Thursday, March 9, 2023

Swap and credit spreads say no recession

Today the market was rattled by news that Silicon Valley Bank (SIVB) was forced to sell most of its bond portfolio at a nearly $2 billion loss and will now have to raise additional capital to remain solvent. The question on everyone's mind: is this the first inning in a replay of 2008's financial crisis? Aggressive Fed tightening over the past year or so has devastated the value of bond portfolios because interest rates have risen by more and faster than during any prior bond bear market. To make matters worse, Chairman Powell two days ago declared that the Fed may well have to raise rates by even more than they expected, in large part because the economy is proving stronger than expected.

So what is it? Will the SIVB collapse mark the beginning of another financial crisis which in turn triggers the long-awaited recession? Or is the economy so healthy that the Fed will need to raise rates even more? Inquiring minds would like to know how these two fears can coexist.

I don't pretend to know the answer, but I do know that—outside of the now-famous inverted yield curve—it's difficult to find any signs that a recession is around the corner. A big disappointment in tomorrow's jobs number might persuade me to become less complacent, however.

I also know that, thanks to the decline in M2 and today's much higher interest rates, inflation pressures peaked some months ago and inflation is quite likely to decline over the course of this year as it returns to the Fed's 2% target. Following are some charts that round out the story:

Chart #1

Chart #1 shows the level of 2-yr swap spreads in the U.S. and Europe. These spreads have an uncanny ability to predict the onset and end of recessions (higher spreads predict bad news for the economy, and lower spreads predict better news). Eurozone swap spreads are still elevated, but they have come down significantly in recent months—thank goodness. U.S. swap spreads are only modestly elevated (a "normal" range would be roughly 15 to 35 bps) and they too have been declining of late. No signs of a recession here.

Chart #2

Chart #2 shows the level of corporate credit spreads. Like swap spreads, these too tend to predict the beginning and end of recessions. Current levels reflect substantially "normal" conditions. The bond market is signaling that the outlook for the economy is generally healthy, and liquidity conditions are good. No signs of a recession here.

Chart #3

Chart #3 is another way of looking at the spreads in Chart #2: the line represents the difference between high-yield and investment-grade spreads, otherwise known as the "junk spread." Here it becomes perhaps clearer that conditions today are pretty normal.

Chart #4

Chart #5

Charts #4 and #5 focus on Credit Default Swap Spreads, which are highly liquid and quite representative of generic credit risk. Here too its difficult to see signs of distress. 

Chart #6

Chart #6 shows the level of 30-yr fixed mortgage rates. Never before have they risen so much in so short a time. This has caused profound distress in the nation's real estate market. Real estate is the one area of the economy that is really suffering, but as the previous charts suggest, this suffering has not been contagious to the broader economy. One positive thing to note is that there is not a large overhang of new construction or a significant inventory of homes for sale (like we had in 2005-2006). The solution to the current real estate problem is not a collapse but a repricing: housing prices went up too far given the simultaneous surge in financing costs. The solution is simple, but it may take awhile to play out: prices need to fall and interest rates need to decline.

There is one good thing to note here: higher interest rates are having a big impact on asset markets, which in turn implies that Fed tightening is working. The Fed doesn't need to do much more, if anything.

Chart #7

Changing the subject, Chart #7 shows a very important macro statistic that is generally ignored by the financial press. Households' real net worth fell by about 9% last year, but it is not out of line with historical experience. As the green line suggests, this measure of our nation's well being has improved by about 3.6% per year for many decades, and the current level of real net worth is right in line with the long-term trend: $148 trillion.

Chart #8

Chart #8 is remarkable in that the jobs market is apparently more healthy today than it has been in a long time. Job openings are near record highs, and they exceed the number of people looking for work by a record margin. Some employers are shedding workers (e.g., the tech sector), but most others are having difficulty finding people willing and able to work. This is not the sort of situation that precedes recessions.


Joe Palmer said...

Hi Scott, I always appreciate your posts, and the data-driven way you present complex subjects. My question is -- with the "abundant reserves" policy in place since 2008, is it possible this diminishes spreads signals that prediced recessions in the past?

John said...


Regarding the spread charts; do these spreads have the same context in a rising or falling rates environment?

Shane said...

