Spread & Containment
A “Soft Landing” Scenario – Possibility Or Fed Myth?
Optimism is increasing on Wall Street, with investors hoping for a "soft landing" in the economy.
"David Kelly, the chief global strategist at JPMorgan…
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Optimism is increasing on Wall Street, with investors hoping for a “soft landing” in the economy.
“David Kelly, the chief global strategist at JPMorgan Asset Management, is betting that inflation will continue to ease in 2023, helping the US economy to narrowly escape a recession. Ed Yardeni, the longtime stock strategist and founder of his namesake research firm, is putting the odds of a soft landing at 60% based on strong economic data, resilient consumers, and signs of tumbling price pressures.” – Bloomberg
The hope is that despite the Fed hiking rates at the most aggressive pace since 1980, reducing its balance sheet via quantitative tightening, and inflation running at the highest levels since the 70s, the economy will continue to power forward.
Is such a possibility, or is the “soft landing” scenario another Fed myth?
To answer that question, we need a definition of a “soft landing” scenario, economically speaking.
“A soft landing, in economics, is a cyclical slowdown in economic growth that avoids a recession. A soft landing is the goal of a central bank when it seeks to raise interest rates just enough to stop an economy from overheating and experiencing high inflation without causing a severe downturn.” – Investopedia
The term “soft landing” came to the forefront of Wall Street jargon during Alan Greenspan’s tenure as Fed Chairman. He was widely credited with engineering a “soft landing” in 1994-1995. The media has also pointed to the Federal Reserve engineering soft landings economically in both 1984 and 2018.
The chart below shows the Fed rate hiking cycle with “soft landings” notated by orange shading. I have also noted the events that preceded the “hard landings.”
There is another crucial point regarding the possibility of a “soft landing.” A recession, or “hard landing,” followed the last five instances when inflation peaked above 5%. Those periods were 1948, 1951, 1970, 1974, 1980, 1990, and 2008. Currently, inflation is well above 5% throughout 2022.
Could this time be different? Absolutely, but there is a lot of history that suggests otherwise.
Furthermore, the technical definition of a “soft landing” is “no recession.“ The track record worsens if we include crisis events caused by the Federal Reserve’s actions.
No Such Thing
The Federal Reserve became active in the late 70s under Chairman Paul Volker. Since then, the Fed is responsible for repeated boom and bust cycles in the financial markets and economy.
As noted above, there were three periods where the Federal Reserve hiked rates and achieved a “soft landing,” economically speaking. However, the reality was that those periods were not “pain-free” events for the financial markets. The chart below adds the “crisis events” that occurred as the Fed hiked rates.
The failure of Continental Illinois National Bank and Trust Company in 1984, the largest in U.S. history at the time, and its subsequent rescue gave rise to the term “too big to fail.” The Chicago-based bank was the seventh-largest bank in the United States and the largest in the Midwest, with approximately $40 billion in assets. Its failure raised important questions about whether large banks should receive differential treatment in the event of failure.
The bank took action to stabilize its balance sheet in 1982 and 1983. But in 1984, the bank posted that its nonperforming loans had suddenly increased by $400 million to a total of $2.3 billion. On May 10, 1984, rumors of the bank’s insolvency sparked a huge run by its depositors.
Many factors preceded the crisis, but as the Fed hiked rates, higher borrowing costs and interest service led to debt defaults and, eventually, the bank’s failure.
Fast forward to 1994, and we find another “crisis” event brewing as the Fed hiked rates.
The 1994 bond market crisis, or Great Bond Massacre, was a sudden drop in bond market prices across the developed world. It started in Japan, spread through the U.S., and then the world. The build-up to the event began after the 1991 recession, as the Fed had dropped interest rates to historically low levels. During 1994, a rise in rates and the relatively quick spread of bond market volatility across borders resulted in a mass sell-off of bonds and debt funds as yields rose beyond expectations. The plummet in bond prices was triggered by the Federal Reserve’s decision to raise rates to counter inflationary pressures. The result was a global loss of roughly $1.5 trillion in value and was one of the worst financial events for bond investors since 1927.
