Wednesday, August 26, 2015

Chart updates II

Only two charts from yesterday merit updating today, one the result of a bounce in stock prices and a drop in fear, the other the result of a further decline in 2-yr swap spreads.

When stock prices move inversely to fear (as proxied in the above chart by the ratio of the Vix index to the 10-yr Treasury yield), it's a good bet that emotions are the primary driver. More and more this looks to be the case with the recent volatility in global equity markets.

Swap spreads typically lead or track credit spreads, but not recently. 2-yr swap spreads in the U.S. are now a mere 14 bps, while high-yield spreads remain somewhat elevated. Equity and corporate bond markets are nervous about a deceleration in China's growth and a possible slowdown in the U.S. economy. But swap spreads are about as low as they get, which is a good sign that markets enjoy a healthy degree of liquidity and a virtual absence of systemic risk. This further suggests that elevated fears may be groundless—since they are as yet unaccompanied by any deterioration in the financial and economic fundamentals.

The next two charts are updated versions of ones I have featured periodically. Both show that the commercial real estate and construction markets are quite strong. As such, they lend support to the notion that the economic fundamentals have not deteriorated, and the market's fears are arguably misplaced.

According to the folks at Co-Star, commercial real estate prices are booming. Prices have been rising at a 12-14% rate for several years now. This is one of the strongest economic indicators I've seen.

New business on the books of the nation's architectural firms is increasing, according to a survey by the AIA. This points to increased commercial construction activity over the next year.


marcusbalbus said...

pointing to commercial real estate as evidence of "goldilocks" is specious. it is as sensitive to ZIRP as stock and bond prices. please.

Scott Grannis said...

I've argued for years that Fed policy has not been stimulative, and I maintain that position. The Fed has merely accommodated the world's intense desire for cash and cash equivalents. Interest rates are low because the markets have been very risk averse, investment has been weak, economic growth prospects have been weak, and inflation has been low.

marcusbalbus said...

this is what you said: "The next two charts are updated versions of ones I have featured periodically. Both show that the commercial real estate and construction markets are quite strong." that's very different than what you say in the comment above.

1leone said...

How do you explain the divergence between Swaps and high yield. This appears to be an anomaly no?

Benjamin Cole said...

Great charts. Love the commercial property chart (although it tends to dispel the whole Fannie Freddie CRA Clinton caused the real estate bust story. It looks like tight money busted real estate values).

The Bank of Japan is doing QE and the ECB is doing very modest QE. I believe the People's Bank of China is going to QE. I sure hope the Federal Reserve goes back to QE.

Now is not the time for a feeble irresolute Fed policy, led by a lady academic with zero business experience.

Damn the torpedoes, gun the presses and pass the ammo!

William said...
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Benjamin Cole said...

"I've argued for years that Fed policy has not been stimulative, and I maintain that position. The Fed has merely accommodated the world's intense desire for cash and cash equivalents."--Scott Grannis.

I wonder about this. If the Fed said today, "We are going to buy $50 billion in U.S. Treasures (net) in the next month," would that be stimulative?

So the Fed goes to the 22 primary dealers (Nomura, Goldman, Merrill etc) and buys $50 billion in Treasuries. The primary dealers buy the Treasuries from their clients or on the open market, and transfer to the Fed.

The Fed the credits the commercial bank accounts of the 22 primary dealers by $50 billion---that is the increase in reserves that you see.

But the people who sold the Treasuries to the primary dealers now have $50 billion in cash. Did they "want" to be be in cash? Well, yes, they sold of their own volition. So the Fed only "accommodated" their desire to be in cash.

Meanwhile, what do the ultimate bond-sellers do with their $50 billion? Well, they can buy stocks, property, bonds, bank it, spend it, or convert it to paper cash.

I think the key here is that when people sell their Treasuries to the Fed, they do not suck money out of another investor's pocket. In other words, if I want to spend the $100k I have locked up in a Treasury note, I have to sell the Treasury note--usually to another person who agrees to lock up their money in the Treasury and not spend it.

But when I sell to the Fed, I am free to spend or invest the money, and no one else has their money locked up.

The mistake is to think the Fed is conducting a traditional OMO when it does QE. That is to say, the Fed is hoping the banks lend the money out. That is not the key.

That is why the scale of QE was so large compared to traditional OMO.

The Fed wanted the ultimate bond-sellers to spend or invest the $4 trillion they received. QE worked--just should of been a permanent program, I think.

A good plan might be $50 billion a month in QE until the CPI is above 3% for one year, and then to consider slowly tapering down. This would give confidence to manufacturers and builders to go ahead with capital projects.

It may be demand-pull results only in a lot of growth. but not much inflation. Well, there are worse problems!

Thinking Hard said...

Benjamin - A note on QE. Does QE end if the Fed maintains the current level seen on its balance sheet? I argue no, as long as the Fed rolls over maturing treasuries then QE has not ultimately stopped. The Fed has approx $200B in USTs maturing in 2016 and 2016 with approx $400B maturing in 2018.

The current normalization procedures do not have the Fed selling these assets to alter the interest rates like we have seen in previous rate hike cycles. This means the Fed will be the ultimate buyer of approximately $800B in treasuries over the next three years just by rolling over the maturing USTs on the books.

Also, see China is selling UST ( which may help explain why we didn't see the 10yr yield drop much at all during the correction. Also, we have seen outflow from bond funds from retail investors during the correction.

I disagree about the Fed hoping the banks lend money out. That is going to be a main point moving forward through IOER. IOER has to be at an ideal level for banks NOT to lend. If the Fed drops the IOER below that level then banks will inherently lend the money out. Looking at policy tools currently in the toolkit, I see IOER and excess reserves as an integral part of the normalization process and easing process moving forward.

M3 is one measure I wish the Fed wouldn't have stopped reporting on. Interested to see that data since 2007. Anyone have access to a privately computed M3?

Scott Grannis said...

Benjamin: you continue to misunderstand how Fed purchases of Treasuries works. I think the confusion comes from trying to trace the flows of money. The better way is to look at the end result:

The public desires to increase its holdings of bank safety deposits, by depositing $50 billion in bank safety deposit accounts.

The banking system desires to increase its holding of excess reserves. The banking system uses its increased deposits to buy $50 billion of Treasuries from the public. The banking system then sells $50 billion of Treasuries to the Fed and receives $50 billion in reserves in exchange. Bank reserves (assets) have increased by $50 billion, and bank liabilities (deposits) have increased by $50 billion. Banks have thus effectively lent their deposit inflows to the Fed rather than to the public. No new money has been created in the process.

The Fed buys $50 billion of Treasuries from the banking system and credits banks with $50 billion of reserves. The Fed's balance sheet expands, with $50 billion more assets and $50 billion more liabilities.

Banks could potentially use their increased holdings of reserves to expand their lending, but they haven't, at least so far, because there has been no unusual increase in the money supply. That is proof that banks wanted more excess reserves and the public wanted more savings deposits.

If the Fed refrains from further expanding its balance sheet, that is not equivalent to a "tightening" of monetary policy, because the banking system will still have trillions of excess reserves and a virtually unlimited ability to make loans and expand the money supply.

Benjamin Cole said...

Scott Grannis and Thinking Hard---very thoughtful comments. I still think I am right, but hey let's have a beer and watch some baseball.
The NY Fed talks about private-sector portfolio rebalancing on their website and perhaps Scott Grannis would like to read that.

Thinking hard: I think when the Fed rolls over on its portfolio it is more or less neutral, but I am not sure.