 5.4% year-over-year growth with a standard deviation of 6.8 percentage points. By comparison, business investment has only grown by 2.8% quarterly year-over-year since 2016 as the economy experienced slower growth; and, logically, slower investment followed. Over that period, capacity utilization averaged about 77%, whereas it averaged over 81% from 1988 through 2009.

This historical analysis raises the question of whether the monetary expansion undertaken by the Fed will prevent some business failures and support consumption in the short run. The monetary expansion should help create the opportunity to dampen the downturn, moderate the number of business failures and resulting loss of capacity, and thus facilitate a faster return. The key is whether a vaccine is discovered, tested, produced, and administered quickly around the globe. We saw how the market responded last Tuesday to the announcement of an experiment with only eight people.

Right now, capacity utilization has slumped to about 65%, according to the most recent number. That decline is due in part to a precipitous drop in demand, but also to production facilities shutting down. That capacity has not been destroyed, but rather it has been idled. We know that larger businesses, such as auto manufacturers, are ramping up production again; and the ability to bring those facilities on-line will depend upon demand. But the capacity will be destroyed only if a significant number of businesses fail. So, we need to watch business failures, as well as how quickly capacity utilization increases. We should also not expect business investment, except in the residential sector, to be an important contributor to growth.

The key to the inflation forecast is how quickly aggregate demand increases and whether it will outstrip supply. Thus, the economy’s longer-term growth prospects hinge, after this crisis has passed, on growth in productivity and growth in the labor force. Right now, the two indicators combined imply a real rate of growth of about 1.2% to 1.4%, which is not all that different from the low inflation environment we experienced during the recovery from the 2008 financial crisis. To the extent that this scenario plays out, it suggests that we should see next to no inflation for at least two or three years, or perhaps even longer.

Robert Eisenbeis, Ph.D.
Vice Chairman & Chief Monetary Economist
Email | Bio


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Cumberland Advisors Market Commentary – Inflation/Deflation: What Do We Know Now?

The most recent CPI numbers show a decline of 0.8% for the month of April, triggering questions about both a possible deflation and where prices are likely to go in the future. The fact is that no one knows what inflation will do in the short run, and all we have to go on, as yet, is fragmentary evidence that might suggest which of the competing hypotheses is more likely to be correct.

Cumberland Advisors' Robert "Bob" Eisenbeis, Ph.D.

The most recent data, aside from the headline CPI figures and some rough breakdown of components for April, are in the March components that make up the CPI. April data show some key components that have accelerated while others have declined. For example, the following chart from BLS shows the sharp decline in energy prices, while not surprisingly, food has increased significantly.

Food to be eaten at home was up more than was food to be purchased from restaurants; and of that, meats and poultry were up the most, followed by dairy products. All these segments have been negatively impacted by supply chain disruptions, creating shortages in the face of increased demand, in part related to panic hoarding and in part to the fact that more Americans have been eating at home. What is also important is to recognize that the large percentage declines are the year-over-year changes for the monthly data.
Clearly, financial dynamics have changed, and this change affects the ability of models to predict with some degree of accuracy. The monthly data for March, broken down by the Dallas Fed in computing its trimmed mean, show that 72 of the 178 components to the CPI declined a weighted cumulative total for the month of minus 33 basis points from the CPI, while the remaining 106 components added 31 basis point to the index.
Additionally, it is not clear that current events have, as yet, had a significant impact upon expectations. The chart below shows the most recent data from the Atlanta Fed’s May predictions for inflation one year ahead, based upon its survey of businesses, which is at 1.5% and unchanged from the previous month. This figure is somewhat surprising given what we know about unemployment and the virus’s impacts on the real economy
Over the longer term, the story is not much different. Those numbers show a much higher rate of inflation than we are seeing now. Here is another picture of the Atlanta Fed’s inflation expectation 10 years out (which actually isn’t very useful for the short term). This number is consistent with a much higher rate of inflation above the Fed’s target rate, a rate that hasn’t been achieved for the past 10 years or so.
Interestingly, the Atlanta Fed also publishes a set of deflation probabilities that the inflation number will be below a reference point. The following chart shows that the probability that we will experience inflation below what was expected as of April 15, 2019 (which was 2% on a year-over-year basis) has been essentially zero for the entirety of 2020, notwithstanding the pandemic.
Breaking that longer-term forecast down to components related to real return versus inflation compensation, at least for the short term, shows inflation compensation next to zero.
With regard specifically to the issue of TIPS, the Cleveland Fed shows longer-term yields essentially at zero.
The bottom line is that we are looking at inflation at or below 1% for the near term. What should we look for in terms of signals otherwise? We should focus on two dimensions – demand and supply. Supply will likely recover faster than demand will, and that difference will keep inflation pressures dampened. Without excess demand, you can’t bid up prices; and if you try to raise them, people will turn to substitutes.
What does this mean for the term structure? Again, the following chart shows recent data on the term structure from the Cleveland Fed. Short-term for the next three years, we see rates below or possibly at 1%.

