The drenching Hurricane-turned-Tropical-Storm Hilary is forecast to leave a destructive swath up the western U.S. this week as relief workers in Maui continue their search for any signs of life among the 850 missing residents of Lahaina over 3,000 miles away.
Meanwhile, economic prognosticators are wondering what’s in store this weekend at the Kansas City Fed’s symposium in Jackson Hole, WY.
The annual summer conference, which will be held Thursday through Saturday, features a slew of speakers who will largely be preaching to a pre-occupied choir.
They will mostly pontificate their profligate theories (or, if you prefer, officiously wax poetic) about this year’s theme – “Structural Shifts in the Global Economy.”
Dispassionate and Fedspeak enough to escape the attention of most common Americans? You betcha!
Although the stream of papers slated to be delivered and discussed at the event have yet to be released, one thing is clear:
Perhaps the most compelling mantras underlying the Structural Shifts theme should be focusing on the storm debt – public and private – brewing in the U.S.
As Jennifer Sor suggests in a recent Business Insider article, troubles are already bubbling up to the surface “as loans pile up and borrower confidence falters.”
Banks Were an Early Sign
By Dave Allen for Discount Gold & Silver
The drenching Hurricane-turned-Tropical-Storm Hilary is forecast to leave a destructive swath up the western U.S. this week as relief workers in Maui continue their search for any signs of life among the 850 missing residents of Lahaina over 3,000 miles away.
Meanwhile, economic prognosticators are wondering what’s in store this weekend at the Kansas City Fed’s symposium in Jackson Hole, WY.
The annual summer conference, which will be held Thursday through Saturday, features a slew of speakers who will largely be preaching to a pre-occupied choir.
They will mostly pontificate their profligate theories (or, if you prefer, officiously wax poetic) about this year’s theme – “Structural Shifts in the Global Economy.”
Dispassionate and Fedspeak enough to escape the attention of most common Americans? You betcha!
Although the stream of papers slated to be delivered and discussed at the event have yet to be released, one thing is clear:
Perhaps the most compelling mantras underlying the Structural Shifts theme should be focusing on the storm debt – public and private – brewing in the U.S.
As Jennifer Sor suggests in a recent Business Insider article, troubles are already bubbling up to the surface “as loans pile up and borrower confidence falters.”
Banks Were an Early Sign
Of course, Fitch's recent downgrading of the federal government’s credit rating and Moody's downgrading of 10 U.S. banks should make all Americans concerned about the nation’s creditworthiness and debt flowing out of the banking sector.
But she rightly puts the focus on “more granular problems mounting across debt markets as well.”
Those issues have arisen as the private and public sector are confronted by “a drastically different environment than they did” in the 2010s – when interest rates were at historic lows coming out of the Great Recession.
“If low rates spurred the sugar rush of heavy borrowing,” Sor says, “rising interest rates may be setting the stage for the sugar crash.”
We witnessed the initial domino fall in March with the implosion of Silicon Valley Bank – thanks to mismanagement of its balance sheet weighed down by longer-term bonds that quickly fell in value as interest rates climbed.
First SVB, then Signature and First Republic Banks quickly fell one after the other.
The initial fallout from those failures was somewhat held in check.
But then came Moody’s warning shot three months later when the ratings agency downgraded mostly smaller banks’ credit by one full notch – banks like Fulton, Commerce and M&T.
At the same time, Moody’s affirmed the ratings of 11 other banks but placed them on a negative outlook because of “a decline in the banks’ stability”: Ally, Simmons, OZK, Fifth Third, Regions, Cadence, First National Bank of PA, Citizens, Capital One, Huntington National and PNC.
And now, market pundits and investing icons – like hedge fund guru Ray Dalio and economist Nouriel Roubini – warning that a full-blown debt crisis could be on the way.
Warning Signs of Coming Crisis
Sor offers these five warning signs “flashing in U.S. debt markets”:
First, private debt levels are rising at a stunning rate.
Private debt levels have hit new records this year. Credit card debt just passed $1 trillion for the first time ever, according to the Fed.
Personal unsecured loans have also hit a new record high, reaching $225 billion in 2023, according to TransUnion.
The same for corporate debt, which has seen volumes grow to $7.8 trillion, per Janus Henderson.
Governmental debt looks even more dire. The gross national debt blew through $32 trillion for first time this year.
And, according to too big to fail Bank of America, $5 billion potentially could be added each day for the next 10 years.