Chart #7 is an excellent chart. I often see people talking about how currencies devalue over time, especially the USD. Would this chart be an argument to show that even though currencies devalue, that mentioning this in isolation misleads? Because as one can see, although the USD has devalued over time, US Households Real Net Worth has gone up. Aka, Standard of Living has risen.

Novice101 said...

I wonder whether the US Real Net Worth chart is a bit misleading. If we chart by income class, would we see the lower income bracket falling far below this trend line as well as the middle income to some extent? Also, looking at the CDS spreads, there is some market concern it seems. The reason that corporate bonds spreads are so tight as opposed to the CDS spreads might be, as you point out, the underlying liquidity; CDS are far more liquid at present than the bonds (and hence, bonds are not being "repriced").

Salmo Trutta said...

Dr. Philip George agrees with you: the corrected money supply "Still running high at 30% year on year. It was 100% a year ago."

Scott Grannis said...

After today's developments (the shutdown of SIVB and the ripples of panic through the banking system and the pricing out of almost 2 Fed tightenings) I think the odds of any increase in the Fed's target rate on March 22 are close to zero.

Financial panics do one thing: they dramatically increase the demand for money, thus dramatically tightening monetary conditions. The last thing the Fed should do in this situation is raise rates. In fact, at this rate it won't be long until they debate how much these should lower rates.

Meanwhile, 2-yr swap spreads are only 30 bps (unchanged from yesterday) and Credit Default Swap spreads are 82 bps, up only 4 bps from yesterday. This tells me the financial foundations of the economy are still healthy. There is still plenty of liquidity, which is the antidote to panics.

The strong jobs number is nothing to worry about at this point. It's great news that the economy continues to expand and people want to accept new jobs.

wkevinw said...

SIVB- evidently they got a lot more deposits and their investment portfolio doubled during 2021. Their "experts" thought that they would diversify into a "safe" investment, such as government bonds- maybe even long bonds- with a large fraction (most/half?) of the portfolio. They also had some commercial RE (in silicon valley, most likely- seeing a pattern?)

Portfolio tanked, along with their depositors' balances- a bunch of "smart" tech people (with their whole portfolio invested in tech stocks).

Yet another failure in the basic knowledge/skill/training of supposed experts in the economic/financial field.

Risk in long government bonds? Who would have known?

Ai said...

What actions should we now expect from the fed to “fix” this problem? (FDIC for deposits, uninsured cash deposits)

What impacts would this have? Would it add to inflation problems?


Scott Grannis said...

Re “What actions should we now expect from the fed to “fix” this problem?”

This incipient bank panic is causing the public’s demand for money (safe and secure money that also pays interest) to soar. The appropriate Fed response should be offset this by reducing interest rates. Or at the very least reassuring the market that it will not raise rates further until the situation improves.

King786 said...

Would it be wise to consider going Long the Bonds (TLT) if the demand for safe and secure money is expected to soar?

Salmo Trutta said...

re: "The appropriate Fed response should be offset this by reducing interest rates"

That is counterintuitive. But the average person doesn't understand that from a macro-accounting perspective, banks don't lend deposits. There is some recognition of this by all the money stock measures. Certain deposit classifications are underweighted in the measurement of the "means-of-payment" money supply.

Dr. William Barnett describes this as "The user cost price is the marginal utility from holding the asset, not the average or total utility and not its weight." The user index is a not about "perfect substitutes".

Dr. Philip George says "that in the Corrected Money Supply, an important part of this measure was that it estimated the amount of precautionary savings held in M1 deposits and subtracted that to arrive at an accurate measure of money. The logic was that such precautionary holdings are not intended to be spent and hence do not qualify as money."

It's stock vs. flow. The fundamental nature of stock (an absolute quantity) vs. flow (a rate-of-change). The study of economics is based on the accurate measurements: of rates-of-change -> in the flows-of-funds.

As Dr. Philip George says: “When interest rates go up, flows into savings and time deposits increase.”

As Dr. Leland Pritchard says: "in a twinkling the economy suffers".

Salmo Trutta said...

Monetary policy is backwards. Monetarism has never been tried. If you wanted to get rid of inflation, you should stop expanding the money supply, indeed drain the money stock, and then gradually drive the banks out of the savings business (increasing velocity).

