Fed Chair Jay Powell and Jamie Dimon on the SLR Debacle

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The bond market is blowing up, what are we going to do about it?

Why should you care? Bonds are Driving Stock Prices
A colossal portion of “growth” stocks have their true worth embedded in the “net present value” of FUTURE cash flows. Thus, as bond yields and inflation expectations rise – tech stocks are worth a lot less.

Stock prices have been HIGHLY driven by bond prices in recent weeks, we MUST pay attention to the fixed income markets.

We noted yesterday in the Bear Traps Report  – “The question is, does this latest Fed move pave the way for no more SLR exemptions? Yes.”

Supplementary Leverage Ratio (SLR)

What is the SLR? The SLR is a measure of capital adequacy, in the years since Lehman Brothers, this is on everyone’s mind. Essentially, it measures in percentage terms a bank’s ability to take losses on its assets. The formula is SLR = (tier 1 capital)/(total leverage exposure).

What happened this week? It’s NOT Fed Chair Powell blinking under pressure from Senator Elizabeth Warren. This is a negotiated deal.

Pop quiz: What is the legal mechanism under which the Fed is independent? Its shares are owned by the member banks. Yep. That’s right. JP Morgan, Citibank, Bank of America, Wells Fargo, et al literally own the Fed. Anyone who thinks the RRP cap raise and the subsequent non-extension of the SLR exemption is wholly unrelated phenomena don’t know half of it. This was heavily negotiated. The Central Bank, believe it or not, talks to Jamie (money center banks), daily.

So it went down like this starting two weeks ago:

Fed on call to Jamie Dimon, CEO of JP Morgan: So folks, what’s cookin’?

Jamie: Eh. Not much. Kind of annoyed by this whole SLR thing.

Fed: Oh that Basel III thing that says Jamie has to raise capital against cash? That is just so stupid.

Jamie: No kidding. This is why we really appreciate having that exemption.

Fed: Yeah well, as you know, that was because of a pandemic. If Covid goes away, the exemption goes away. You all know this.

Jamie: Oh! For sure for sure but…

Fed: But you’re about to get tons of cash deposits from Treasury from fiscal stimulus. What’s the big deal? That money will all be spent soon enough. The problem will go away quickly.

Jamie: True, but before the money is spent we’ll be in non-compliance (new deposits are liabilities for banks). Can’t you just extend it?

Fed: Nah. Not in the mood. But just avail yourself of our RRP facility. Your cash will become reverse repos and you don’t have to raise capital.

Jamie: We thought of that.

Fed: I’m sure you did. (after a strained silence) But…?

Jamie: But the $30 billion cap just isn’t working for us.

Fed: Ahhh! I knew you wanted something!

Jamie: We always do!
(General laughter)

Jamie: Well, how about no cap?

Fed: Forget it! That doesn’t look right. Besides…

Jamie: Besides you need to keep your chokehold on our necks in case we get out of line on something else.

Fed: Precisely!
(General laughter)

Fed: So how much you think you need?

Jamie: Worst case $100 billion.

Fed: $100 billion. Are you crazy? Way too much. Do you think money grows on trees?

Jamie: Yes.

Fed: Oh yeah, you’re right about that.
(General laughter)

Fed: Gimme a number less than a hundo. That extra digit gives me the willies.

Jamie: $90 billion?

Fed: Too close. Make it $80 billion and we’ll throw in some language that if that’s not enough we can always raise the cap more.

Jamie: Done.

Federal Reserve Bank of New York to conduct overnight reverse repurchase agreement (ON RRP) operations with a per- counterparty limit of $80 billion per day, effective March 18, 2021.

Fed: Not quite.

Jamie: Oh God what now?

Fed: Lighten up on your treasury book.

Jamie: Say what? We thought treasuries were risk-free!
(General laughter)

Fed: Look. We don’t want to turn around and raise the RRP cap two weeks after the SLR exemption expires. That’s stupid.

Jamie: But…

Fed: But nothing. Reduce your treasury holdings. We’ll tell everyone on the planet we’re not concerned that rates are backing up, that we want inflation and full employment blah blah blah. You just do what you got to do and we’ll put a nice face on it.

Jamie: Ok. Fair.

Fed: And one last thing…

Jamie: One of you guys has to raise capital now.

