FOMC Sees Fed Funds Going To 4% by 2018

Yesterday the FOMC provided a statement about the fed funds rate. The decision: No change.

Janet Yellen gave remarks and answered questions regarding the FOMC's decision to hold rates at this lower bound. Yellen fielded several hard questions from the audience, like "Do you think the Fed overstepped it's bounds in the AIG bailout?" and "Are you aware that housing prices and rents are squeezing the average consumer?" Yellen answered the questions head on, except for a question regarding whether or not the IMF had any business making recommendations about the US Federal Reserve. This question and the subsequent answer were lost.

The main takeaway, the clear message that Yellen was trying to relay, was that any decision to move rates would be "data driven", which is to say that the Fed will base its decision on the data and nothing else. It is a marvel how the Fed can say this and then say that rates will most likely go up before the end of the year. The disconnect is that Q1 data was bad, but the FOMC insists it's transitory, so we'll see.

 Perhaps the most interesting part of the presentation was the dot plot below. It's from a survey of FOMC participants on the timing and amount of rate action over the next 2 years and it's the pace or the trajectory that's fascinating, which is to say that by the end of 2017 the plot shows a fed funds rate hovering around 3-4%, which means at least 3.25 - 4.25 for the IOER. Yellen was surprised by the pace as well and alluded to it in her speech. Whatever the case, if rates do rise at this level banks will have field day.

http://www.federalreserve.gov/monetarypolicy/files/fomcprojtabl20150617.pdf

One interesting note is that the effective fed funds rate is creeping up on its own -- hitting .14% yesterday after hovering around .12% since the beginning of the year.investment kit from Regal Assets.

FOMC Statement Countdown, New Regulatory Rules For Lg/Sm Banks, Construction's Up, Employee Retention's Up & Ohio-based Firm Caught In Ponzi Scheme

• Waiting on the FOMC to release a Statement about the fed funds rate hike at 2pm today. In the minutes from the last meeting, the Committee alluded to providing more information in the Statement regarding rate hike timing so this could be a very interesting read. The fed funds rate, which has been hovering around .12% - .13% for the past 6 months, popped up to .14% yesterday confirming that banks are easing on lending even without a rate hike.
• The Federal Reserve Board, FDIC, and OCC finalized revisions to regulatory capital rules adopted in July 2013. The rules apply to bank holding companies with at least $250 billion in total assets and will go into effect on October 1, 2015.  
• The FDIC approved a proposed rule on risk-based assessments for banks with less than $10 billion in total assets. "In particular, the proposal would base assessments on a model estimating the probability of failure using data from the financial crisis and prior years," said FDIC Chairman Martin J. Gruenberg at an FDIC Board Meeting. "These contemplated improvements would allow assessments to better differentiate riskier banks from safer banks, and allocate the costs of maintaining a strong Deposit Insurance Fund accordingly," he said. It is important to note that the rule appears to be "revenue neutral", but it will add a premium to small banks with riskier profiles which will increase the cost of capital.  
• The Department of Commerce released the New Residential Construction report for May 2015. Building permits for private owned subdivisions were up 25% over last year, and 2.6% for single family approvals. Housing starts are up over 5% and housing completions are up over 14%. New Residential Construction data for June will be released on Friday, July 17. 
• The supplemental survey to the June Empire State Manufacturing Survey and Business Leaders Survey was published yesterday and focused on recruitment and retention of workers. ~44% of those surveyed in the service sector and ~34% in the manufacturing sector said that their firms planned on increasing headcount. Only 11% and 13% of manufacturers and service firms reported that they planned on reducing employment. 
• The SEC announced charges against Ohio-based Equity Trust Company which allowed Ephren Taylor and Randy Poulson to push a Ponzi scheme on more than 100 investors. “We allege that Equity Trust failed to protect the interests of its customers when it acted as more than a passive custodian,” said Andrew J. Ceresney, Director of the SEC’s Division of Enforcement.  “When custodians like Equity Trust are aware of red flags suggesting an ongoing fraud, they must take action to try to prevent it.” A public hearing will be scheduled before a law judge.  