The 1966 Interest Rate Adjustment Act is prima facie evidence. M1 peaked @137.2 on 1/1/1966 and didn’t exceed that # until 9/1/1967. Deposit rates of banks decreased from a high range of 5 1/2 to a low range of 4 % (albeit not enough). A .75% interest rate differential was given to the nonbanks.

A recession, as Powell claimed (“Powell cited 1965, 1984 and 1994 as examples where the FED corrected the economy without a recession.”), was avoided.


Salmo Trutta said...

In "The General Theory of Employment, Interest and Money", pg. 81 (New York: Harcourt, Brace and Co.): John Maynard Keynes gives the impression that a commercial bank is an intermediary type of financial institution (non-bank), serving to join the saver with the borrower when he states that it is an:

“optical illusion” to assume that “a depositor and his bank can somehow contrive between them to perform an operation by which savings can disappear into the banking system so that they are lost to investment, or, contrariwise, that the banking system can make it possible for investment to occur, to which no savings corresponds.”

In almost every instance in which Keynes wrote the term "bank" in his General Theory, it is necessary to substitute the term non-bank in order to make Keynes’ statement correct.

This is the source of the pervasive error that characterizes the Keynesian economics, the Gurley-Shaw thesis, the elimination of Reg Q ceilings, the DIDMCA of March 31st, 1980, the Garn-St. Germain Depository Institutions Act of 1982, the Financial Services Regulatory Relief Act of 2006, the Emergency Economic Stabilization Act of 2008, sec. 128. “acceleration of the effective date for payment of interest on reserves”, etc.

This is both the source of stagflation and Secular Strangulation, not robotics, not demographics, not globalization, not monopolization, not higher indebtedness.

Tom L said...

Scott - thanks again for your timely analysis. I just got a 11mo CD at 4.72% These rates can't last much longer.

Benjamin Cole said...

Bill Ackman says SVB depositors need to be bailed out 100%.

Interesting dilemma.

wkevinw said...

"Bill Ackman says SVB depositors need to be bailed out 100%. "

Yes, the elites always want the plumbers, janitors, day care providers, etc., to bail them out, don't they?

There needs to be an orderly bankruptcy, without bailouts.

Benjamin Cole said...

wkeview....Well, right.

My two cents is that if a private-sector commercial bank wants federal deposit insurance, there are no regulations but they have to keep a fat layer of convertible bonds in effect, equal in value to (say)25% of loans outstanding.

To meet bond covenants the bank would operate prudently, I imagine. Let the private sector do the work.

If not, then the convertible bond holders take over the bank, and shareholders lose, but not depositors or taxpayers.

The strange thing about the SVB failure, if I read it right, is that the bank failed for being rather obviously exposed on its bond portfolio. A mark-to-market problem on their holdings of US government bonds.

It was not that they lent a lot of money to crappy companies.

No one at the bank said "Maybe we should hedge our bond portfolio."?


NickT said...

Great post Scott and interesting you say "I think the odds of any increase in the Fed's target rate on March 22 are close to zero."

The market now has a max rate of 500-525 then cuts.

@Benjamin Cole - exactly! why didn't someone in Finance hedge their massive interest rate risk (unrealised losses)?

Did they just think tech dollars would keep coming in (deposits) and therefore why hedge?

Still they should have hedged a portion at least.

Novice101 said...

Can't agree more

1- SVB is an LP in many venture capital funds
2- Those VCs pushed startups to get venture debt from SVB
3- The terms made startups put nearly all cash in SVB

So, directly or indirectly taxpayers saved the VCs' skin

Roy said...


Thank you for your very prescient insight... spot on.

Would be greatly appreciated if you could keep sharing your thoughts in the comments as this is developing.

wkevinw said...


Well, if depositors get their money, that's not all bad. There is a difference between them and the investors. Investors need to see "$0" in their investments in SVB.

The Fed: make rates 0% for years- let VCs and banks lend money to startups = risk!
The Govt: send many checks for Covid = inflation!
The Fed: Raise rates to cure the above = something got broken

We may have seen the end of the rate hikes/top of the interest rates for this cycle already.

If depositors get their money and a further contagion/meltdown is avoided, that's better than the alternative.