The wild card in all this is that we don’t know what the Treasury financing needs will be and how much upward pressure they will put on rates. How much of that will end up on the Fed’s balance sheet, and how much crowding out will this result in? If we get another $3 trillion in government spending, what will this do to rates? And this is in an environment with little or no inflation.
Robert Eisenbeis, Ph.D.
Vice Chairman & Chief Monetary Economist
Email | Bio

Links to other websites or electronic media controlled or offered by Third-Parties (non-affiliates of Cumberland Advisors) are provided only as a reference and courtesy to our users. Cumberland Advisors has no control over such websites, does not recommend or endorse any opinions, ideas, products, information, or content of such sites, and makes no warranties as to the accuracy, completeness, reliability or suitability of their content. Cumberland Advisors hereby disclaims liability for any information, materials, products or services posted or offered at any of the Third-Party websites. The Third-Party may have a privacy and/or security policy different from that of Cumberland Advisors. Therefore, please refer to the specific privacy and security policies of the Third-Party when accessing their websites.

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ROBERT EISENBEIS: Too early to tell on financial relief programs in pandemic

Excerpt from the Sarasota Herald-Tribune

Eisenbeis - Too early to tell on financial relief programs in pandemic

Too early to tell on financial relief programs in pandemic
Posted May 11, 2020
by Robert Eisenbeis, Ph.D.

Congress and the Trump administration have embarked upon a massive federal stimulus program to mitigate the impact of the coronavirus on the U.S. economy. At the same time, the Federal Reserve has stepped up to bolster financial markets, having announced, in addition to its ongoing support of the repo market, a series of 10 loan programs, some old and some resurrected from the 2008 financial crisis.

So far, markets have responded relatively favorably to the announced programs and have backed up from their lows. But aside from the injection of funds to support business in the first congressional stimulus program, the markets’ response has been based only on hope rather than tangible evidence that the programs are having the desired effect.

Continued here: https://www.heraldtribune.com


Matthew Sauer, the executive and general manager of the Herald-Tribune, says “the press is a critical component of our democracy that has been here knitting the fabric of our country together since before it was a country.”

Show your appreciation for a free press and read Matthew’s op-ed while you’re at their site: https://www.heraldtribune.com/opinion/20200510/wonderful-gesture-that-will-inform-those-most-in-need


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Cumberland Advisors Market Commentary – The Fed and Markets