Jamie: C’mon! That’s not fair! We already have to deal with the SLR exemption expiring and doing all these RRPs and selling down our treasury book and now we have to raise capital and lower our shareholders’ returns? The whole point of this convo is to avoid just that!

Fed: Brilliant, eh?( Jamie grumbling amongst themselves)

Fed: Calm down calm down. It doesn’t have to be all of you. Just one of you. You know, as a signal that you are willing and able to raise capital if need be.

Jamie: So if one of us raises capital preemptively, that signals to the markets that all of can…

Fed: Exactly. So Jamie…

Jamie Dimon: Oh no…

Fed: About this share buyback of yours that actually reduces capital…

Jamie Dimon: Oh no…

Fed: Not a good look just before the SLR exemption expires.

Jamie: Ok. I’ll take a bullet for the team I guess. Kinda sucks though.

Fed: You’ll live. Besides, once all the excess deposits are spent, you can use that cash to buy your stock.

Jamie: Oh yeah! I feel better already.
(General laughter)

Fed: $4 billion.
Jamie: $2 billion.

Fed: $3 billion and we are done with everything.
(Pause)

Jamie: Ok
Jamie: Sounds good to us!

Fed: Great. So the SLR exemption expires, the RRP cap is raised to $80 billion with flex above, you sell your treasuries and we talk nice, JPM raises $3 billion in prefs and everybody’s happy. Right?

Jamie: Right, the World is Saved for another day.

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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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RIP Covid-19 Portfolio

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The global reflation rotation, what´s the problem? Millions of investors have a portfolio constructed for 2010-20 (big tech and bonds), not 2020-30 (commodities, value, and global equities). Trillions are on one side of the seesaw and billions are on the other. A colossal rebalancing process is born.

The 30 year treasury index is solidly oversold for the first time since 2018. The prior time before that was 2016. The sell-off has taken it close to its 20 quarter moving average, in other words, to where it should have been in the first place. It is not unusual to be at roughly the same level you have been at for five years. What is unusual, perhaps, is for Treasuries to finally be at normal levels in the time of Covid. But this means one very big fat fact: the Covid trade is over. Mean reversion to normality = mean reversion away from the abnormality. The Covid trade is dead. And the treasury market buried it yesterday. We have thus officially entered the Covid-Is-Dead trade.

Bonds are NOT there to Protect Stocks

Risk-parity asset managers delivered their worst day in nearly 5 months this week, the $1.2 billion RPAR Risk Parity ETF plunged the most since the depths of the Covid rout in March.

Positive Correlation – Stocks and Bonds
It was the worst single day for 5s (five-year Treasuries) since 2002… What lending instruments are tied to US 5 year bond yields? FCIs are key, financial conditions will determine when the Fed comes in with YCC, yield curve control. Most investors don´t realize that for much of the 80s and 90s, stocks and bonds were positively correlated, moved together (see above in red). As we move back toward that regime, investors must be positioned accordingly. Email tatiana@thebeartrapsreport.com to get our latest Bear Traps Report.

The Year 2021 – So far we have Two 6 standard deviation moves so far.

– hedge fund deleveraging in the GameStop drama, de-grossing…

– relative value rates, sell-off in 5s vs rest of the curve, US treasuries.

*in both cases too much capital was hiding out in crowded venues. Death of the Covid trade.

Credit Leads Equities
When central banks do NOT allow the business cycle to function over longer and longer periods of time – the good news is wealth creation becomes colossal. The bad news is Capital moves into crowded venues, poised for disruption. In rates, as the bond market sold off. Originally, the long end 30s was deemed at risk. Next, capital moved into 10s, 7s (10 and seven-year U.S. Treasuries), a “safe” place. As selling pressure moved into the middle part of the curve, trillions moved into the front-end looking for duration risk shelter. In recent weeks, 5s (5 year U.S. Treasuries) became the colossal hangout, a perceived “safe” place. Then the US treasury brought another* $100B for sale (5-7 year paper) this week. Anemic demand triggered the now historic, 6sd (standard deviation ) blow-up in 5s.

*total $1.8T U.S. Treasuries for sale in 2021, ABOVE Fed asset purchases.

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Commodities and Bond Yields, tied at the hip – 10 Things you Need to Know

See our Reports Here

Must-Read List

1. Lessons from Omaha

2. Convexity Climax

3. Juggernaut

4. Energy Bull Case

“Commodities are starting to revive after a 10-year bear market. Natural resources like energy, metals, and agriculture look set for an extended run, and investors should get on board.