There is still pain ahead, I am guessing a lost decade kind of like ~1995-2008/~2000-2014-- that's how long it took to get to even in the stock market during those years. (No real gain between 1995 and 2008, and it took until 2014 to get back to even in the S&P from the 2000 top).

Scott Grannis said...

As I see it, the SVB fiasco had two key elements: a management that spent a lot more time on politically correct "woke" projects instead of paying attention to their core business (such as hedging their interest rate risk—if they had read this blog a year ago they might have realized that buying a lot of long bonds was not a good idea), and the totally "unexpected" action (unexpected for those who didn't read this blog I suppose) on the part of the Fed to 1) totally ignore rising inflation a year ago and 2) to raise interest rates by leaps and bounds in an attempt to recover what little was left of their credibility. SVB was blindsided by higher rates just as the Fed was blindside by rising inflation. In finance, making mistakes like this is a prescription for disaster.

Yellin has stanched the bleeding for now (by effectively insuring all depositors of SVB), and that will mitigate the concerns of many. But it also introduces a new risk to markets (moral hazard) which may surface at a later date, since some aggressive bankers may be more inclined to take risks they otherwise wouldn't, knowing that the feds will pick up the pieces if things blow up.

At the end of the day, I am reassured by the fact that 2-yr swap spreads were virtually unchanged today, and the bond market has priced in the strong likelihood (which the Fed will undoubtedly follow) that further rate increases are off the table—and really, the issue now is when the Fed will decide to lower interest rates. Big declines in interest rates boost the value of the bonds that many banks now hold, and that will greatly reduce the likelihood that they will incur huge losses if they are forced to sell assets to meet deposit outflows. And that will calm the markets more than anything.

Finally, I've been saying for months that the Fed has done enough with its rate hikes and it doesn't need to do more. The market has just seconded my motion.

If the February CPI number released tomorrow is as expected or lower, this will be a huge plus, since it will allow the Fed to back off from even hints of tightening. That is what the market needs to hear.

randy said...

A third element for SVB was of course the concentration of it's economic world to the silicon valley crowd. Most of it's deposits were venture capital and related. And issuing loans sweetened with warrants in startups on the asset side. Supply of money for deals crashed as interest rates rose - which resulted in less money coming in as deposits. Less zero interest money also meant new financing rounds dried up. Essentially everyone started getting squeezed. On top of that they are all surrounded by the smartest people in the room who can't imagine they don't know everything. It's the right thing to backstop depositors to limit spread, but irritating as hell that this crowd that is so quick to bash government intervention in anything else are begging the Feds to be spared a maybe 15% loss on their deposits. If I had to choose one villain I'd say the Fed and easy money for too long making misallocation of capital too easy.

Shane said...

So now tech investments are "woke"? No need to hammer libs at every turn. SVB execs were negligent. This had nothing to do with wokeness.

Richard H. said...

Salmo, you often say banks don't, and can't, loan out deposits. What happened with SVB?
I think you are going to say the banking system as a whole cannot loan out deposits, but one bank can begin a cascade. No?

Roy said...

So, the Fed made two mistakes: not raising when it should have and then raising when it should not. The logical conclusion here is that they would Raise again 0.25 in March because they should not. If the market goes up because everyone expects them to pause/pivot and there's no panic/fear; I think that's a good trade.

Salmo Trutta said...

Yes, a bank must defend its balance of payments or suffer bank credit contraction. SVB's deposits get redistributed in the system. Lyn Alden points this out with the division of small vs. large banks.

I guess the stigma associated with the discount window was the deciding factor in introducing the Bank Term Funding Program. Discounting eligible securities "at par".

Richard H. said...

Thanks Salmo. That Lyn Alden explained that very well.
Why she would risk her cogent thinking on Bitcoin though is suprising. Despite all the rational about bitcoin avoiding the issues of fiat money, it still suffers from not being anything but an electronic ledger.
Gold, although not an investment (as Buffett always tells us), has value in and of itself. What has that always been? A unique shiny metal that people like to wear on their bodies.

wkevinw said...

Listening to the supposed bank experts in the media:

1. This problem caused by QE- so all banks have this problem to some extent (bonds trading at 30% loss)
2. Banks are "required"/limited to buying some items, e.g. long term US bonds- which have a "0" (yes zero!) risk profile by most bank risk systems (clearly not correct in the messy "real world")
3. Fed will have to continue to respond with i. lending facility (backstop to let banks meet withdrawal/run problems), ii. possibly have to do QE or other interest rate easing
4. some experts said allowing for some more inflation might be the easiest way to "normalize" things.