Is There An FOMC Data Disconnect & New DFA Stress Tests For Medium Sized Banks

Federal Reserve Governor Lael Brainard Talks About The FOMC Data Disconnect

The Fed Issued A Joint Release On Stress Test Requirements For Medium Sized Banks

  
A summary of noteworthy news and publications from financial regulatory and supervisory agencies on June 2, 2015.

This spring marks the end of the Federal Reserve's calendar-based forward guidance and the return to full data dependency in the setting of the federal funds rate. So it is notable that just as policy making is becoming more anchored in meeting-by-meeting assessments of the data, the data are presenting a mixed picture that lends itself to materially different readings.

These were the words of Federal Reserve Governor Lael Brainard in a speech delivered at the Center for Strategic and International Studies. This is the first speech I've seen coming out of the Fed to acknowledge the disconnect between Federal Reserve Staff Forecast data and the real data that's coming in. Fed staff believes Q1 was transitory, but the data suggests that low growth may be the norm. 

Brainard is clearly not in favor of a rate hike in June, but he hasn't ruled one out for the year and reminds the audience that "the stance of monetary policy will remain highly accommodative even after the federal funds rate moves off the effective lower bound, because the real federal funds rate will initially still be low and because of the elevated size of the Federal Reserve's balance sheet and the associated downward pressure on long-term rates." This is a point most don't appreciate -- the Federal Reserve isn't lowering the real fed funds rate, only the interest rate on excess reserves. The hope is that raising this rate will also increase the fed funds rate, but the actual fed funds rate will start off low. June 17, the date of the next FOMC "statement", should be interesting.

In other regulatory news, the Board of Governors of the Federal Reserve System issued a joint release with the FDIC on the Dodd Frank Wall Street Reform and Consumer Protection Act (DFA). The DFA states that starting in June 2015, banks, federal and state savings associations, and bank holding companies with assets between $10 billion and $50 billion must undergo stress tests "that include the annual public disclosure" of test results. Starting June 2015, medium sized banks will be required to "publicly disclose DFA stress test results on an annual basis." The press release stated that the test requirements are significantly less than they are for large banks so this should have little impact on stock prices.

FOMCs $80b Term Offering, Mortgage Contract Design, Atl's Gray Financial Grp, & The Euro-bond Sell Off Opportunity

The FOMC conducted an $80 billion floating-rate offering on a 14-day term for IOER+.01%

The Fed published the opening remarks at a mortgage contract design conference

The SEC announced charges against Atlanta-based Gray Financial Group

An OFR paper suggests Europe is a hot investment due to QE

• On May 21, 2015, the FOMC conducted a floating-rate offering of 14-day term deposits with a rate equal to the interest rate paid on excess reserves (IOER) plus 1 bps (IOER +.01%). The offering awarded $80 billion and had 53 participants. The "award" will settle on May 21, and mature on June 4. This is why the fed funds rate dropped a bps point, from .13% to .12% on May 19, one day after the Fed announced the offering, which suggests that while increasing the IOER acts like a magnate to pull interest rates up, term deposits at a rate of IOER + .01% can have the opposite effect. Expect to see this policy tool used frequently in the coming years as the Fed looks for ways to control rates.
• The Federal Reserve published the opening remarks at the Mortgage Contract Design: Implications for Households, Monetary Policy, and Financial Stability Conference. The remarks were given by James McAndrews, Executive Vice President and Director of Research at the Federal Reserve Bank of New York. The conference is sponsored along with the NYU Stern Center for Real Estate Finance Research. I won't go into the details of this report as I will be providing a full write up due to its significance, but I can say that the speech provides a great deal of insight into the true nature of what drives interest rate design in the mortgage debt market, and therefore the securities that back it. This is a must read. 
• The SEC announced charges against an Atlanta-based Gray Financial Group, its founder and president Laurence O. Gray, and co-CEO Robert C. Hubbard IV for "selling unsuitable investments to pension funds for the city’s police and firefighters, transit workers, and other employees." To be clear, these are stewards of public pension funds. Evidently, "Georgia law allows most public pension funds in the state to purchase alternative investment funds," the announcements states, "but the investments are subject to certain restrictions that Gray Financial Group’s fund allegedly failed to meet."  The order accuses the group of collecting over $1.7M from investors. Not only did the Group breach their fiduciary duty to the investor, but they profited from the breach of service. Expect heavy penalties if convicted.
• The OFR published an interesting paper suggesting that Europe is a good place to put you monetary over the next QE season. "Over the last month, long-term euro area bonds experienced a sharp sell-off, leading to outsized moves in other major global bonds, including U.S. Treasuries," the write up states, adding that the, "sell-off reflects a partial unwinding of the euro area “QE trade,” in which investors established sizable positions in euro area bonds, equities, and the euro in response to the European Central Bank’s expanded asset-purchase program." In other words, asset prices went up in the US largely due to QE over the last 5 years, and now that Europe is about to embark on the same journey, the same will happen to euro area bonds and equities, most especially the euro itself. I see this unwinding as opportunity. Expect a new portfolio coming out focusing on euro area equities.