The recovery in commodity prices, Goldman Sachs analysts say, “will actually be the beginning of a much longer structural bull market” that could rival that of the 1970s, when gold rose 25-fold, and the mid to late 2000s, when oil peaked at over $140 a barrel.

Reasons to be bullish are ample. Global economies look poised to revive in the second half of 2021 as pandemic restrictions ease. And monetary conditions have rarely been so easy. The Federal Reserve may keep short interest rates near zero through 2023, while tolerating 2%-plus inflation.

“Commodities are set up for a significant period of outperformance after such a long period of underperformance relative to other asset classes,” says Roland Morris, commodity strategist at VanEck Global. “There is a lot of fiscal and monetary stimulus being applied globally, and the dollar may fall as global growth rebounds. There are supply constraints and new demand drivers for industrial metals from the electrification of the world.”

The Goldman Sachs commodity analysts are bullish in part because of what they see as “structural underinvestment” in commodities, particularly in energy, following a decade of poor returns. While the energy-heavy S&P GSCI commodity index has rallied 66% from its April 2020 low, its total return has been negative 60% over the past 10 years against a 263% total return for the S&P 500 index.”

Barron’s

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A Colossal Failure of Common Sense 2.0, Act or Crash FOMC

*Our institutional client flatform includes; financial advisors, family offices, RIAs, CTAs, hedge funds, mutual funds, and pension funds.

Email tatiana@thebeartrapsreport.com to get on our live Bloomberg chat over the terminal, institutional investors only please, it’s a real value add.

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In our global NY Times bestseller*, “A Colossal Failure of Common Sense” – there are two key points the book focuses on – risk recognition failures by the Federal Reserve and the importance of short-sellers in the marketplace.

*now published in 12 languages, over 600,000 sold.

Today, at precisely the same moment – we are once again witnessing key stress points in the financial system which can unravel very quickly. Our 21 Lehman Systemic Indicators are screaming higher. The inmates are running the asylum and the probability of the Federal Reserve breaking out their creative “macro-prudential” toolbox is the highest in years.

What is going on? For example, when five to 15 hedge funds are in trouble, all down 10-40% each in less than 30 days and they command $100B or so of AUM (assets under management) – that´s NOT the problem. The problem is – they are levered about 10-1. So these fellows actually control $1T of assets. And when the margin clerk comes walking by your desk it’s a VERY unpleasant experience on a trading floor. It´s NOT a friendly visit, especially when the risk management team has his back, NOT yours.  You don´t just sell your losers, you MUST sell your winners, nearly “everything must go” to raise precious cash.

Here lies the problem with central bankers. Academics are often clueless about systemic risk, even when it´s right under their noses. The history books are filled with these lessons. Very quickly the Fed will scream ¨there is NO problem, all is well, stay in your seats, ladies, and gentlemen.” After a rude awakening, they realize, “oh, we do have a problem.”

This is when happens when you bail out the bad actors in March, just ten months later the leverage comes back VERY quickly.

Looking forward, U.S. central bankers are no longer Trump constrained, the banking system is strong but the equity market has far more in common with Steve Wynn (Vegas) than Warren Buffett (Omaha). We think the Fed (and SEC) sends a shot over the bow very soon. Our social justice, inequality embarrassed Fed is not happy. They will not taper but they can make serious threats to risk-takers. All the signals are there; we have an explosion of SPAC / IPO issuance, $850B of margin debt or 75% above 2015 levels, the most shorted equities up 75% vs. 16% for the S&P 500 since October (bulls running over bears), record-high call vs. put volume with the little guy leading the charge, SELL Mortimer Sell. The risk-reward is atrocious from a long perspective in U.S. equities. Unless the Federal Reserve acts quickly and decisively, we will crash, the destruction will be of epic proportions. Central bankers have a chance to arrest out-of-control animal spirits, they MUST act now.

Companies Outed by Short Sellers

Enron‬
Wirecard‬
Sunbeam ‬
Lehman‬
Worldcom ‬
Madoff‬
Cendant‬
Tyco

*In a world of state-controlled central bank liquidity, message boards, and leverage; who are we actually protecting?‬ How many Bernie Madoffs, how many Bernie Ebbers will be running around the Hamptons this Summer?

