Resilience or Potential Risks
February 2, 2025 – Weekly Comment
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When I started in this business, there were “Fed watchers”. Guys like David Jones, chief economist for Aubrey Langston, who would occasionally appear on the weekly financial news show, Wall Street Week with Louis Rukeyser. They interpreted what the Fed was doing. It wasn’t always immediately clear if the Fed had hiked or eased. No press conferences, no statements. Just open market operations; liquidity adds or drains, repos or matched sales. Now of course, we have Fed “whisperers”. Journalists who leak the Fed’s message. Fed officials make numerous appearances.
In a way, the old system probably made traders a bit more cautious about possible surprises. Currently we have a lot of people whining about Trump’s unscripted and sometimes contradictory pronouncements which jolt the market. What did you think would happen? We’re going to have this every week.
Thoughtful Money’s podcast last week featured Cem Karsan of Kai Volatility. He made the point that markets may be more volatile for the next few years. Not exactly an earth-shattering revelation. We’re only a couple of weeks into the new administration. It will create both uncertainty and opportunity. But it should also make people much more cognizant of tail risks, something that many analysts have warned about. The range of outcomes is likely wider. When asked in last week’s press conference about financial stability, Powell said,
‘… asset prices… I’d say they’re elevated by many metrics right now. A good part of that, of course, is this thing around tech and AI, but we look at that. But we also look at how resilient the households and businesses and the financial sector are to those things. So, we look at that mainly from our financial stability perspective and we think that there’s a lot of resilience out there. Banks have high capital, and households are actually overall, not all households but in the aggregate, households are in pretty good shape financially these days. So, that’s how we think about that. We also, we look at overall financial conditions, and you can’t just take equity prices, you’ve got to look at rates too, and that represents a tightening in conditions with higher rates. So, overall financial conditions are probably still somewhat accommodative, but it’s a mixed bag.”
The other thing Karsan mentioned (and I’m taking liberties in paraphrasing): “what we call ‘money’ is actually leverage, loans. A lot of new collateral has been created in the system, and it functions in a self-reinforcing way, in both directions.” He implies that the Fed and admin need to pump up liquidity to keep things going, and off-handedly assigns a multiplier of 4 to 6 per 1 unit of ‘liquidity’. The real question in my mind, is what happens at the margin. Does extra liquidity, if it even comes, pump financial assets, inflation, or both?
It gets to the core issue of what might be called “resilience”. Household resilience might be framed in terms of balance sheets, shelter costs as a percent of income, the unemployment rate, amount and risks of government transfer programs. I’ll just cite Household Net Worth, which is at a new high, as shown by the chart below. The slope of the ascent has significantly steepened since covid. A lot of that Net Worth is driven by financial assets/corporate equities. How much of that is resilience, and how much represents a risk that we’ll return to the 2011 to 2019 trendline? If that were to occur, my eyeball estimate is that it would lop off about $30 trillion in assets, equal to a year of GDP. Is this something to worry about?
https://www.federalreserve.gov/releases/z1/dataviz/z1/balance_sheet/chart
https://www.federalreserve.gov/releases/z1/dataviz/z1/changes_in_net_worth/chart
I’ve added a couple of links from the Fed, the top one is pretty much a replica of the St Louis Fed chart presented above. The bottom shows CHANGES in net worth, with the biggest factor being corporate equities. On Monday NVDA alone shed $600 billion in value. On Friday AAPL had a range of $14 from a high of 247.19 to a low 233.44. That’s about 6% of the close at 236. The final close was only down 1.59, but the range represented > $200 billion swing.
I am not drawing conclusions from the above, apart from sharpening focus on risk management.
Adding a couple of charts below, as I spent some time looking at the Fed’s balance sheet and mortgages. The spread between the Bankrate 30y mortgage and the 10y treasury is now around 250 bps. In 2023 it was over 350 bps and last year it was mostly around 290. From 2010 to 2019 the spread ranged from 100 to 225. (Lower chart). The top chart is MBS holdings on the Fed’s balance sheet. Waller had said in a speech that he didn’t think the Fed should own any MBS. Current holdings are $2.2 trillion. In general, balance sheet run-off periods have lasted a bit over two years. Then the next crisis hits. Current run is about 2.5 years.
News this week,
Monday ISM Mfg, Tuesday JOLTS, Durables. Wed, ADP, ISM Services. Thud, Claims and Productivity. Friday NFP expected 170k. Powell to testify before the House on Feb 12.
| 1/24/2025 | 1/31/2025 | chg | ||
| UST 2Y | 426.9 | 423.0 | -3.9 | |
| UST 5Y | 442.8 | 436.4 | -6.4 | |
| UST 10Y | 462.1 | 457.1 | -5.0 | |
| UST 30Y | 484.7 | 482.2 | -2.5 | |
| GERM 2Y | 229.0 | 211.9 | -17.1 | |
| GERM 10Y | 256.9 | 246.0 | -10.9 | |
| JPN 20Y | 190.0 | 192.6 | 2.6 | |
| CHINA 10Y | 166.4 | 163.0 | -3.4 | |
| SOFR H5/H6 | -26.0 | -33.5 | -7.5 | |
| SOFR H6/H7 | 7.5 | 5.5 | -2.0 | |
| SOFR H7/H8 | 8.0 | 7.5 | -0.5 | |
| EUR | 105.04 | 103.63 | -1.41 | |
| CRUDE (CLH5) | 74.66 | 72.53 | -2.13 | |
| SPX | 6101.24 | 6040.53 | -60.71 | -1.0% |
| VIX | 14.85 | 16.43 | 1.58 | |
| MOVE | 86.75 | 91.76 | 5.01 | |
