Federal Reserve’s ‘Great Pause’… And What Happens Next
Every headline in the financial press earlier this week says the same thing. The Fed’s “Great Pause” has now commenced.
The Federal Reserve raised interest rates by a quarter point—and could be done.
Well, they might be done “raising” rates, but they shouldn’t be in the rate setting business—up, down or sideways— in the first place. That’s because market capitalism doesn’t work if financial asset prices are being pegged artificially and falsely by a 12-man monetary politburo rather than the vast throng of suppliers and users of funds in the global marketplace.
Here is the madness that rate pegging has led to over the last 22 years.
To wit, the Fed has made overnight money so ungodly cheap that it has distorted, tortured and twisted the very warp and woof of the entire financial system. All financial asset prices have been drastically falsified because 221 months of negative carry costs in real terms have triggered reckless leveraged speculations, rampant options chasing and dangerous financial asset arbitrages like never before.
Inflation-Adjusted Fed Funds Rate Since October 2001
Alas, none of this is stable or sustainable. So here we are with another day in which the stock market is open, and like clockwork a new batch of regional banks are hitting the skids.
% Stock Price Change Today/From Recent Peak:
- PacWest: -50%/-93%;
- First Horizon: -33%/-55%;
- Western Alliance: -40%/-84%;
- Zions Bancorp: -12%/-73%
In all, this batch of plummeting regional banks posted a combined market cap of just $10.6 billion at last Thursday’s close, down from $40 billion at recent valuation peaks. And again, the collapse is not because trailing earnings have cratered.
In fact, the above four regionals posted $3.2 billion of net income in 2022, meaning that as a group they closed last Thursday’s session at just 3.2X trailing net income.
Obviously, investors and traders are spooked big time not by trailing results, but by what is surely coming down the pike. The combination of faltering asset books and fleeing deposits is just plain deadly, as KBW CEO Tom Michaud said on CNBC today:
Investors are very nervous, and I think what they’re nervous about is the fact that Silicon Valley lost 75% of their deposits in 36 hours. There’s not a bank in the world that could really sustain that….
To be sure, there is no mystery as to why these thundering bank runs are now underway. The Fed caused these banks to be flooded with absurdly cheap deposits, which, in turn, were pumped into higher yielding long-term debt securities (blue area), commercial real estate (red area) and business loans (black area).
The problem, of course, is that the cheap deposits are now fleeing with alacrity, while small bank loan and securities books are increasingly underwater. Sharply rising interest rates and an economy visibly sliding into recession will do that!
Stated differently, these deposits never had a chance of being permanent at 25 basis points or less. Likewise, there was nothing sound about asset books which grew by 10% per annum between 2014 and the present in the three above mentioned categories.
After all, during the same eight year period nominal GDP grew by only 3.2% per annum. Needless to say, true underlying demand for money at honest market rates did not grow at anything close to 3X GDP, meaning that these loans were not underwritte
Article from LewRockwell