The Problem of 2021 – The Fed’s Macro Pru Risk Tools are designed for 2008, not 1999

In our live chat on Bloomberg, several Institutional Clients are talking up a Possible macro-pru Fed Adjustment, Central Bank Action. Warning, beware…

Bailout Alert: *CITADEL, POINT72 TO INVEST $2.75 BLN IN MELVIN CAPITAL

Comments from Our Live Institutional Chat on Bloomberg

The bailout of Long Term Capital Mgmt LTCM: $3.6B.
The bailout of someone short $GME: $2.75B.

*According to usinflationcalculator.com, that $3.6B bailout in 1998 is equivalent to $5.72B today. The bailout that saved the world was $5B now look at us.. $1 trillion “isn’t enough.”

CIO West Coast: “ I think mkt is really scary when a $13bn hf can be down 40%+ a few weeks into the year and asking for bailouts.”

CIO East Coast: “ Classic Fed, wrong macropru toolbox. What did citadel securities do in revenue? $6.7bn?  I’ll bet 60% of that drops straight to the bottom line. We have an Option vol seller (Citadel) + buy-side (point 72) deploying a Reddit fire hose, comedy”

CIO Hedge Fund NYC: “I remember 1999 well.  I think this is now at least as crazy. The GME squeeze is quite a doozy.  I think the short-selling community is pretty destroyed. “

What Triggered the Bailout? It’s similar to the SoftBank whale gamma squeeze.

A) Large herd of organized players buys large amounts of upside calls on stocks with the greatest % short interest.

B) Option traders getting lifted in SIZE, have (MUST) to buy stock to hedge all the incoming call buyers.

C) As option buyers buy the stocks GME, BB, BBBY etc, this triggers short squeeze as % of the float (actual shares outstanding) is very small, short interest is HIGH. Compared to the 1990s, the options ease of use is 10x more accessible today, cheaper commissions (they are paying, just don’t see it) today as well. Message boards (Reddit), a social element similar to the 1990s. So the options angle triggers more of a gamma squeeze with a larger, more mobilized herd. Next, Elon Musk and VCs pile on the action.

Impact: On Wednesday morning, Nasdaq witnessed two inter-day bearish reversals of 2.7% and 1.8% this week. The VIX touches 200d (27.45) first time since election day. It would later touch 37.

A Bull-Raid on Short Sellers
Think of the 1990s mob taking out famed short-seller Julien Robertson vs. the 2020 mob trying to attempt the same thing, now think Genghis Kahn vs. Atila the Hun innovation, mobilized, organized leverage.

We are Looking at more Macro-pru fix Incentive Fuel for the Fed!!!

Market extremes always force a policy response, oftentimes in Bear markets with March 2020 the shock and awe moment of all time. But what about a colossal bull market perch… covered in froth?

WHAT ARE MACROPRUDENTIAL POLICIES? AND HOW DO THEY DIFFER FROM MICROPRUDENTIAL POLICIES?

With Lehman Brothers in mind, macroprudential policies are financial policies aimed at ensuring the stability of the financial system as a whole to prevent substantial disruptions in credit and other vital financial services necessary for stable economic growth. The stability of the financial system is at greater risk when financial vulnerabilities are high, such as when institutions and investors have high leverage and are overly reliant on uninsured short-term funding, and interconnections are complex and opaque.

For the first time in four years, we are looking at an FOMC without Trump constraints. More importantly, they’re wearing the inequality dunce cap sitting in the corner. After a decade of fueling gross inequality, central bankers are out to prove their innocence as newfound social justice warriors.

The problem, looking over the list of the Fed’s macro-prudential tools – most are bank balance sheet related, that’s not where the problem is. Over the last hundred years, after each financial crisis, there has been a unique metamorphosis, a transformation into another serpent, a far different beast. If the Fed has learned anything, this time the focus must be on stock market leverage, margin requirements, etc. It´s far more 1999 than 2008. If Alan Greenspan could go back in time, what macropru tools should he have used in the dotcom era?

Mobs vs. Shorts
Good one from MacroCharts… In our view, mobs have been taking out shorts for decades, NOW they use tactical nuclear weapons (mob-induced option leverage), vs. more primitive methods in the 1990s.

How Times Have Changed

The bailout of Long-Term Capital Management LTCM: $3.6 billion*
The bailout of someone short $GME:  $2.75 billion

*Fourteen financial institutions recapitalized LTCM with $3.6B: Bankers Trust, Barclays, Chase Manhattan, Credit Agricole, CSFB, Deutsche, Goldman, JPM, Merrill, Morgan Stanley, Paribas, Salomon SB, SocGen, UBS.