Congress and the Trump administration have embarked upon a massive federal stimulus program to mitigate the impact of the coronavirus on the US economy. At the same time, the Federal Reserve has stepped up to bolster financial markets, having announced, in addition to its ongoing support of the repo market, a series of ten loan programs, some old and some resurrected from the 2008 financial crisis.
Cumberland Advisors' Robert "Bob" Eisenbeis, Ph.D.
So far, markets have responded relatively favorably to the announced programs and have backed up from their lows. But aside from the injection of funds to support business in the first Congressional stimulus program; the markets’ response has been based only on hope rather than tangible evidence that the programs are having the desired effect. The $349 billion in the Paycheck Protection Program was quickly exhausted, but Congress expanded the amount by another $310 billion on April 24. It is too early to be able to assess the impact of the first round of relief on the economy, let alone that of round two.
As for the Fed programs, four are extensions of programs that were put in place during the 2008 crisis. They are the Primary Dealer Credit Facility (PDCF), the Money Market Fund Liquidity Facility (MMLF), the Commercial Paper Funding Facility (CPFF), and the Term Asset-Backed Securities Loan Facility (TALF). These programs were designed to support financial institutions and the functioning of key segments of short-term money markets. Five of the remaining six programs extend the Fed’s reach to supplying credit to nonfinancial entities. These programs include two programs that support corporate borrowing (the Primary and Secondary Market Corporate Credit Facilities [PMCCF and SMCCP]), two programs for smaller firms (the Main Street New and Expanded Loan Facilities [MSNLF and MSELF]), and a program to support the municipal securities market (the Municipal Liquidity Facility [MLF]). Finally, the Fed also created the Paycheck Protection Program Lending Facility (PPPLF), which would enable the Fed to provide liquidity to financial institutions where the collateral is government guaranteed loans made under the Paycheck Protection Program. Those loans are typically made by banks through the Small Business Administration, which is managing the PPP.
Although, as with the Fed’s repo program, the potential amounts could be huge, to date little has happened in terms of implementation of the programs, and the channeling of funds to their projected uses has yet to take place. The following chart shows what we know about the programs to date. The first two programs (MMFL and PDCF) were announced on March 25 and were a little over $30.6 billion and $27.7 billion respectively. Since then, use of the MMFL has ranged between $52.7 billion and $48.8 billion as of April 22. Use of the primary dealer credit facility has been smaller, ranging between $27.7 billion and a high of $33.4 billion. By comparison, the PDCF peaked at about $148 billion in the third quarter of 2009.
The two other programs that have just gotten off the ground are much smaller. The Commercial Paper Funding Facility is now only at $2.7 billion, whereas during the financial crisis it got as high as $224.2 billion in January 2009. The newest program to start is the PPP Liquidity Program, and it is only at $8 billion as of April 22.
What we see is that compared to past usage, most of these current programs are quite small, and therefore it is difficult to determine what positive effects they can or will have on markets. The other programs have yet to be operational, but we will monitor them all and report on their likely impacts in future commentaries. As mentioned at the outset, the positive effects that have been realized are largely expectational and not rooted in hard performance numbers yet.
Robert Eisenbeis, Ph.D.
Vice Chairman & Chief Monetary Economist
Email | Bio

Links to other websites or electronic media controlled or offered by Third-Parties (non-affiliates of Cumberland Advisors) are provided only as a reference and courtesy to our users. Cumberland Advisors has no control over such websites, does not recommend or endorse any opinions, ideas, products, information, or content of such sites, and makes no warranties as to the accuracy, completeness, reliability or suitability of their content. Cumberland Advisors hereby disclaims liability for any information, materials, products or services posted or offered at any of the Third-Party websites. The Third-Party may have a privacy and/or security policy different from that of Cumberland Advisors. Therefore, please refer to the specific privacy and security policies of the Third-Party when accessing their websites.

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Cumberland Advisors Market Commentary – Narrow Banks

In a move largely overlooked due to the virus pandemic, on March 25, Judge Andrew L. Carter, Jr., of the United States District Court for the Southern District of New York dismissed a case filed by principals of The Narrow Bank (TNB) against the Federal Reserve Bank of New York (https://www.tnbusa.com/wp-content/uploads/2020/03/2020.03.25-TNB-Order.pdf). What is The Narrow Bank, and what are the issues it poses?

Narrow Banks

For the past two years, a former Fed employee and investors have been pursuing a charter for what they call The Narrow Bank. The Narrow Bank would be structured as a state-chartered, uninsured, non-retail bank whose sole function would be to hold a master account at the Federal Reserve Bank of New York, through which it would earn interest on its reserve holdings and pass that return, after extracting a small fee, to its depositors, comprised of hedge funds, accredited investors and other financially sound institutions.

The proposed bank applied for a charter in Connecticut, whose banking department issued a temporary approval subject to conditions, including obtaining a master reserve account at the Federal Reserve Bank of New York before final approval would be granted. All states require that a bank that accepts retail deposits (deposits from individuals who are not accredited investors) must have Federal Deposit Insurance from the Federal Deposit Insurance Corporation. However, because TNB would not accept retail deposits, it would be regulated only by the State of Connecticut and not need FDIC insurance, nor would it be regulated by the FDIC or any other federal bank regulator. It would also not be subject to the FDIC’s large bank risk assessment charge that large federally insured banks must pay should TNB attract significant deposits.