Thanks Fed. Sounds like the chaos might not be over yet.

Fred said...

I don't understand why Scott keeps saying that inflation is not a problem. It may not be for high net worth individuals, but for the average consumer it's been brutal. Just because the year over year rate of increase is decreasing does not mean it's not a problem for people trying to afford the basics. Every restaurant I've been to in the last year or so has doubled its prices.

Salmo Trutta said...

If the shelter component wasn't published in arrears, then inflation would be slowing faster.

"February was yet another month of declining real wages, and was the twenty-third month in a row during which growth in average hourly earnings failed to keep up with CPI growth"

"The neutrality of money, also called neutral money, is an economic theory stating that changes in the money supply only affect nominal variables and not real variables."

How long does it have to be? Or maybe money is not neutral?

Scott Grannis said...

Fred: I have always said that inflation is a problem. I hate inflation, one reason being because it hurts the little guy the most. What I have been arguing in recent months, however, is that the Fed should stop worrying about inflation because all signs suggest we have seen the worst of it. On the margin, prices are beginning to stabilize. For example, the Producer Price Index has been flat since last June, and commodity prices are broadly unchanged over the past year. Real estate prices are falling. The CPI is rising at a slower and slower rate (the last place inflation will show up is in the CPI). I think the Fed should at the very least stop raising rates and in fact they should actively consider lowering interest rates.

Roy said...


Impact on M2 and inflation, if this is done together with pausing or lowering rates?

Fred said...

Scott- Should the FED and US Govt not intervened in 2008 with the TARP and QE and simply let the market sort things out? Of course the fear was a decades long Great Depression and we'll never know what would have happened had the Govt not intervened. Likewise, should the FED have ignored those (including you) in 2018 who claimed its interest rate increases and cessation of QE was killing the stock market despite a decade of easy money policies? How about Govt intervention during the Covid Pandemic- what if the Govt had simply not flooded the economy with dollars to help out all the businesses shut down and people who lost their jobs? I agreed with you at the time that the shutdowns would ultimately be viewed as the greatest self-inflicted wound in history, but they happened and the alternative to flooding the economy with dollars looked bad. Perhaps the markets are now telling us that unless we continue with low interest rates, QE Forever and unregulated banking, they will collapse and we will be in a Great Depression for a long time. At some point we may have no choice but to suffer a Great Depression to clean out the excesses, but I think market participants would rather have Argentina style inflation than the alternative.

Scott Grannis said...

Roy: JP Morgan is saying that theoretically the Fed could inject as much as $2 trillion into the banking system. That projection is extreme relative to what is much more likely, e.g. a hundred billion or so. In any event, we won't really know how much the money supply expanded this month until March M2 is released April 25.

Scott Grannis said...

Fred: "flooding the market with dollars" is a poor description of what actually happened prior to the true flood of dollars created from 2020-2021. We know that because whatever the Fed did prior to 2020 was not inflationary, because inflation was never a problem prior to 2021. Yes, interest rates were extremely low, but again, that did not prove inflationary. As for the flood of dollars injected in 2020-2021, we know now that was extremely inflationary and costly, and did little or nothing to help the economy. Massive government transfer payments were a big mistake. My sense now is that the economy is on the mend, and the current banking crisis is the last spasm of pain, brought on by a Fed that became too aggressive in an attempt to regain its inflation-fighting credentials.

Fred said...

Scott: You're ignoring a big issue- the FED's massive QE program that ultimately increased its balance sheet to trillions of dollars to give the market unlimited liquidity. With the reduction of that balance sheet I think the market is saying: "The economy can't survive." You yourself said the unprecedented increase in the FED's balance sheet brought us to unchartered waters and no one knows how it will all play out once the balance sheet is reduced. I think we now know how this will play out.

Richard H. said...

The age old argument ... about whether there was inflation after the GFC. There should have been natural deflation (in fact there should always be deflation - a good thing - equivalent to the productivity rate), so yes there was inflation - just keeping things even. There was in fact a lot of actual inflation in asset prices which, although helping most of those who read this blog, prevented more and more average income Americans from being able to afford the American dream of owning real estate and, yes, even stocks.

