Inside the Supplementary Leverage Ratio SLR – Bond Market Impact

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Our New York Times best seller is now published in 12 languages and focuses on the failure of Lehman Brothers. In the post financial crisis era, capital adequacy has been an important driver of the strength of U.S. banks relative to the rest of the world. The Supplementary Leverage Ratio SLR is the ultimate measure of capital adequacy. If the Fed doesn’t extent the SLR, it will have a large impact on the bond market, stress is high. Essentially, the SLR measures in percentage terms a bank’s ability to take losses on its assets. The formula is SLR = (tier 1 capital)/(total leverage exposure). This change reduces the denominator in the SLR calculation and as a result temporarily increases banks’ SLR.

If the Fed ends the SLR cushion, we see US banks as a net seller of Treasuries. As they are short in duration, it could well be enough to do some crowding out, and push the 10-year back up to 1.6%, and likely break above. This will put more pressure on long duration equities, aka the Nasdaq 100 NDX.

With TGA (Treasury General Account) cash coming in by this Summer to the tune of $1.1T as per the current TBAC schedule.. Bank SLR defined as Tier 1 Capital/(On + Off Balance Sheet Assets will decline. This is because deposits will come in and cash will go up at banks. Cash asset is in the denominator of SLR calc. As a result, U.S. banks won’t have room to accommodate the cash deposits.. their SLRs could trip minimum requirements.

Fed could fix all this by  excluding cash & treasuries from the SLR calc making the denominator lower and SLR higher for Banks so they don’t trip their minimum requirement which is 6% at the OpCo where most  of the deposits get flushed in with TGA.

No SLR relief means banks must turn away deposits and then there is nowhere for money market capital to reinvest (ex RRP which is still capped) that MMF Bill maturities floods more cash. So entire money market constellation trades close to zero or lower and Banks can’t buy US Treasuries no room on Balance sheet due to SLR so they start puking them out, TROUBLE!

Nominal GDP vs. Bond Yields
The Street is up at 6-7% 2021 GDP growth expectations.  BUT, including the inflation outlook – nominal GDP growth could be nearly 10% in 2021, but comparisons get tough in 2022 with growth estimates falling below 3%.

The March 31, 2021 Deadline

This month policymakers MUST consider extending the interim final rule that allows bank holding companies to exclude U.S. Treasuries and deposits held at Federal Reserve Banks from the calculation of their Supplementary Leverage Ratio (SLR) through March 31st, per ACG Analytics in Washington.

On April 1st, 2020, the Federal Reserve announced that it would exempt U.S. banks’ Treasury bond holdings and holdings at Federal Reserve Banks from Supplementary Leverage Ratio (SLR) calculations for one year. This was done “to ease strains in the Treasury market resulting from the coronavirus.” SLR rules broadly affect financial institutions with more than $250 billion in assets and require them to hold a minimum ratio of 3% Tier 1 capital against their total leverage exposure.

This form of regulatory relief enjoyed by big banks is set to expire on March 31st, 2021. If the Federal Reserve chooses not to extend the modified SLR rules, these banks will be forced to raise the level of capital held against their Treasury bonds and deposits at the Federal Reserve. This could result in a temporary decrease in market liquidity and lower demand for U.S. government debt as financial institutions reduce their exposure.

The Federal Open Market Committee (FOMC) will conclude its 2-day meeting on March 17th and an announcement on the SLR rule’s status could be made then. However, the issue has become politicized due to a recent letter by Senate Banking Committee Chairman Sherrod Brown (D-OH) and Committee member Sen. Elizabeth Warren (D-MA) requesting that the rule change be permitted to expire. Despite this, ACG Analytics believes that the SLR rule change will be… Join us…

We are happy to set up a call with ACG Analytics in Washington, just email tatiana@thebeartrapsreport.com.

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Gas Prices, Inflation and Inequality – All Fed Drivers

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The Fed Must Cap Real Yields: We think the following debate below is critical, an important juncture is coming at us all. Above all, we love when washout technicals line up in front of a policy response. The Federal Reserve must cap real yields in 2021 in order to preserve the economic recovery and attempt to fend off inequality. Their first weapon of choice is found in a roll-out of “calendar guidance.” Offering investors a well defined path focused on the certainty on asset purchases. All attached to a future time frame or date. If that fails, they will propose a twist (buy longer dated bonds, sell short ones) or YCC (yield curve control, simply cap 10s).

The Impact of High Rates: “A rise in real rates would give me concern that the amount of accommodation we’re providing the economy is reducing, and that might warrant us considering a policy response…“

– Neel Kashkari, President of the Federal Reserve Bank of Minneapolis

Everyone thinks we are heading for a 2013 style taper with higher real bond yields. The picture of a growth recovery (BlackRock’s Rick Rieder now talking up 7% GDP) where bond yields surge far higher than inflation expectations, that’s the consensus. This vision is laying a hammer on gold – a real yield nightmare. But with inequality being a significant eye sore for the Fed, higher bond yields relative to the rest of the world will simply strengthen the USD, suck capital back into the USA. The global wrecking ball will once again – be reborn. The negative economic feedback loop back to the U.S. is well documented. Strong greenback fueled manufacturing jobs losses most likely cost the Dems the 2016 election. The Fed must conduct monetary policy on planet Earth surrounded by other countries, NOT isolated on Mars. Likewise, with the U.S. debt profile (State, Federal and Corporate), $10T larger than it was a decade ago, each 50bps of real yield expansion comes with a gale force headwind equivalent to 150bps higher rates. Above all, today, too much debt sits below 2%, an extra $50T relative to 2018. In 2021, duration capital losses are – COLOSSAL – with higher bond yields. This is a possible inferno the Fed doesn’t want to toss a match on. The Federal Reserve cannot repeat the mistakes of 2011-2013, they must cap reals before the taper stage, if they want to extend the economic recovery that is. Thus, the convexity with gold is very attractive today. Every leg lower will act like a sling shot higher once the Fed makes their move. They must start to lay out calendar guidance, hint YCC as a future possible weapon on March 17th. We see large upside for gold, next 5 weeks.

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The Cost of Rising Yields: “A 50 basis point increase in the cost of funding for the U.S. Government is equal to the cost, the annual cost of the U.S. Navy. A 30 basis point increase is equivalent to the cost of the U.S. Marine Corps.” – Louis-Vincent Gave

Rates Impact: The UK government has just quantified a 1% rise in yields as costing £25bn in extra interest expense (OBR) which is just over 1% of GDP.

Inequality Issues Rising, a Problem for the Fed
Gasoline is testing its five year highs and Core CPI is down. Say what? How can that be? Is the government manipulating inflation measures so it can keep its money printing presses running hot? Of course! But there’s more to the story than that.  As to highly questionable lower inflation readings, it’s true. The components have changed over the decades such that if one were to calculate CPI using the 1980 formula, it would be more than twice as high as the current reading! But there is another less nefarious (or blindingly stupid) reason. An increase in gasoline prices is a tax on consumer demand. A person making $45k a year only has so much money to spend. And every dollar made is spent. So if an extra dollar goes to gas, that is one less dollar to a component of Core CPI. So higher gasoline prices take demand away from other goods and services. Higher gasoline prices exert deflationary pressure on other goods and services. 

 

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