The latest buzzword is “macroprudential” as in macroprudential regulation. It’s basically means be more conservative, or save a penny for a rainy day. The idea is to institute laws and rules in order to avoid systematic risk, the risk of the collapse of the entire financial system. Policymakers and their research analysts are warming to the view that regulating in anticipation of collapse is better than after collapse. However, no regulator has ever correctly foreseen a financial collapse, even recognized it as it began under their very noses. Like generals, they always fight the last war. At best they invent new tricks for an old game.

The macroprudential thought has actually been around quite a while, in England, where the term was first coined in the 1970s. It only became less obscure, however, after the Bank for International Settlements took up the banner in the early 2000s. It came truly into its own after the late-2000s financial crisis, or the global financial crisis, in the wake of what in retrospect has been deemed as excessive risk-taking by banks given the popping of the housing bubble in the US.

So macroprudential regulation is an effort to reduce the risks of financial instability. It is viewed as optimally complimentary to macroeconomic policy and microprudential rules for financial institutions.

The important point from this history lesson is that macroprudential policy never evolved out of the collapse of the dotcom stock market bubble. It is a bank or banks-to-markets mindset. Instinctively, it views any risk as curable by treating it as in essence bank risk. So if markets are at risk for non-bank reasons, macroprudential policy may still address it, but that would involve a new mindset developing new policies and new tools.

Now to review macroprudential policy as it currently stands. Macroprudential concern divides into three categories: the agency paradigm, the externalities paradigm, and the mood swings paradigm, with most of the focus on the last two.

In the agency paradigm, principal-agent problems (where one person can make decisions for another, but not always in the latter’s best interests) are the focus. So those who run a bank may care more about their own pay than the best interests of the bank’s shareholders or society at large. Imagine! The fear is that as lenders of last resort, the Fed thereby emboldens bank heads to take undue risks. This is a moral hazard, which in economics means the incentive to increase risk at someone else’s expense. Because of the individual actor’s nature of such risk, the macroprudential policy usually focuses on the other two paradigms.

In the externalities paradigm, the main focus is mainly on pecuniary externality which occurs when an economic actor’s decision affects the welfare of another economic actor. For instance, if a lot of suburban dwellers buy apartments in the city as second dwellings, that can drive up the prices of urban apartments, negatively impacting the ability of young urbanites to purchase apartments. The macroprudential view is that when price distortions caused by lack of perfect competition occurs, policy intervention is the cure. Which is stupid. How can an economist, or government employee, determine perfect competition? What criterion would government hacks use? What prejudices and hidden agendas would affect their determinations? A world where no one is worse off no matter what choices are made by others is a pipe dream. The view seems to be that over-borrowing, excessive risk-taking and excessive levels of short term debt deserve macroprudential regulation because market failures hurt the real economy. Meanwhile the 1987 crash and zero impact on the real economy. But now banks have 52% loans to deposits, the lowest and most conservative in half a century! A classic case of developing a cure for a disease that has gone away.

As for the mood swings paradigm, keying off Keynes’s animal spirits idea, the thought is that there are moments of excessive optimism during which money managers tend to ignore risk. This means that price signals lose value and this leads to systemic crisis. So theoretically macroprudential regulation would curb such optimism. Of course, this is exactly the opposite of the current monetary policy. Ahem.

Thus, the concern over macroprudential regulation is really a fancy way of worrying about when the Fed and other regulators change their collective mind and turn off the money spigot.

So how would a macroprudential regulator monitor systemic risk in the first place? One way is to monitor balance sheets. In the case of large banks, these are superb. In the case of small businesses and individuals, as a result of lockdowns, these are disastrous and too late to repair. Another proposed monitor is to look at interconnectedness risk. But it is safe to say that the economy and markets are highly integrated and making them less so at any point in any way for whatever reason carries with it a high degree of risk.

Other measures to monitor risk include credit to GDP and monetary assets such as M1 growth, but of course, the response to lockdowns of Central Banks has been to inflate those metrics. Real asset prices as a measure of potential systemic risk is a joke given that Central Banks are deliberately inflating them, at least so it would seem if one simply observes their behavior. Stress tests of course have been used and, to be fair, for all their flaws, seem to have had some positive impact.

