The details of the Bank Term Funding Program (BTFP) were described in the press release by the Federal Reserve.

“The additional funding will be made available through the creation of a new Bank Term Funding Program (BTFP), offering loans of up to one year in length to banks, savings associations, credit unions, and other eligible depository institutions pledging U.S. Treasuries, agency debt and mortgage-backed securities, and other qualifying assets as collateral. These assets will be valued at par. The BTFP will be an additional source of liquidity against high-quality securities, eliminating an institution’s need to quickly sell those securities in times of stress.

With approval of the Treasury Secretary, the Department of the Treasury will make available up to $25 billion from the Exchange Stabilization Fund as a backstop for the BTFP. The Federal Reserve does not anticipate that it will be necessary to draw on these backstop funds.”

Banks quickly tapped the program, as shown by the $152 billion surge in borrowings from the Federal Reserve. It is the most significant borrowing in one week since the depths of the Financial Crisis.

 

 

The importance of this program is that, as noted by Bloomberg, it will inject up to $2 Trillion into the financial system.

Major banks like JP Morgan likely will not tap the Feds lending program due to the stigma often attached to such usage. Moreover, there are roughly $3 Trillion in reserves in the U.S. banking system, of which the top-5 major banks hold a significant portion.

The Fed caused this problem by aggressively hiking rates which dropped collateral values. Such has left some banks which didn’t hedge their loan/bond portfolios with insufficient collateral to cover the deposits during a ‘bank run.’”

As shown, the rapid increase in rates by the Fed drained bank reserves.

 

 

The demand by banks for liquidity has now put the Federal Reserve between a “rock and a hard place.” While the Fed remains adamant in its inflation fight, the BTFP may be the next “QE” program disguised as “Not QE.”

While the BTFP facility is technically “Not QE,” it does reverse the Fed’s efforts to reduce financial liquidity. As shown below, the Fed’s balance sheet surged since last week, reversing more than six months of previous tightening.

 

 

This reversal of liquidity is not surprising given the recent rout in the banking sector.

J.P. Morgan noted on Friday that U.S. banks lost nearly $550 billion in deposits last week. Investors, in a panic, were transferring funds to major banks from regional banks, which put further stress on already discounted collateral due to the Fed’s rate hiking campaign.

Speaking to a Senate Appropriations subcommittee meeting in Washington last Wednesday, Janet Yellen, Treasury Secretary,  told lawmakers that she had “not considered or discussed anything having to do with blanket insurance or guarantees of deposits” when asked about reports suggesting the Treasury was looking to bypass Congress in order to shore-up confidence in the U.S. banking system.

Yellen instead suggest deposit guarantees be made on a “case-by-case basis”, predicated on any bank failure having the potential to create “systemic risk, which I think of as the risk of a contagious bank run”.

Then she said the White House is not considering plans to raise the FDIC deposit insurance cap above $250,000.

This threw investors for a loop after Treasury Department officials said earlier this week they were looking into how they could do this without Congressional approval. Elizabeth Warren, among others, had floated the idea over the weekend as a way to placate the potential for more bank runs.

 

The Fed

 

In the past year, we have seen both a reduction in the Fed’s balance sheet AND higher rates. What is the likely consequence of a Fed that has started adding back to its balance sheet all while continuing to increase interest rates?

For those who missed it amid the Fed’s recent bank rescues and an effort to squelch more runs on deposits, the central bank’s balance sheet spiked by a casual $300 billion in the past 10 days.

In this chart below of the Fed’s balance sheet over the past year, you can see the bank trimmed from a high near $9 trillion down to around $8.4 trillion. Then came the rescue efforts that, in part, allowed banks to tap more cash through (another) new Fed lending facility.

 

 

Here is the Fed’s balance sheet, with five months of QT reversed in two weeks.

 

 

As you can see, this essentially erased the past four months of balance-sheet “trimming” that the Fed has been working on since the start of 2022 in its effort to fight inflation. Evidently, that inflation fight doesn’t matter as much anymore.

As the chart shows, when the Fed’s balance sheet grew during the pandemic recovery, it was good for stocks. And the opposite has been true the over the past 14 months or so.

 

 

The balance sheet more than doubled from $4 trillion at the start of the COVID-19 pandemic in February 2020 to a recent peak of $9 trillion in April 2022. Over that time, the S&P 500 rallied 58.4%, or 24.7% on an annualized basis.

And a similar thing happened during the great financial crisis. From September 2008 to January 2015, the Fed’s balance sheet swelled from $900 billion to more than $4.5 trillion. During the same period, the S&P 500 rose 102.4%, or 11.9% annually.

Something usually breaks at the end of the Fed’s tightening cycle (2 charts). As Warren Buffett once said, “Only when the tide goes out do you discover who’s been swimming naked.”

 

Source: Oxford Economics

 

Source: BofA Global Research

 

Coming out of its most recent policy meeting last week, the central bank announced another 25-basis-point (0.25%) rate hike to a target range of 4.75% to 5%, the highest since 2008. Meanwhile, its quarterly economic projections suggested perhaps only one more increase to come. That means a “pause” in rate hikes could be ahead in the next few months.

Before the recent banking crisis, traders were increasingly betting on a 50-basis-point (0.5%) rate hike last week and perhaps more into the summer. But after the run on Silicon Valley Bank, the consensus expectation among bond traders fell and was in line with what the Fed announced.

In 1982 Paul Volker purposely threw the US economy into recession to break inflation. While 2023 isn’t the same, it does rhyme. The Fed cannot say this, Powell cannot say this, and they all hope that it won’t come to this, but they’re willing to intentionally put the US into recession if necessary to once again stop inflation. No, they don’t want to, but they recognize it’s a significant risk.

The Fed is saying to expect “more of the same,” meaning some economic slowing, and that the additional rate hikes many were expecting a month ago probably aren’t going to happen.

And then, perhaps, the Fed will stop hiking rates after its next meeting in early May.

Then, Fed Chair Powell’s acknowledgment that Fed participants do not see rate cuts this year, caused the big drop in the markets last week.

 

US Economy

 

  • The pace of manufacturing activity in the US continued to slow this month.
  • The NY Fed’s regional index was well below forecasts, as demand slumped.

 

 

  • Companies accelerated staff reductions and cuts in workers’ hours.

 

 

  • Businesses see softening price pressures ahead.

 

 

  • The Philly Fed’s regional index was also depressed, …

 

 

  • with demand crashing.

 

 

  • Similar to the NY Fed’s region, factories in PA, southern NJ, and DE accelerated staff reductions and cuts in workers’ hours.

 

 

  • CapEx expectations are tanking …

 

 

  • … which is now a national trend.

 

 

  • The regional Fed surveys don’t bode well for factory activity at the national level.

 

 

  • Last month’s existing home sales topped expectations.

 

 

Source: MarketWatch   Read full article

 

  • But slower mortgage applications this month point to weakness ahead for home sales.

 

 

  • IT job postings on Indeed:

 

 

Market Data

 

  • The 2-year Treasury yield plunged further this morning after the announcement of UBS taking over Credit Suisse.

 

 

  • Leading indicators continue to signal an earnings recession ahead.

 

 

  • The slowdown in domestic demand growth will cause a contraction in profits.

 

Source: BCA Research

 

  • Rate hike cycles typically precede profit recessions.

 

Source: BCA Research

 

  • S&P 500 2023 earnings estimates (stabilizing?):

 

 

Quote of the Week

 

“Before you marry a person, you should make them use a computer with slow Internet to see who they really are.” – Will Ferrell

 

Picture of the Week

 

 

 

 

All content is the opinion of Brian Decker