The nonpartisan Congressional Budget Office projects that debt held by the public could rise from % of GDP this year to an astounding % by _ under current policies in place today.
Second, corporate defaults are swelling.
Sor points out that with rising interest rates and companies’ growing debt burdens, defaults in 2023 have already surpassed all of last year's total.
A total of 55 U.S.-based firms defaulted on their debt in the first six months of the year – a 53% increase from the 36 companies that defaulted in 2022, according to Moody's.
Sor adds that as much as $1 trillion in corporate debt could default if the nation faces a full-blown recession, according to a BoA warning.
Third, late payments are growing.
Sor reports that people and companies alike “are increasingly falling behind on their loan payments.”
Commercial property owners that were 30 days or more late on monthly payments – or that have already defaulted on their mortgages – rose to 3% in the 1st quarter this year, according to data from the Mortgage Bankers Association.
At the same time, the delinquency rate for all personal loans rose to 2.2% in the 1st quarter this year, up from just 1.7% in the same period of 2021, according to the Fed.
And, fourth, banks are itching to dump their risky debt.
Banks have been trying to dump loans that have a higher default risk, even if it means selling those assets at a discount (loss).
Too big to fails JPMorgan Chase, Goldman Sachs, and Capital One are among the WallStreeters trying to get rid of large commercial real estate assets, Bloomberg reported last week.
Sor notes that banks are also pulling back on their issuing new debt as financial conditions tighten, which she says “spells trouble for the commercial real estate industry.”
About $1.5 trillion of so-called CRE debt set to mature in the next few years will need to be refinanced – right now at higher interest rates.
Property owners could be surprised when they go to refinance their mortgages with higher rates and resulting lower property valuations.
And with fears of commercial real estate default looming, banks have already started to put a hold on lending – especially after the triad of bank failures earlier this year.
In fact, the credit crunch is already here, as banks have recorded the sharpest decline in lending on record.
QT…We Hardly Knew Ye
And it could get crunchier than a freshly opened box of Kapt. Krunch.
According to the minutes of their July policy meeting, Fed officials are seriously considering that they may not have to stop shrinking their massive balance sheet when they begin cutting interest rates:
“A number of participants noted that balance-sheet runoff need not end when the committee eventually begins to reduce the target range for the federal funds rate.”
Janelle Marte writes that this approach “could present communication challenges for the [Fed].”
She says that’s because reducing their portfolio of Treasuries and Mortgage- Backed Securities — the crux of Quantitative Tightening — is normally considered a strategy for tightening monetary policy.
Interest-rate cuts work the opposite way – loosening or easing policy by lowering borrowing costs.
Marte notes the Fed’s most recent economic projections from June, showing that policymakers expect to start lowering interest rates sometime in 2024.
She adds that although the goal of rate cuts are usually to stimulate the economy — think the early days of the pandemic — Fed officials are now trying to keep rates from becoming too restrictive as inflation falls, with the goal of avoiding a recession.
For that reason, some officials have said such rate cuts might not necessarily undermine the Fed’s efforts to keep shrinking its portfolio.
One of them, Dallas Fed President Lorie Logan, observed: “If we are lowering interest rates to get back to a neutral position, that wouldn’t be a reason to stop the decline.”
“My expectation,” she continued, “is that we have room for the balance sheet to continue shrinking for quite some time.”
Marte believes Fed officials want to keep reducing their balance sheet, which ballooned during the pandemic – to a peak of just shy of $1 trillion – to stabilize markets and support the economy.
Since last June, the Fed has been rolling off some of those balance sheet assets as they mature – at a pace of about $800 million a month.
The Fed’s balance sheet now stands at about $8.2 trillion. But Marte notes that efforts “to keep the runoff going could be interrupted for reasons unrelated to rate cuts.”
For example, the last time Fed officials were unwinding the balance sheet, circumstances forced them to halt the runoff — and start intervening in money markets.
Remember when reserves in the banking system fell too low and caused rates on overnight repurchase agreements to skyrocket?
More recently, a lot of liquidity drain has come from the Fed’s reverse-repo program. That’s where money-market funds can park their cash with the Fed overnight.
But, Marte warns, now that the decline in banks’ RRP usage has leveled off, some analysts are concerned that more cash could leak from other segments of the financial system.
The most important of those segments is bank reserves.
And if reserves would fall too much – because of their importance particularly to systemically important global banks (i.e., the too bigs to fail) – the Fed would likely slow or abruptly stop QT.
The moral of this convoluted story is, Eat your Kapt. Krunch while it’s still crunchy.