As noted in the judge’s ruling, the master account application process involves a one- page form and is usually acted upon in a week or so. But in this case the process dragged on for weeks, with the New York Fed’s attorney finally indicated that several conditions must be met, including having at least $500K in deposits, proof of final charter approval, and completion of due diligence by the New York Fed. In late December 2017 the application was escalated to the Fed’s Board of Governors, which was concerned about the implications of such an institution for the efficacy of the Fed’s monetary policy tools, including IOER (interest on excess reserves). On March 6, 2019 the Board issued proposed changes to Regulation D that would lower the interest rate paid on reserves to institutions such as The Narrow Bank, essentially making TNB uneconomic. No final ruling has been forthcoming from the Board, but the advent of the COVID-19 financial crisis has essentially made TNB uneconomic for the moment, given that the IOER is at 0.1%, compared with the 1.0% that it was in August 2017, when TNB was granted a temporary charter certificate, or the 2.4% that it reached in December 2018 before plunging to its current level.

Some might claim that TNB has been treated unfairly and has been denied due process, an argument that at least one court has rejected. But TNB raises three general policy questions. First, is there a public policy reason to broaden access to Federal Reserve services and interest on reserves beyond banks, perhaps even to individuals? Second, are there risks associated with narrow banks that may impact financial stability? Finally, what implications are there for the efficacy of the Fed’s monetary policy tools? The answers to these questions are complex and not always clear.

As for who should have access to Federal Reserve services, it should be recognized that as a central bank, the institution’s main function is to conduct monetary policy, not to provide payments services to individuals or to the general public. It does provide wholesale payments clearing and settlement services, which evolved out of its historical check-clearing activities. It also serves as fiscal agent for the US Treasury and aids in issuance of Treasury debt. The appeal of TNB and similar entities when it comes to retail payments is that they provide a riskless alternative. In this respect the idea of a 100% reserve backing as a means to provide riskless payments services to individuals is not new. Irving Fisher and others put forth such a proposal in 1935 in the aftermath of the Great Depression; and later, Milton Friedman supported a 100% reserve requirement for checking accounts to counter what many thought was the inherent instability of a fractional reserve banking system (https://monneta.org/en/100-money-and-chicago-plan-full-reserve-banking/). Today, there are many payments options, and for individuals it is possible to have FDIC insurance to cover most payments and savings needs. (There have even evolved workarounds to get more than $250K of insurance on accounts). So the case for individuals to have access to the central bank is weak and could provide a distraction to the Fed’s main monetary policy function.

The second concern is potential risks that TNB and similar institutions might pose to financial stability. Because narrow banks’ only assets are reserves on deposit at the Federal Reserve, they are essentially riskless, and the rate that they earn is a riskless rate. In times of financial stress, when there is a flight to quality, the concern is that funds would disintermediate from the Treasury market, from money market funds, and from banks into narrow banks, thereby creating liquidity and, potentially, solvency problems. While this is a hypothetical concern, recent experience in both the repo market and the liquidity problems that have emerged across a wide range of financial markets during the pandemic shows that in desperate times there can be extreme pressures on certain financial markets and institutions. The recently announced nine Fed programs to support primary dealers, the corporate credit market, the municipal market, money market mutual funds, and the commercial credit market are but a few examples of the need to address such stresses.

Finally, and perhaps most importantly, there is concern about the implications of narrow banks for the efficacy of the tools the Fed employs to implement monetary policy. These tools include, but are not limited to, reserve requirements, interest on reserves (IOER), the discount rate, and the federal funds rate. These tools provide levers that flow into the economy through short-term money markets and across the term structure. Reserve requirements have receded into the background as a tool, since they are so low as to not be binding. The Fed could not pay interest on reserves until it was permitted to do so under the Economic Stabilization Act of 2008, which authorized payment of interest on both required and excess reserves. Because of the Fed’s asset purchase programs, bank reserves ballooned; and the Fed began paying the same rate of interest on both excess reserves and required reserves. That remains the case today. The IOER was intended to put a floor on the band within which the Fed would set its fed funds target rate. However, for much of the period since IOER was adopted, the effective federal funds rate was slightly below the floor supposedly set by IOER. The reason for this lies in a technical problem, in that Freddie Mac and Fannie Mae as well as the Federal Home Loan Banks are permitted to hold deposits at the Fed but are not permitted to receive interest on those funds. So they lend the funds out in the overnight market at rates slightly below IOER. These entities would appear to be prime candidates for placing deposits in TNB and similar narrow banks. While eliminating the discrepancy between the effective federal funds rate and IOER might be a desirable outcome, it is not obvious that simply permitting the Fed to pay interest on GSE and Home Loan Bank funds is not a better alternative, especially since these entities are, at present, government institutions.