Assuming that policy geeks can identify risks beforehand, which is questionable (isn’t the definition of a dangerous risk one that can’t be foreseen???), what tools are available to reduce identified risks?

Correcting loan to value ratios might be one, but for the fact they are currently the most conservative in over a generation. And this was done by the banking industry voluntarily. Some CLOs have stepped in where banks have feared to tread, true, but no one views them as globally systemically important (yet).

Another macroprudential tool is controlled through debt to income measures, but by all appearances, as a result of the pandemic, these have been thrown by the wayside.

A levy on non-core assets would restrict banks’ ability to wander too far afield. The counter-argument is this reduces their diversification and thereby increases risk.

Countercyclical capital requirements would restrain desperately risky lending by soon to be troubled lending institutions. However, it is difficult to ignore the irony of governments who would never dream of imposing countercyclical measures on themselves. It was Adam Smith who noted centuries ago that emergency monies borrowed by governments temporarily were never repaid. Still too true to this very day.

Penalties for excessive short term funding, charges on maturity mismatches, penalties for insufficient liquidity ratios, and haircuts on asset-backed securities valuations are further macroprudential tools, none of which have any present relevance to currently overfunded global banks. In the US, banks have $6.6 trillion in deposits that cost 6 basis points to maintain, $115 billion in actual cash, $3.3 trillion in securities most of which government-issued, and about $3.4 trillion in loans. Hard to see the systemic risk there.

Further, more junior capital for banks is a basic macroprudential tool, and has already been implemented.

Basel III is in fact often enough macroprudential in outlook. Capital requirements, for example, have been strengthened, capital buffers are in place.

Pro-cyclical dynamic loss provisioning and time-varying minimum capital requirements are basically fancy names for saving pennies for a rainy day, only in this case the pennies are billions, and, while adjusting for time frames, basically means hoarding cash while you can get it and before you need it. While macroprudential, these measures are also anti-growth and ultimately makes the task of growing out of economic inequality impossible. Besides, after the existential crisis of the late-2000s, banks are if anything too risk adverse, and the pandemic has only confirmed them in their ways.

In essence, then, “macroprudential” just means “conservative”.

The management of systemic risk in the USA is in part institutionalized in the guise of the Financial Stability Oversight Council, created in 2010.

The non-coordination of macroprudential policy and monetary policy is detrimental to both.

While theoretically, they should complement each other, in fact, they are inherently at odds in the very times of crisis each seeks to avoid in opposite ways. Macroprudential regulation is conservative in its essence. Monetary policy in times of crisis is fundamentally a printing press. The one restricts as the other expands.

Current fiscal policy and government backing of loans are together meant to maintain personal spending and reward business risk-taking behavior. How to compliment fiscal policy and monetary policy to macroprudential regulation is more of a mystery than a revelation.

In any case, it may all be besides the point. If the main systemic risk is the current equity bubble, it is hard to see how making banks still more conservative will help.

All current macroprudential regulatory tools are geared to solve the last crisis, not the oncoming crisis. Besides, the easiest way to pop the current equity bubble is to raise initial margin from 50% to 60% and maintenance margin from 30% to 40% under regulation T. One doesn’t need the regulatory and intellectual baggage of macroprudential policy to pop a bubble. It’s not a secret.

The most likely scenario, in our view, is louder discussion of macroprudential regulation with everyone very concerned about what it all means. What it all translates into is good old fashioned jaw-boning asset prices lower, an oft practiced method, that can in fact prove effective in overstretched and overvalued markets such as ours now.

Solutions, Reg T

Two points about ending the bubble macroprudentially: the reason why changing regulation T would pop the bubble is because a mere pinprick pops a bubble! It is true changing reg T isn’t much of a big deal compared to options volumes. Changing reg T, compared to options flows, is a mere pinprick. But that’s all you need to pop a bubble. Secondly, it is empirically the case that heavily shorted stocks are targets in today’s world. That story moderates if margin requirements increase. Again, just a pinprick. What is so satisfying from the Fed’s point of view about tightening margin requirements is precisely the fact that isn’t a big thing. It’s just an adjustment. A second lure for the Fed is that it is easily reversed. A third lure is that if it doesn’t work, there is no immediate major harm either.