2018 was also not a pain-free rate hiking cycle. In September of that year, Jerome Powell stated the Federal Reserve was “nowhere near the ‘neutral rate'” and was committed to continuing hiking rates. Of course, a 20% meltdown in the market into December changed that tone, but the hike in interest rates had already done damage. By July 2019, the Fed was cutting rates to zero and launching a massive monetary intervention to bail out hedge funds. (The chart only shows positive weekly changes to the Fed’s balance sheet.)
At the same time, the yield curve inverted, and recessionary alarm bells were ringing by September. By March 2022, the onset of the pandemic triggered the recession.
The problem with rate hikes, as always, is the lag effect. Just because Fed rate hikes have not immediately broken something doesn’t mean they won’t. The resistance to higher rates may last longer than expected, depending on the economy or financial market’s strength. However, eventually, the strain will become too great, and something breaks.
It is unlikely this time will be different.
The idea of a “soft landing” is only a reality if you exclude, in most cases, rather devasting financial consequences.
The Fed Will Break Something
It’s only a question of what.
So far, the economy seems to be holding up well despite an aggressive rate hiking campaign providing the cover for the “soft landing” scenario. Such is due to the massive surge in stimulus sent directly to households resulting in an unprecedented spike in “savings,” creating artificial demand as represented by retail sales. Over the next two years, that “bulge” of excess liquidity will revert to the previous growth trend, which is a disinflationary risk. As a result, economic growth will lag the reversion in savings by about 12 months. This “lag effect” is critical to monetary policy outcomes.
As the Fed aggressively hikes rates, the monetary influx has already reverted. Such will see inflation fall rapidly over the ensuing 12 months, and an economic downturn increases the risk of something breaking.
The slower rate of growth, combined with tighter monetary accommodation, will challenge the Fed as disinflation risk becomes the next monetary policy challenge.
The Federal Reserve is in a race against time. The challenge will be a reversion of demand leading to a supply gut that runs up the supply chain. A recession is often the byproduct of the rebalancing of supply and demand.
While Jerome Powell states he is committed to combatting inflationary pressures, inflation will eventually cure itself. The inflation chart above shows that the “cure for high prices is high prices.”
Mr. Powell understands that inflation is always transitory. However, he also understands rates cannot be at the “zero bound” when a recession begins. As stated, the Fed is racing to hike interest rates as much as possible before the economy falters. The Fed’s only fundamental tool to combat an economic recession is cutting interest rates to spark economic activity.
Jerome Powell’s recent statement from the Brookings Institution speech was full of warnings about the lag effect of monetary policy changes. It was also clear there is no “pivot” in policy coming anytime soon.
When that “lag effect” catches up with the Fed, a “pivot” in policy may not be as bullish as many investors currently hope.
We doubt a “soft landing” is coming.
The post A “Soft Landing” Scenario – Possibility Or Fed Myth? appeared first on RIA.
recession pandemic stimulus economic growth bonds yield curve monetary policy fed federal reserve treatment spread recession interest rates stimulus japan
Spread & Containment
Treasuries Pain Can Get Much Worse, Term Premium Dynamics Show
Treasuries Pain Can Get Much Worse, Term Premium Dynamics Show
By Garfield Reynolds, Bloomberg Markets Live reporter and strategist
Treasuries’…
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By Garfield Reynolds, Bloomberg Markets Live reporter and strategist
Treasuries’ recent slump owed plenty to the return of the so-called term premium as investors became more concerned about the risks of holding longer-dated debt. Even as US bonds get some help from geopolitical uncertainty, there’s plenty of scope for yields to march considerably higher on the same dynamics that helped drive September’s spike.
For one thing there’s little chance that the supply outlook is going to improve noticeably, no matter how the Middle East conflict and the US House speaker situation are resolved. For another, an examination of the relative yields for Australian and US debt signals there’s potential that US term premiums have further to go to.
Australia’s 10-year term premium has tended to align closely with the US gauge, but it’s been going through a relatively rare period since the pandemic with the two diverging. At first, it was the US term premium that swelled, perhaps representing the impact of extreme QE or lingering liquidity concerns after Treasuries froze as the pandemic broke out. That script flipped from early 2022 as the Fed started what would prove to be a far more aggressive hiking cycle than the RBA.