BHP Billiton, Data Jobs Pay $41.04/hr, New Reporting Rules, FOMC Minutes, Real GDP & Arjent LLC

Why Are Interest Rates So Low? 

SEC charges BHP Billiton  

Fed announces more charges against banks

Data jobs pay more? How much?

SEC votes for stronger reporting rules 

The FOMC released minutes from the last meeting

Real GDP increased .2%  

SEC charges Arjent LLC

• A working paper published by the Federal Reserve titled Why Are Interest Rates So Low?  analyzes the former Chairman of the Federal Reserve System, Ben Bernanke's, three part post about why interest rates are so low.  The paper suggests that Bernanke believes rates are low due to a reduction in the natural rate of interest, saying that "Monetary policy has largely accommodated the decline in the natural rate of interest, in order to mitigate the adverse effects of the crisis, but the zero lower bound on interest rates has imposed a constraint on the ability of interest rate policy to stabilize the economy." The operative phrase is "the zero lower bound on interest rates has imposed a constraint." It implies that the Fed may be inclined to raise rates more so out of a need to be able to impose monetary policy than a real need to tighten economic policy.

• The SEC charged BHP Billiton with violating the Foreign Corrupt Practices Act (FCPA) as it sponsored the "attendance of foreign government officials at the Summer Olympics." The company has agreed to pay $25 million in penalties to settle the charges. The charges allege that BHP Billiton did not maintain sufficient controls over the program after the company invited over 150 government officials to attend the Games at BHP's expense. “BHP Billiton footed the bill for foreign government officials to attend the Olympics while they were in a position to help the company with its business or regulatory endeavors,” said Andrew Ceresney, Director of the SEC’s Division of Enforcement.

• The Fed announced that it will impose $342 million each for UBS AG, Barclays Bank PLC, Citigroup Inc., and JPMorgan Chase & Co.; $274 million for Royal Bank of Scotland PLC (RBS); and $205 million for Bank of America Corporation. The Fed also issued cease and desist orders over activities in wholesale FX. Five banks were charged with failing to detect illegal agreements between traders. Bank of America was charged with failing to detect traders that merely discussed the possibility of entering illegal agreements. The Federal Reserve also found UBS, Citigroup, JPMorgan Chase, and Barclays conducted unsafe FX sales. Action is being taken against UBS, Barclays, Citigroup, JPMorgan Chase, and RBS alongside charges from the Department of Justice (DOJ) regarding the FX markets, however, Bank of America was not part of the actions taken by the DOJ. Other actions from entities such as the Connecticut Department of Banking and the New York Department of Financial Services are taking separate actions.

• According to the Department of Commerce's Economics & Statistics Administration data jobs are growing at a faster clip than non-data jobs. "The unemployment rate for data jobs was just 3.1 percent in 2014, or half the national average," said the official announcement. Data jobs are defined as occupations where data analysis is central to the work performed. 