 

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Renewable Froth: Memories of the Dot-com Boom

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Party like it’s 1999…

“There’s nothing in this world, which will so violently distort a man’s judgment more than the sight of his neighbor getting rich,”

JP Morgan, After the Panic of 1907

Peak Price to Sales Ratio

Tech in 2000

CSCO Cisco: 31x
QCOM Qualcomm: 29x
MSFT Microsoft: 25x
INTC Intel: 14x

Renewables in 2020

PLUG Plug Power: 52x
NIO Nio Inc: 30x
ENPH Enphase Energy: 29x
TSLA Tesla: 19x

Renewable froth, memories of the dot-com boom.

Price to Sales in Growth Equities

Not only are renewables trading at sky-high valuations, but price to sales ratios in growth stocks as a whole are now above their 2000 peak.

Renewables Quarterly RSIs (Relative Strength Index)

ENPH: 96.8
DQ: 89.8
SEDG: 89.5
PLUG: 88.6

Tech Quarterly RSI 2000 Peak

CSCO: 98.5
QCOM: 97.8
TXN: 92.8
INTC: 92.3

ENPH Enphase Energy

The solar panel manufacturer, Enphase Energy, has a quarterly RSI (Relative Strength Index, momentum indicator) of 96.8, one of the highest readings we could find today. Historically when a quarterly candle is this far above its upper bollinger band (purple) it is hard for a stock to maintain its strength, however, with a quarterly RSI of nearly 97 it’s even more challenging. We see meaningful downside in Q1 for this heavily overbought stock.

Renewables Monthly RSIs

PLUG: 95.3
DQ: 92.5
ENPH Enphase Energy: 88.6
SEDG Solar Edge: 87.9

Tech Monthly RSIs 2000 Peak

QCOM: 98.1
TXN: 93.9
CSCO: 93.4
INTC: 82.7

TXN Texas Instruments Monthly RSI Pop in 2000

Overall, the monthly/quarterly RSIs in the renewable energy space look very similar to tech in the dot-com boom…

Lessons From Cisco

Out of dozens of stocks back in 2000, the highest RSI we could find on a quarterly basis was CSCO at 98.5, only slightly higher than ENPH’s current readings of 96.4.

Despite becoming a very successful company over the past twenty years, now employing over 80,000 people, CSCO is still -45% below its 2000 peak!

The important thing to remember is when equities become this overbought on a long-term technical basis, they are pricing-in DECADES of success. Everyone knows renewables are the future of power-generation, that does not mean these valuations are sustainable in the near-term.

PLUG Plug Power Monthly RSI Above 95

There is unsustainable momentum in high-flying renewable names on a monthly and quarterly basis. When considering we are currently running into month-end / quarter-end, this means January will open with new candles very over-stretched on a technical basis. In our view, this speaks to heavy downside risk in Q1 in the renewable space, RSIs above 95 are very very rare.

RSI Divergence

Any trader experienced with technical analysis will tell you RSI works best when there is price and momentum divergence. As a bearish indicator this means RSI is well BELOW its highs while price is HIGHER. Despite RSI at the highs (blow-off tops) in many renewable and technology equities, this bearish divergence is occurring in the most important equity index in the world – the S&P 500.

S&P 500 Quarterly RSI Divergence

Just like the dot-com peak, the quarterly RSI in the Index has been fading lower for a few years (loss of momentum), while the S&P 500’s price has hit new highs, this is MEANINGFUL bearish divergence. In our view, we are close to a long-term top.

Apple Quarterly Bollinger Insanity

While US equity indexes (and even some non-US equity indexes are over-stretched using quarterly bollinger bands, in some single name equities the over-heating is severe. Namely, Apple and some other volatile tech names like AMD were some of the most extreme examples we could find. Importantly, these all speak to meaningful downside in the first quarter of 2021, especially if we rally into year-end.

Nasdaq Quarterly Bollinger Bands

On a quarterly bollinger band chart, this quarter’s candle is meaningfully extended over the upper bollinger band across US indexes, especially the Nasdaq. Historically, it is hard for equities to maintain their technical strength above this upper band. The nasdaq currently sits 11% above the upper bollinger band, this is the largest spread since the dot-com peak.

TAN Solar ETF Spread Above the 200 DMA
The TAN Solar ETF is now 102% above the 200 day moving average, the largest spread in the ETF’s history. 

The argument in 2019: Big tech is not a 1999 bubble because of underlying profits. Now, we have a whole host of tech, renewable, and EV plays with no profits and a colossal newly minted valuation up-take since October 1st.

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