Still, as inflation slows in both economies and traders anticipate and end to rate hikes, that term premium gap closed dramatically even as September’s selloff drove steep losses for both Treasuries and Aussie bonds. Term premiums are tough enough to measure, let alone predict, but there’s a case to be made that one potential guide for the way for this to develop would be for the US term premium to close much of the remaining spread to Australia, which stood at about 60bps at the end of last month.
Spread & Containment
How Has Treasury Market Liquidity Evolved in 2023?
In a 2022 post, we showed how liquidity conditions in the U.S. Treasury securities market had worsened as supply disruptions, high inflation, and geopolitical…
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In a 2022 post, we showed how liquidity conditions in the U.S. Treasury securities market had worsened as supply disruptions, high inflation, and geopolitical conflict increased uncertainty about the expected path of interest rates. In this post, we revisit some commonly used metrics to assess how market liquidity has evolved since. We find that liquidity worsened abruptly In March 2023 after the failures of Silicon Valley Bank and Signature Bank, but then quickly improved to levels close to those of the preceding year. As in 2022, liquidity in 2023 continues to closely track the level that would be expected by the path of interest rate volatility.
Importance of Treasury Market Liquidity
The U.S. Treasury securities market is the largest and most liquid government securities market in the world, with more than $25 trillion in marketable debt outstanding (as of August 31, 2023). The securities are used by the Treasury Department to finance the U.S. government, by countless financial institutions to manage interest rate risk and price other financial instruments, and by the Federal Reserve in implementing monetary policy. Having a liquid market is important for all of these purposes and thus of concern to market participants and policymakers alike.
Measuring Liquidity
Liquidity often refers to the cost of quickly converting an asset into cash (or vice versa) and is measured in various ways. We look at three commonly used measures, estimated using high-frequency data from the interdealer market: the bid-ask spread, order book depth, and price impact. The measures are estimated for the most recently auctioned (on-the-run) two-, five-, and ten-year notes (the three most actively traded Treasury securities, as shown in this Liberty Street Economics post), and are calculated for New York trading hours (defined as 7 a.m. to 5 p.m.).
Market Liquidity Worsened in March 2023
The bid-ask spread—the difference between the lowest ask price and the highest bid price for a security—is one of the most popular liquidity measures. As shown in the chart below, bid-ask spreads widened abruptly after the failures of Silicon Valley Bank (March 10) and Signature Bank (March 13), suggesting reduced liquidity. For the two-year note, spreads exceeded those observed during the COVID-related disruptions of March 2020 (examined in this Liberty Street Economics post). Spreads then narrowed over the subsequent month or so to levels close to those of the preceding year but remained somewhat elevated for the two-year note.
Bid-Ask Spreads Widened in March 2023
Source: Author’s calculations, based on data from BrokerTec.
Notes: The chart plots five-day moving averages of average daily bid-ask spreads for the on-the-run two-, five-, and ten-year notes in the interdealer market from September 1, 2019 to September 30, 2023. Spreads are measured in 32nds of a point, where a point equals one percent of par.
The next chart plots order book depth, measured as the average quantity of securities available for sale or purchase at the best bid and offer prices. This metric again points to relatively poor liquidity in March 2023, as the available depth declined precipitously. Depth in the five-year note was at levels commensurate with those of March 2020, whereas depth in the two-year note was appreciably lower—and depth in the ten-year note appreciably higher—than the levels of March 2020. Within about a month, depth for all three notes was back to levels similar to those of the preceding year.
Order Book Depth Plunged in March 2023
Source: Author’s calculations, based on data from BrokerTec.
Notes: This chart plots five-day moving averages of average daily depth for the on-the-run two-, five-, and ten-year notes in the interdealer market from September 1, 2019 to September 30, 2023. Data are for order book depth at the inside tier, averaged across the bid and offer sides. Depth is measured in millions of U.S. dollars par and plotted on a logarithmic scale.