In summary, the issues raised by the narrow bank proposals are complex and not always clear. What is needed at this point is a serious and in-depth reassessment of the Fed’s policy tools, the structure of the markets in which those tools are applied, and how the tools are linked, both theoretically and practically, to the macroeconomy. Just one example may serve to illustrate that need. The present primary dealer system is a relic of the past when Treasury securities were paper documents and primary dealers submitted paper bids in connection with daily open-market operations. With the evolution of technology, including digital securities and electronic bidding, there is no reason that all sound member banks and other qualified entities should not be permitted to bid and eliminate the privileged position of the primary dealers. Right now, more than half of primary dealers are affiliates or subsidiaries of foreign banking institutions that are currently being supported by the Fed though the primary dealer credit program, effectively subsidizing foreign institutions.

Robert Eisenbeis, Ph.D.
Vice Chairman & Chief Monetary Economist
Email | Bio


Links to other websites or electronic media controlled or offered by Third-Parties (non-affiliates of Cumberland Advisors) are provided only as a reference and courtesy to our users. Cumberland Advisors has no control over such websites, does not recommend or endorse any opinions, ideas, products, information, or content of such sites, and makes no warranties as to the accuracy, completeness, reliability or suitability of their content. Cumberland Advisors hereby disclaims liability for any information, materials, products or services posted or offered at any of the Third-Party websites. The Third-Party may have a privacy and/or security policy different from that of Cumberland Advisors. Therefore, please refer to the specific privacy and security policies of the Third-Party when accessing their websites.

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Cumberland Advisors Market Commentary – Repos Revisited

On March 12, a Wall Street Journal headline announced, “Fed to Inject $1.5 Trillion in Bid to Prevent ‘Unusual Disruptions’ in Markets” (https://www.wsj.com/articles/fed-to-inject-1-5-trillion-in-bid-to-prevent-unusual-disruptions-in-markets-11584033537).

Market Commentary - Cumberland Advisors - Repos Revisited

The inference was that the Fed was embarking upon a massive injection of funds into short-term money markets. That is, the first three offerings of $500 billion each were but the first of a much larger potential program to be played out over March and April and possibly subsequent months.

The program actually began on March 12 with a $500-billion, 84-day offering, followed on March 13 with two $500-billion offerings, one of 84 days and one of 31 days. A lot has happened since then in terms of government and Fed efforts to brace the economy against the costs of the coronavirus pandemic. For example, the Fed subsequently announced nine additional $500-billion offerings to be executed through April 13. Most recently, the Fed announced resumption of emergency lending facilities to money market funds and primary dealers, and even actions, which will begin shortly, to support the muni market.

Against this background Cumberland has been publishing daily updates on the Fed’s repo facility, and it is time to assess what has actually happened. The bottom line is that there have been few signs of liquidity problems in short-term markets, and the total takedown of potential offerings has been very small. In other words, the massive injection that people expected never happened. This means either that there have been no problems or else that the demand for Treasuries and MBS from the private sector has been so great that dealer inventories are small and there is no need for the extra funding. So let’s look back at how the NY Desk’s repo (reverse repo – remember, the Fed’s terminology is from the counterparty’s perspective) actually worked.

First, some operational details. The Desk announced a monthly schedule of proposed daily transactions ranging from overnight repos to term repos of various maturities including 11 days, 13 and 14 days, 28 and 31 days, up to 84 days. The $500-billion offerings have all been for at least 28 days or longer. The shorter offerings have been for $45 billion, except for one $50-billion, 25-day offering on March 12. As for the overnight offerings, they were increased from $100 billion on March 4 to $150 billion on March 9 and later that week it was boosted to $175 billion on March 11.