  

  Source: Department of Commerce's Economics & Statistics Administration

  The average pay in the private sector for data jobs was $41.04 an hour.  During the Great Recession the unemployment rate related to data jobs was 4.9 percent compared to 9.6 percent for the national average. 

• SEC voted for stronger reporting rules for investment companies and investment advisers. “These recommendations will vastly improve the type and format of the information that funds provide to the Commission and to investors,” said SEC Chair Mary Jo White.  The new reporting requires a new monthly portfolio reporting form, Form N-PORT. The form will ask for the following information as listed in the press release:

• Data related to the pricing of portfolio securities.
• Information regarding repurchase agreements, securities lending activities, and counterparty exposures.
• Terms of derivatives contracts.
• Discrete portfolio level and position level risk measures to better understand fund exposure to changes in market conditions.

The proposed rules also call for a new annual reporting form, Form N-CEN, which requires "registered funds to annually report certain census-type information to the Commission and would replace the form currently used to report fund census information (Form N-SAR)."  Additionally, funds must report data in a structured data format, and provide more information about fund financial statements, particularly relating to the fund’s securities lending activities. The new rules also allow mutual funds and other registered investment companies to provide shareholder reports on their website instead of printing and mailing. The comment period for the rules will be open for 60 days.

Source: BEA

• The Federal Reserve Board and the FOMC released the minutes of the meeting held on April 28-29. I'll discuss my views on the minutes in an upcoming post. 

• Real GDP increased .2% in the fist quarter compared to 2.2% in the fourth quarter of 2014. The drop was blamed on weather, strength in the dollar, West coast labor disputes, and lower energy prices. Lower energy prices may have dampened the energy economy but it also helped consumer spending, as can be seen in the chart to the right, as well as investments in inventory. However, exports, nonresidential fixed investment, and imports are down considerably.  

• The SEC alleges that Arjent LLC and its UK-based affiliate Arjent Limited misrepresented themselves to investors on the value of the firm's assets and how investor money would be used. The CEO allegedly transferred the first $2.3 million raised in an offering directly to his own bank account and used it for his personal benefit.“We allege that DePalo and Gladtke sold overvalued interests in Pangaea and then raided investor funds for their own personal benefit,” said Andrew M. Calamari, Director of the SEC’s New York Regional Office. The New York County District Attorney’s Office also announced criminal charges against Robert P. DePalo and Joshua B. Gladtke. Gregg A. Lerman was also named in the charges. 

1 Arrest, 1 Charge, Consumer Credit Up & FOMC Annual Report Out

Jeffrey Ray Filla was arrested
SEC charged LA based Pacific West Capital Group, Inc. and its owner Andrew B Calhoun IV
Consumer credit increased 
Annual report for the Federal Open Market Committee Published 
Update on Economic Indicators

• Jeffrey Ray Filla was arrested on April 6 in Fort Bend County, Texas on securities fraud in the sale of investments in Prophecy Fund LP, a commodities trading program in which he primarily found investors from his church. Filla is also accused of trying to hide the state of the fund by concealing losses with false financial statements. According to the filing Filla invested a large amount of the proceeds in Auto Direct LLC, an automobile sales lot; Filla was the sole managing member of Auto Direct. 
• On April 8 the SEC charged LA based Pacific West Capital Group, Inc. and its owner Andrew B Calhoun IV with fraud in the sale of "life settlement" investments. A life settlement, as odd as it may sound, is when an investor invests in an insurance policy in exchange for a share of the death benefit on the policy holder. Specifically, the SEC alleges that Calhoun IV, a Beverly Hills, California, life insurance agent, raised ~$100 million from life settlement investors and defrauded investors by paying them with the proceeds of new life settlement investors -- classic Ponzi scheme. Also named as defendants are Ohio-based PWCG Trust, and five sales agents of Pacific West, Brenda C. Barry of Issaquah, Washington, and her company BAK West, Inc., Andrew B Calhoun Jr. of Anderson, South Carolina, Eric C. Cannon of Lakewood, California, and his company Century Point, LLC, and Michael W. Dotta and Caleb A. Moody, both of LA.
• In February, according to the FRB, consumer credit increased at a seasonally adjusted annual rate of 5-1/2 percent. "Revolving credit decreased at an annual rate of 5 percent, while non-revolving credit increased at an annual rate of 9-1/2 percent." In a nutshell, these means consumers are taking on more debt which bodes well for consumer confidence, but not for inflation.