Measures of the price impact of trades also suggest a notable deterioration of liquidity. The next chart plots the estimated price impact per $100 million in net order flow (defined as buyer-initiated trading volume less seller-initiated trading volume). A higher price impact suggests reduced liquidity. Price impact for the two-year note rose sharply in March 2023 to a level about twice as high as at its March 2020 peak, and then within a month or so returned to levels comparable to those of the preceding year. Price impact for the five-and ten-year notes rose more modestly in March.
Price Impact Rose in March 2023
Source: Author’s calculations, based on data from BrokerTec.
Notes: The chart plots five-day moving averages of slope coefficients from daily regressions of one-minute price changes on one-minute net order flow (buyer-initiated trading volume less seller-initiated trading volume) for the on-the-run two-, five-, and ten-year notes in the interdealer market from September 1, 2019 to September 30, 2023. Price impact is measured in 32nds of a point per $100 million, where a point equals one percent of par.
Volatility Spiked in March 2023
The failures of Silicon Valley Bank and Signature Bank increased uncertainty about the economic outlook and expected path of interest rates. Interest rate volatility increased sharply as a result, as shown in the next chart, with two-year note volatility in particular reaching levels more than twice as high as in March 2020. Volatility causes market makers to widen their bid-ask spreads and post less depth at any given price to manage the increased risk of taking on positions, producing a negative relationship between volatility and liquidity. The sharp rise in volatility and its subsequent decline hence help explain the observed patterns in the liquidity measures.
Price Volatility Spiked in March 2023
Source: Author’s calculations, based on data from BrokerTec.
Notes: The chart plots five-day moving averages of price volatility for the on-the-run two-, five-, and ten-year notes in the interdealer market from September 1, 2019 to September 30, 2023. Price volatility is calculated for each day by summing squared one-minute returns (log changes in midpoint prices) from 7 a.m. to 5 p.m., annualizing by multiplying by 252, and then taking the square root. It is reported in percent.
Liquidity Continues to Track Volatility
As in “How Liquid Has the Treasury Market Been in 2022?,” we assess whether liquidity has been unusual given the level of volatility by examining scatter plots of price impact against volatility. The chart below provides such a plot for the five-year note, showing that the 2023 observations (in gray) fall in line with the historical relationship. That is, the association between liquidity and volatility in 2023 has been consistent with the past association between these two variables. This is true for the ten-year note as well, whereas for the two-year note the evidence points to somewhat higher-than-expected price impact given the volatility (as also occurred in fall 2008, March 2020, and 2022).
Liquidity in Line with Historical Relationship with Volatility
Notes: This chart plots price impact against price volatility by week for the on-the-run five-year note from January 1, 2005, to September 30, 2023. The weekly measures for both series are averages of the daily measures plotted in the preceding two charts. Fall 2008 points are for September 21, 2008–January 3, 2009, March 2020 points are for March 1, 2020–March 28, 2020, 2022 points are for January 1, 2022–December 31, 2022, and 2023 points are for January 1, 2023–September 30, 2023.
The preceding analysis is based on realized price volatility—that is, on how much prices are actually changing. We repeated the analysis with implied (or expected) interest rate volatility, as measured by the ICE BofAML MOVE Index, and found similar results for 2023. That is, liquidity for the five- and ten-year notes is in line with the historical relationship between liquidity and expected volatility, whereas liquidity is somewhat worse for the two-year note.
Continued Vigilance
While Treasury market liquidity has not been unusually poor given the level of interest rate volatility, continued vigilance by policymakers and market participants is appropriate. The market’s capacity to smoothly handle large trading flows has been of concern since March 2020, as discussed in this Brookings paper. Moreover, new empirical work shows how constraints on intermediation capacity can exacerbate illiquidity. Careful monitoring of Treasury market liquidity, and continued efforts to enhance the market’s resilience, are warranted.
Michael J. Fleming is the head of Capital Markets Studies in the Federal Reserve Bank of New York’s Research and Statistics Group.
How to cite this post:
Michael Fleming, “How Has Treasury Market Liquidity Evolved in 2023?,” Federal Reserve Bank of New York Liberty Street Economics, October 17, 2023, https://libertystreeteconomics.newyorkfed.org/2023/10/how-has-treasury-market-liquidity-evolved-in-2023/.