Richard H. said...

Does anybody know why First Republic, or any other bank for that matter, needed these deposits (from the big banks) since the Fed's new facility should have done the trick?
(Assuming they had enough of the type of pledgable assets for the Fed).
For that matter, why is the stock even down since the new facility was created? My understanding is that the shareholders' capital does not need to be sacrificed first for this bailout.

Ai said...

That little bounce in the balance sheet should theoretically cause the fed to be even more reticent to hike.

More pressure on banks is now correlated with a worsening balance sheet by the added pressure to bank balance sheets.

Carl said...

Household net worth to GDP (or household income) has been deviating from long-term historical trend to the same extent all deposits to GDP (or income) has. Any link?

Scott Grannis said...

Interesting fact regarding the "wokeness" of Silicon Valley Bank. According to this database (, in recent years SVB has donated almost $71 million to the BLM movement and related causes.

Scott Grannis said...

Fred, re "the unprecedented increase in the FED's balance sheet." The Fed's balance sheet expanded from about $4 trillion pre-COVID to a peak of almost $9 trillion in April 2022. It then shrunk moderately (-7%) to $8.33 trillion at the end of Feb. '23. In the past week it increased by $300 billion to $8.64 trillion. Relative to GDP, it rose from 19% pre-COVID to 32.5% as of the end of Feb. '23.

So the Fed's balance is still enormous by any measure. However, the Fed's balance sheet is not the money supply, and it is not necessarily the cause of our inflation problem, nor is it the likely cause of the current bank crisis. There has been no significant shrinkage of either over the past year. Bank reserves remain quite abundant, which gives the banking system an almost unlimited capacity to make new loans. The relatively low level of swap and credit spreads suggests that the financial markets are enjoying abundant liquidity.

I would emphasize that the expansion of the Fed's balance sheet was largely a function of the Fed purchasing notes and bonds and paying for them with bank reserves, which are not money. Bank reserves are effectively equivalent to 3-mo. T-bills. So the Fed essentially swapped T-bills for notes and bonds. Banks were apparently eager to stock up on safe, interest-bearing assets, and the Fed simply facilitated that via its balance sheet expansion.

Scott Grannis said...

I hasten to add to my previous comment. This past week's $300 billion increase in the Fed's balance sheet (which also shows up as a $300 billion increase in the supply of bank reserves) does not necessarily reflect an equivalent increase in the M2 money supply. Unfortunately, we won't know how this has impacted the money supply until the March number is reported on April 25. In other words, we don't know if this $300 billion was in addition to the $6 trillion of "helicopter money" that occurred during the 2020-2021 period. It could be just an increase in bank reserves, which are not spendable money, and which serve largely to add liquidity to the banking system.

Did Fed helicopters just drop $300 billion of new cash into the US economy? We won't know for a while, and that's very unfortunate.

Richard H. said...

Was QE Inflationary? Yes.
What happened?
- Banks make bad loans to homebuyers, which pushes up prices of homes (inflation) - as well as prices for everything else (based on people’s psychological valuation of their homes)
- Homebuyers default and then banks begin to default which, either:
1) cause home prices to fall and other dependent prices to fall. Final result regarding Inflation: NO Inflation; market corrects bad mistakes (and perhaps recession/depression).
2) Fed recapitalizes banks (preventing bank defaults) swapping mortgages and treasuries for Reserves: this causes no ADDITIONAL inflation (what Scott emphasizes). Final result: Artificial inflation of original bad loans is preserved.
(note: “swapping”, innocent sounding term, actually not so innocent - Bills/Reserves are not the same as Bonds)

2) is what happened of course. So, was QE inflationary? Absolutely, it preserved, or locked in, all (or most) of the artificial inflation that was created by bad bank loans.

Kenneth said...

Has there been any significant change in the various swap spreads since you last posted them on March 9? The regional bank problem at least as indicated by their stock prices doesn’t seem to be responding very favorably to the deposits by the large banks or the statements by various bank executives. Those spreads have been a very reliable indicator of what is really going on as you have pointed out so many times over the years during periods of market anxiety.

Ai said...