While the Fed has been willing to supply liquidity, it is interesting to see how little of the potential lending has actually taken place. The chart below shows the amount of funding outstanding for different maturities as of the morning of April 8 in terms of overnight borrowings and the amount of term funding that has also been granted. The chart nets the amount of under/over funding of the potential takedowns that might have happened across maturities. The amount of underfunding includes both term (yellow) and overnight (green) amounts.

Total outstanding amounts peaked on March 18 and remained over $400 billion through March 25 but have declined steadily since then. Interestingly, overnight financing remained under $4 billion from March 30 through April 9 and summed to only $ 40.25 billion out of a possible $1.8 trillion of overnight financing over that period. Use of the longer-term offerings thus far has also been far below capacity. Over the same March 30–April 9 period, only $7.25 billion out of a possible $2.1 trillion was taken out.

Overall, conditions appear to have moderated in the repo market. We will look forward to monitoring the other emergency programs that the Fed has put in place as data become available. We need to avoid being complacent about financing conditions. With the additional borrowing the government has to do in order to finance the emergency spending programs that have been put in place, plus others that may be in the pipeline, we can only imagine what the dealer financing needs are likely to be and how much of that borrowing will ultimately end up on the Fed’s balance sheet.

Robert Eisenbeis, Ph.D.
Vice Chairman & Chief Monetary Economist
Email | Bio


Links to other websites or electronic media controlled or offered by Third-Parties (non-affiliates of Cumberland Advisors) are provided only as a reference and courtesy to our users. Cumberland Advisors has no control over such websites, does not recommend or endorse any opinions, ideas, products, information, or content of such sites, and makes no warranties as to the accuracy, completeness, reliability or suitability of their content. Cumberland Advisors hereby disclaims liability for any information, materials, products or services posted or offered at any of the Third-Party websites. The Third-Party may have a privacy and/or security policy different from that of Cumberland Advisors. Therefore, please refer to the specific privacy and security policies of the Third-Party when accessing their websites.

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Cumberland Advisors Market Commentary – One Less Worry?

It is tempting to focus on the here and now, especially when we are worrying about the economic fallout from the coronavirus pandemic and its impact on the nation. We are withdrawing from social contact and are concerned about all sources of risks. We have seen reports of people sanitizing cash as one way of protecting against the transmission of the virus, and we have all experienced expanded use of electronic payments via cell phones, credit cards, and even no-signature requirements as a way of avoiding touching touchscreens at all point-of-sale terminals.

Cumberland Advisors Market Commentary - One Less Worry (Eisenbeis)

The fact is that we are moving closer to being a cashless society; and that may be, at least here in the US, one of the side effects of 9/11 and the growth of technology. When 9/11 occurred, the Fed was forced to arrange trucks to transfer checks across the country since its private fleet of airplanes that physically transported paper checks from place to place could not fly. In response to that experience, both the Fed and the private sector made changes to how transactions were cleared and settled and installed robust backup processes.

As a consequence of those changes, technology may be an important and underappreciated source of resilience for our financial system, mitigating some of the possible costs of the financial crisis. On CNN just recently there was an interview of an expert and her response to the NY governor’s claim that a lockdown of New York would cause economic disaster to the US economy. She made the point that financial markets are now essentially electronic and that we have already operated a week with the floor of the NY Stock Exchange closed. The exchange floor is basically a TV set at this point, and is not critical to the functioning of equity markets.

The same is true of all the actions that the Federal Reserve has taken to support financial markets. The Treasury market is electronic; the repo market is electronic; the federal funds market is electronic, as are the SWIFT international foreign exchange market, the large dollar transfer system, the credit card system, and the ACH funds transfer system among financial institutions, just to name a few.

As far as retail payments are concerned, prior to 9/11, checks and check clearing was so important that the Federal Reserve had 56 facilities across the country involved in the physical transfer of paper checks. Now it has only one office involved in that activity. The reason is that check images are now captured electronically and are truncated at the point of sale. Much of this shift was the logical fallout of the changes in the payment system that resulted from 9/11.