Disclaimer
The views expressed in this post are those of the author(s) and do not necessarily reflect the position of the Federal Reserve Bank of New York or the Federal Reserve System. Any errors or omissions are the responsibility of the author(s).
Spread & Containment
New York Supreme Court Upholds Ban On COVID Vaccine Mandate For Health Workers
New York Supreme Court Upholds Ban On COVID Vaccine Mandate For Health Workers
Authored by Benjamin Kew via The Epoch Times (emphasis ours),
New…
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Authored by Benjamin Kew via The Epoch Times (emphasis ours),
New York's Supreme Court has upheld its previous ruling invalidating the COVID-19 vaccine mandate for health care workers, a decision that will have ramifications on the power of the state's executive.
The ruling came from the Supreme Court's Appellate Division, Fourth Department, which dismissed the state's appeal to have the mandate reinstated.
"4th Dept dismissed state’s appeal as moot, and declined to vacate lower court win," attorney Sujata Gibson wrote on X, formerly known as Twitter.
"The mandate is over and declared unconstitutional," she continued. "[Thank you] [Children's Health Defense], [Robert F. Kennedy Jr.], and [Medical Professionals For Informed Consent], and everyone who helped in this fight.
"Doesn’t make up for the harm [New York] Inflicted, but will help protect us from more."
The health care worker vaccine mandate was first implemented in September 2021, resulting in the departure or termination of about 34,000 medical professionals from their positions.
That mandate was originally struck down by the state's Supreme Court in January, although the state's executive branch chose to appeal the decision.
In his opinion in Medical Professionals for Informed Consent vs. Bassett, Justice Gerard Neri wrote that the state's Department of Health was "clearly prohibited from mandating any vaccination outside of those specifically authorized by the legislature" and that it had "blatantly violated the boundaries of its authority as set forth by the legislature.”
Justice Neri added that the mandate was “arbitrary and capricious” given that the COVID-19 vaccines failed to prevent transmission of the virus, meaning the policy had no rational basis.
New York Gov. Kathy Hochul, a Democrat, had previously explained her opposition to rehiring health care workers who lost their jobs as a result of the vaccine, saying that this was "not the right answer."
“I think everybody who goes into a health care facility or a nursing home should have the assurance and their family member should know that we have taken all steps to protect the public health," she said at the time. "And that includes making sure those who come in contact with them at their time of most vulnerability, when they are sick or elderly, will not pass on the virus."
In April, the state agreed to unilaterally drop the mandate of its own accord, although it still contested the decision for the sake of maintaining executive authority.
"Due to the changing landscape of the COVID-19 pandemic and evolving vaccine recommendations, the New York State Department of Health has begun the process of repealing the COVID-19 vaccine requirement for workers at regulated health care facilities," the state health department stated.
Last October, the New York Supreme Court also struck down a mandate enforced specifically by New York City on all public employees, with Justice Ralph Porzio arguing there was no evidence to "support the rationality of keeping a vaccination mandate for public employees, while vacating the mandate for private sector employees or creating a carveout for certain professions, like athletes, artists, and performers."
In January 2022, the U.S. Supreme Court similarly blocked an attempt by President Joe Biden to enforce a mandate on large private companies that their employees either get the vaccine or face regular testing. However, it did allow the mandate to continue in medical facilities that took funding from Medicare and Medicaid.
"Although Congress has indisputably given OSHA the power to regulate occupational dangers, it has not given that agency the power to regulate public health more broadly,” the court wrote in its unsigned opinion. "Requiring the vaccination of 84 million Americans, selected simply because they work for employers with more than 100 employees, certainly falls in the latter category."
Margaret Florini, a spokesperson for Medical Professionals for Informed Consent, told The Defender that the latest decision was a "historic" win that would help prevent such abuses of power in the future.
"I think we will see many new lawsuits come about because of this historic win," Ms. Florini said. "There is still plenty of work to be done. We lost so much, not just money but relationships, marriages, friends, and homes. We cannot forget what was done to us, and we must continue to shed light on it and make impactful changes that will truly prevent this from happening again."
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