A Midsummer Night's Meme - Episode 20
last updated on Tuesday, July 27, 2021 in General
Hello and thank you for joining us for another episode of “The Insider”, a monthly podcast production of the Federal Home Loan Bank of Des Moines and your source for industry news, strategies and key information about the bank. This is your host, John Biestman, Senior Relationship Manager.
Whether it comes to daughters, sons, nieces, nephews or those in your life that are younger than you, there comes a time when you realize that you're benefiting from what I'll call a “crossover point.” That's the juncture in which you realize that you're learning more from those that are younger than vice-versa. And, no, I'm not going to tell you at what age I reached that particular crossover point!
I'll give you a case in point. Like most bankers, I try to do my best at keeping up with market cross-currents; be they currency, commodity or money markets. I'll add another item to the list that my younger family members are encouraging me to watch, which actually has been around a long time but just in a different form; the so-called meme markets.
You know, stocks whose virtues exponentially proliferate on social media channels such as Twitter and Reddit. In many cases, they represent shares in companies (think game arcades and such) whose glory days have long since past. So, yet another word that I begrudgingly added to my vocabulary, “stonk,” an intentionally misspelled word that connotes social media-hyped stocks that are expected to generate significant degrees of return variability.
Sorry, but in my day, that was politely referred to as “high beta!” Turning to the fixed income world, I'm wondering if the social media platforms might sometime soon turn the spotlight on the current interest rate market that some would describe as having gone bonkers in the wake of continued low rates despite increased inflation metrics, labor shortages, supply disruptions and increases in debt at the government and private levels that almost require scientific notation!
Although much has been forgiven in the case of PPP and other programs, other forms of stimulus are just now taking place. Expanded child tax credits could further bolster consumer spending. And here's another incentive to spend, save or pay down debt.
The Federal Housing Finance Agency has made a midsummer reversal on its previously imposed Adverse Market Fee from last year, effective August 1. As a result, Fannie Mae and Freddie Mac refinanced mortgages will no longer be subject to a half-percent fee. Some Monday morning quarterbacks might say that the timing was interesting from simply a demand perspective.
Imposed at the pinnacle of COVID uncertainty and repealed at a time of heightened housing demand. It wasn't too long ago that second home mortgages purchased by the two agencies became subject to 7% purchase caps, a feature that has prompted more members to ask us about how this mortgage category could fit into FHLB Des Moines Traditional Mortgage Partnership Finance program.
So here we are in the thick of earnings season. Many depositories are, not surprisingly, reporting reversals in their loan loss provisions. Thank you CECL or current expected credit loss accounting! After many months of pricing to zero, the phenomenon of deposit growth overshadowing loan growth doesn't seem to have yet turned the tide.
The Fed's H8 update shows that insured depository annualized loan growth shrunk by 0.4% in the face of deposit growth of 13.3% during the second quarter of 2021. Those distorted proportions are of similar magnitude to what took place during the first quarter. Loan portfolios continue to be diminished by meaningful balance reductions in C&I loans.
Sparse inventories caused by supply chain interruptions is also responsible. Perhaps the cessation of the PPP program can reverse the C&I downtrend.
Speaking of balance sheet proportionality, I had an interesting conversation with a group of bankers who shared an interesting perspective. Whereas in years past, franchise value was significantly derived from the ability to generate core deposits, in this day-and-age, value seems to be about developments on the left-hand side of the balance sheet.
Whoever can generate growth in quality loans seems to be destined for the victory lap. As we face more months of “transitory” inflation, at least at the headline levels, many are pondering the bond market's recent antithetical reaction to surging annualized consumer and producer price indices.
Indeed, the Fed's Survey of Consumer Expectations posted inflation expectation over the next year to be 4.8%, the highest consumer inflation forecast since the survey's inception in 2013. It almost seems time to throw rationality in the waste bin and instead focus on the brute strength of the Fed when it comes to its share the treasury and mortgage markets.
With the Fed continuing its monthly purchases of mortgages in the vicinity of $40 billion per month (that's over $2 trillion cumulatively since March 2020), option adjusted mortgage-backed securities remain tight. And…don't forget that we are in what appears to be a healthy housing market (at least if you're a seller).
All told, the Fed now owns roughly one-third of the entire agency MBS market. So, if the economic conditions warrant (and they will someday in spite despite the omnipresent virus variants), we'll be listening more intently to taper talk. As the “t-word” makes the rounds, we'll no doubt be asking ourselves if the Fed would disproportionately taper its mortgage position relative to treasuries.
I suppose that if we take into account year-to-date inflation, we can call the Fed the 900-pound gorilla in the room as far as the mortgage market is concerned! Some interest rate policy searchers of the canary-in-the coal mine are looking of late at some changes that have occurred in the reverse repo markets.
Reverse repo transactions are executed between the Fed's counterparties, including banks and money market funds. The Fed sells securities with the agreement to repurchase those securities on a later date and at a higher repurchase price. Reverse repos have the effect of reducing reserves in the banking system.
Well, usage of the reverse repo market by the Fed has expanded in recent weeks. Some days during July, activity has approached $900 billion, whereas activity was next to nothing during Q1. Since then, the Fed hiked the rate that it pays under its reverse repo facility from zero to five basis points.
Perhaps changes in this market portend eventual reductions in levels of quantitative easing? Remember that this market caused some seismic market activity in September of 2019! Notwithstanding the abundance of liquidity in the financial system, seasoned tillers always prepare for a drought.
To that end, we have just inked a strategy piece on scenarios in which you might not be able to respond to the fire. I'll run through a few examples:
- Have you ever had a situation when there's money need before the end of the day's settlement and the person responsible for initiating an overnight advance isn't available? Test a live overnight advance transaction by someone other than the primary authorized transactor for your institution.
- How about personnel changes? When a new user is added with advance transaction authority, it may be a good idea to give that new individual the experience of initiating an advance request.
- OK. Let's look at the strategic angle and say that you would trigger some balance sheet changes if rates shifted and you went beyond your risk parameters. One of your contingent strategies may very well involve taking out some term advances in order to increase asset sensitivity. While it's one thing to say that you could deploy this balance sheet strategy at some point should the need arise, it's another thing to prove that you can do so on the spot. Even if it's a test amount, seeing can be believing when it comes to regulatory discussions.
- There are many other stress testing scenarios that could warrant testing of your availability: loan fundings or purchases, investment purchases, loan sales that didn't close when expected, funding third-party payroll, deposit runoff or even daylight overdrafts at the Fed.
You can test-borrow up to $15 million by using your eAdvantage online execution platform or more, simply by calling the Money Desk. Next day, you can wire or transfer funds back to your FHLB Des Moines DDA in order to repay your advance test. The best time to test for leaks is when the forecast calls for dry weather!
Anyway, back to my midsummer night's meme, I spotted a captioned picture of an exasperated banker who sighed, “I don't know what reverse repo going up means and I'm afraid to ask!” Stay well and we'll see you next time on the FHLB Des Moines Insider Podcast. Test those lines and thanks for tuning in.
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