Why is this important today? Well, we can continue to go to the store and use credit cards, phones, and the like (electronics) to make purchases with greatly reduced risk of picking up the coronavirus or transferring it to others. While this convenience may not seem like a big deal, transferring money electronically certainly reduces risk in this time of crisis and is one less thing to worry about.

At Cumberland Advisors we have been working remotely for more than a week with full functionality, using technology and implementing emergency preparedness procedures that we had developed for exactly such a crisis.

Robert Eisenbeis, Ph.D.
Vice Chairman & Chief Monetary Economist
Email | Bio


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Fed Outstanding Repo Transactions March 2020

Fed Outstanding Repo Transactions March 3 – March 31

Eisenbeis Chart - Fed Outstanding Repo Transactions March 2020 Overnight & Term Repos ($Billions)

Fed repo transactions have been declining is volume both in terms of outstanding credit being supplied as well as in take-downs of the daily offerings.  Today no one-day credit was applied for and only $250 million of the $45 billion 13 day-offering was taken down.  Most interesting is of the five the widely touted $500 billion 84-day and $500 billion 28  day offerings that have been put forward so far, which could have injected $2.5 trillion of liquidity into financial markets, only a total of $150 billion has been taken and none was taken of the $500 billion 28-day offering on March 27th.

This pattern suggests there the so-called liquidity squeeze in the repo market was a concern at the time but not a reality in fact and may be overblown.

Robert Eisenbeis, Ph.D.
Vice Chairman & Chief Monetary Economist
Email | Bio




Fed Outstanding Repo Transactions March 03-26, 2020

Fed Outstanding Repo Transactions March 3 – March 26

Fed Outstanding Repo Transactions March 2020 Overnight & Term Repos ($Billions). Chart by Robert Eisenbeis, Ph.D.

Liquidity needs in the repo market appear to have stabilized and transactions proposed are far below the amounts that the Fed is willing to buy from dealers. There was a slight bump up in demand for overnight funding, no doubt due to the uncertain status of the stimulus bill, which was resolved early Thursday morning.

The new claims for unemployment insurance are literally off the charts and is a harbinger for what we might expect to see next week. The support packages should ease the financial burdens for both the unemployed as well as businesses, but they will not bring back demand or spur production in the short run until the virus has run its course.

Eisenbeis Chart - Unemployment March 26, 2020

Robert Eisenbeis, Ph.D.
Vice Chairman & Chief Monetary Economist
Email | Bio




Cumberland Advisors Market Commentary – Whatever It Takes, Part II

On Thursday, March 12, the Federal Reserve announced additional measures designed to send a message to markets that the Fed is there should it be needed. Pundits hyped that the Fed was going to inject up to $1.5 trillion of liquidity into financial markets, but that amount is misleading in many important ways.

Whatever It Takes, Part II

First, the Fed has been adding to its balance sheet at the rate of $60 billion a month, mainly in T-bills, and had planned to continue through at least the second quarter of 2020. On March 12, this policy was modified to include purchases across the term structure (see: https://www.newyorkfed.org/markets/opolicy/ operating_policy_200312a).

Second, more significant than the change in the maturity structure of its purchases, however, was the announcement of the intention to offer a series of potentially large repo transactions, which the press reported would expand the Fed’s balance sheet by as much as $1.5 trillion (see: https://www.cnn.com/2020/03/12/investing/ny-fed-trillion-coronavirus/index.html or https://www.nbcnews.com/business/economy/why-did-federal-reserve-inject-half-trillion-dollars-financial-system-n1157166). Some interpreted the action as another QE but in some cases totally misstated what the Fed was proposing and missed the central point that the proposal was actually a series of short-term collateralized loans.

In any case, the press reports on the quantitative significance of the new repo transactions are actually significantly understated. The monthly announcement schedule of the Fed’s proposed repo offerings (https://www.newyorkfed.org/markets/domestic-market-operations/monetary-policy-implementation/repo-reverse-repo-agreements/repurchase-agreement-operational-details), which is adjusted each business day, shows, for example, for Thursday, March 12, a 25-day offering of at least $50 billion, a 14-day offering of at least $45 billion, and an 84-day offering of at least $500 billion. For March 13 it shows both an 84-day offering of at least $500 billion and a 31-day offering of $500 billion.  Similar patterns exist throughout March and up to April 13. Interestingly, New York Fed data show that, of the five above offerings, the 25-day and 14-day term repos were oversubscribed but only $119.4 billion of  the first three $500 billion offerings (on March 12 and March 13) were taken, indicating little demand for the $1.5 trillion of  repo transactions that could have been conducted.