From the WSJ:

"If banks were suddenly forced to liquidate their bond and loan portfolios, the losses would erase between 77 percent and 91 percent of their combined capital cushion. It follows that large numbers of banks are terrifyingly fragile."

Elon Musk in response to this quote: FDIC needs to change to unlimited coverage to stop bank runs and Treasury needs to stop issuing ridiculously high yield bills, such that it makes no sense to have money in a low interest rate bank “savings” account. Right now.

Any thoughts on this exchange?


Carl said...

"Any thoughts on this exchange?"
Where will deposits go?
"Did Fed helicopters just drop $300 billion of new cash into the US economy? We won't know for a while, and that's very unfortunate."
The new facility is only a modified Discount Window where money reserves are exchanged with defined depository institutions at par value (versus fair market value) as a 'Fed' loan secured against a collateralized security.
It's a financial plumbing measure to help money liquidity for banks. By definition, money dollar for money dollar 'printed', there will be an increase in M2 as reserves are, by definition, included in basic money supply measures.

Scott Grannis said...

Carl: reserves are not included in basic money supply measures. Reserves are not money and cannot be spent on anything by the average person.

Re swap spreads: I follow 2-yr swap spreads and they have actually gone down a bit since my last post. I'm hoping to do a post this weekend that features a chart of swap spreads.

Carl said...

M2=M0+M1+some stuff
M0 is monetary base
M0=currency in circulation + total "reserves"
In the graph below. you will find that the above is true.
This is not a multi-variable subjective argument.,CURRCIR_TOTRESNS&scale=left,left&cosd=1959-01-01,1917-08-01&coed=2023-01-01,2023-02-01&line_color=%234572a7,%23aa4643&link_values=false,false&line_style=solid,solid&mark_type=none,none&mw=3,3&lw=2,2&ost=-99999,-99999&oet=99999,99999&mma=0,0&fml=a%2F1000,a%2Bb&fq=Monthly,Monthly&fam=avg,avg&fgst=lin,lin&fgsnd=2020-02-01,2020-02-01&line_index=1,2&transformation=lin,lin_lin&vintage_date=2023-03-18,2023-03-18_2023-03-18&revision_date=2023-03-18,2023-03-18_2023-03-18&nd=1959-01-01,1917-08-01_1959-01-01

Unknown said...


Look forward to your next post - incredibly insightful and valuable in volatile times such as the past two weeks!


Salmo Trutta said...


M0 is monetary base

Not true. The monetary base was required reserves. The increase in the currency component is contractionary.

Salmo Trutta said...


re: "It's a financial plumbing measure to help money liquidity for banks"

The BTFP is expensive. “Banks can now bring this impaired collateral to the Fed and get cash to meet deposit outflows, but the Fed charges the short-term market rate, which is closer to 4% or 5%.”

BAGEHOT’S DICTUM: the central banks should lend early and ‘without limits’ to solvent firms at a ‘higher interest rate’ with ‘good collateral’. Discounting was made a penalty rate on January 6, 2003

But Volcker did the opposite. Loaned funds at a real discount.

And: “In 2002, the Federal Reserve began to set the discount rate above the federal funds rate, reversing its previous practice of keeping the discount rate below the funds rate.”

Salmo Trutta said...

Savers never transfer their savings outside the banks.

Reg. Q ceilings were enacted by the Banking Act of 1933 to decrease the competition for deposits. Banks used to store their liquidity, and now they unrestricted in the buying of their liquidity through open market devices. This creates the need to "reach for yield".

The competition between the regional banks and banks with assets > 250b has shifted the uninsured deposits "across the system". It has destabilized the core deposit structure.

See: March 2023 Newsletter: A Look at Bank Solvency - Lyn Alden

All monetary savings, income not spent, originate within the payment's system. But banks don't lend deposits. Deposits are the result of lending.

The solution to the Austrian Business cycle is to gradually drive the banks out of the savings business altogether.

Why do you think yields just dropped so much?

Salmo Trutta said...

Monetary savings, income held beyond the period in which received, or income not spent, flowing through the nonbanks (investors leaving the banks and buying Treasuries), increases the supply of credit (loan funds), but not the supply of money (a velocity relationship). I.e., the NBFIs are the DFI's customers.

That's part of the reason why yields fell.

Salmo Trutta said...

@ AI

re: "it makes no sense to have money in a low interest rate bank “savings” account. Right now."