While the press reported that the Fed intended to inject up to $1.5 trillion of liquidity through its repo operations,  no such limit is contained in either the monthly transactions schedule, referenced above, nor in the announcement accompanying the change. Indeed, up to 8 more potential $500 billion offerings are contained in the above-referenced schedule. It is hard to believe that that much would be injected, especially as the recent takedowns shown in the chart below provide evidence as to how much markets are stressed for liquidity.  But it does send the clear message that the Fed is willing to do whatever it takes.

Interestingly, all of the overnight and under-25-day repos offered between March 3 and March 13 were oversubscribed, as indicated by the tan bars above the total line in the chart below; but the first three installments  installment of the  two 84-day and one 31-day $500 billion offerings amounted to only $119.4 billion and thus were  undersubscribed by more than $1.380 trillion(shown with the bars below the zero line), suggesting either that right now pressures are not anticipated to be great or that there are simply not many eligible securities needing to be financed. To put those numbers in perspective, the maximum amount outstanding last September and early October was about $281 billion. Given the fact that the Fed has proposed at least eleven such $500 billion offerings from March 12 through early April, we might have supposed that the Fed would have put out a more general announcement from both the Board of Governors and the New York Fed, rather than a communication to only those active in the repo market.

Fed Outstanding Repo Transactions

Epilogue

If last Thursday and Friday’s actions weren’t enough, on Sunday the FOMC in a series of actions made the unprecedented decision during a weekend-emergency meeting to slash its target rate for the federal funds to 0-.25%. The Board of Governors also slashed the discount rate by 150 basis points to .25 percent effective March 16 thereby narrowing the spread between the federal funds rate and discount rate to the top of the new federal funds target range. If that weren’t enough, the Federal Reserve also announced that it would restart its QE bond buying program. It will begin the purchase of $500 billion of Treasury bonds across the curve beginning March 16 and it will also buy $200 billion of mortgage backed securities as a means to support the housing market. As part of this new QE the Fed will resume reinvestment of both maturing Treasury securities and mortgaged backed securities. At the same time, the Board of Governors put out a statement that not only encouraged banks to rely upon intraday credit to support a smooth functioning payments system but also urged large bank holding companies to dip into their liquidity buffers as needed to support lending and the economy. Lastly, as part of a coordinated effort, the world’s major central banks (Canada, Bank of England, Band of Japan, the Swiss National Bank and Federal Reserve) announced they will expand the volume and lower the cost of standing US dollar standing swap lines by 25 basis points. Additionally, these banks will expand their current one-week maturity US dollar liquidity offerings to also offer an 84-day transaction as well.

We now have the makings of both a wave of fiscal policies to mitigate the costs of the coronavirus pandemic to the US economy, if the Senate enacts legislation that has already passed the House with presidential support, and complimentary monetary policy. This is not only “whatever it takes squared” but also all the chips are now on the table.

Robert Eisenbeis, Ph.D.
Vice Chairman & Chief Monetary Economist
Email | Bio


Links to other websites or electronic media controlled or offered by Third-Parties (non-affiliates of Cumberland Advisors) are provided only as a reference and courtesy to our users. Cumberland Advisors has no control over such websites, does not recommend or endorse any opinions, ideas, products, information, or content of such sites, and makes no warranties as to the accuracy, completeness, reliability or suitability of their content. Cumberland Advisors hereby disclaims liability for any information, materials, products or services posted or offered at any of the Third-Party websites. The Third-Party may have a privacy and/or security policy different from that of Cumberland Advisors. Therefore, please refer to the specific privacy and security policies of the Third-Party when accessing their websites.

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Cumberland Advisors Market Commentaries offer insights and analysis on upcoming, important economic issues that potentially impact global financial markets. Our team shares their thinking on global economic developments, market news and other factors that often influence investment opportunities and strategies.