Savers never transfer their funds out of the payment's system unless they are hoarding currency or convert to other National currencies. The deposits are just redistributed across the system.

Salmo Trutta said...


re: "Fred said...
Scott- Should the FED and US Govt not intervened in 2008 with the TARP and QE?"

Bernanke caused the GFC all by himself, as was predicted in May 1980 by Dr. Leland James Pritchard, Ph.D. Economics Chicago 1933, M.S. Statistics, Syracuse (Phi Beta Kappa).

Carl said...

M0 = monetary base = currency in circulation and all reserves deposited at the Fed by commercial banks (whether required or excess).
If you don't like the law, change the law otherwise..
QE does not create a new liability, it only swaps liabilities (money vs government paper) but government paper doesn't count in M2, but money does.
Before going into deep theoretical and subjective considerations, let's get this straight. :)

Scott Grannis said...

M0, which includes bank reserves and currency, became largely irrelevant once the Fed adopted QE and became willing to tolerate an abundant reserves regime.

M1 and M2 are the only meaningful money supply measures today, and neither include bank reserves. Since 2008, bank reserves have become functionally equivalent to T-bills: they are a risk-free, default-free asset that carries a floating interest rate.

Carl said...

M2 as reported includes M0 (monetary base).
It is as simple as that.
If your assertion is that M0 is irrelevant, that's an interesting question but that does not negate that M0 is part of M2 official reporting by the Federal Reserve (H.6 releases etc).,checks%2C%20and%20other%20checkable%20deposits.

Ai said...

“NEW: The Fed and other global central banks announce an expansion in the frequency of dollar swap line operations.

The standing swap lines currently conduct weekly dollar loan operations. Starting Monday, they will offer daily operations”

Scott Grannis said...

More thoughts on the current bank crisis:

By calling into question the value of a significant portion of the country's bank deposits, the failure of one or more regional banks is equivalent to a sudden tightening of monetary policy in which the supply of money is perceived to have contracted while the demand for the remaining portion has increased.

Background: The "ideal" money can be defined as a highly liquid, universally-accepted medium of exchange that holds its value over time and can—but not necessarily—also pay a floating rate of interest, e.g., currency, checking and demand deposits, and retail money market funds. M2 incorporates all of these and is thus an excellent way to track the supply of money.

In other words, we might say that the current banking crisis is being caused by the perception that some portion of M2 (e.g., bank deposits in regional banks) may lose—or may have already lost—value in the event of a bank failure or expected bank failures. That perception automatically triggers an increased demand for the rest of M2. Together, this has the same effect as a sudden tightening of monetary policy; the supply of money has increased at the same time the demand for money has increased.

If the Fed does not offset this effective tightening by reducing interest rates, things can get ugly. Reducing interest does two things: 1) it makes holding money less attractive on the margin, and 2) it makes borrowing money more attractive on the margin. This serves to reduce the demand for money while at the same time increasing the supply of money (because an increase in loans expands the supply of money).

Scott Grannis said...

Carl: bank reserves are a part of M0 but they are NOT a part of M1 or M2.

Carl said...

^If you click on the monetary aggregates link which is found in your reference,
below Understanding M2:
These measures are typically classified as “M”s and fall along a spectrum from narrow to broad monetary aggregates. Typically, the “M”s range from M0 to M3, with M2 typically representing a fairly broad measure.

you will find:
"MO Physical paper and coin currency in circulation, plus bank reserves held by the central bank also known as the monetary base
M1: All of M0, plus traveler's checks and demand deposits
M2: All of M1, money market shares, and savings deposits"

Carl said...
This comment has been removed by the author.
Scott Grannis said...

See this for a complete accounting by the Fed of the components of M0, M1, and M2. It should be clear here that M1 and M2 do NOT include bank reserves.

Richard H. said...

Scott: “Reserves are not money and cannot be spent on anything by the average person.”
But the public, at any time, can demand physical currency (this is not just some theoretical concept) and if there is not enough currency in bank vaults then Reserves are exchanged for this needed currency. Thus, Reserves can very quickly be turned into money, and can be spent by the average person. Why do you not accept this?
This fact is what is important as to whether the Fed’s actions are inherently inflationary, not whether Reserves are, or are not, included in M1 or M2.