FRB Consumer Credit - G.19

• The annual report for the Federal Open Market Committee was published yesterday by the Markets Group of the Federal Reserve Bank of New York. The report covers operations during 2014 as well as many of the latest developments around the Fed's operations. It also has some great charts like the one below and is a must read for all those curious about the Fed's role in monetary role and the mechanics of operations vs policy. I'll be publishing my thoughts on the report within the week.  

Update on Economic Indicators

Crude Inventories is coming out in about 15 min. and FOMC Minutes for the day should arrive around 2pm. It's a given the Fed is going to raise rates by the end of the year - I suspect earlier rather than later. What's not clear is what they plan on doing about inflation or if Committee members are uniformly concerned. On deck tomorrow: initial claims, continuing claims, wholesale inventories, and natural gas inventories.

Oil Prices & The FOMC

New Monetary Policy

These are unprecedented times for monetary policy and it's compounded by abnormally low energy rates. Even if labor indicators improve and inflation remains at the 2% target, oil prices are a wild card. The FOMC may not feel comfortable raising rates until they believe:

1. Energy rates are back to "normal" with no impact on inflation.
2. Energy rates will remain low and there's no worry of an impending or surprise increase.

Both options require more than six months to establish a track record.

What Do FOMC Meeting Notes Tell Us

To get a better understanding for how the FOMC feels about the probability of a hike we can data mine the minutes from the last FOMC meeting. The dominant argument is to keep rates low; examples provided below:

• Raising rates too soon could "damp the apparent solid recovery in real activity and labor market conditions, undermining progress toward the Committee's objectives of maximum employment and 2 percent inflation."
• Raising rates too soon "would increase the likelihood that the Committee might be forced by adverse economic outcomes to return the federal funds rate to its effective lower bound." Committee members noted the "challenges associated with the prospect of commencing policy tightening at a time when inflation could be running well below 2 percent..."
• Raising rates too soon could lead to reputation and effectiveness issues, "..the public could come to question the credibility of the Committee's 2 percent goal."
• One person on the committee recommended "in light of the outlook for inflation, the Committee consider ways to use its tools to provide more, not less, accommodation."

Indeed, Committee members appear just as concerned about their reputation and ability to control the fed funds rate -- for more on this read the article: Can The Fed Control The Fed Funds Rate In Times Of Excess Liquidity?  -- as they are about the effect of the rate hike on the economy. Committee members are also concerned about inflation and acknowledge that it's currently being held down by large increases in energy prices. Here's an excerpt from the minutes:

Consumer price inflation moved further below the FOMC's longer-run objective of 2 percent, held down by continuing large decreases in energy prices.

It goes on to say:

The staff's outlook for economic activity over the first half of 2015 was revised up since December, in part reflecting an anticipated boost to consumer spending from declines in energy prices.

Clearly, the FOMC believes lower energy prices have contributed to lower inflation and a better economy by boosting household purchasing power, which means they believe it can also have the reverse effect if prices rebound. This volatility translates into uncertainty and it's just one of the many risks FOMC members are finding hard to digest. "Many participants," the notes said,

indicated that their assessment of the balance of risks associated with the timing of the beginning of policy normalization had inclined them toward keeping the federal funds rate at its effective lower bound for a longer time.

GAFI's Fed Funds Prediction  - 1 Yr At Least

The FOMC wants to give the appearance of being data driven and prudent so look for very specific data points like improvements in labor compensation to drive a rate increase "language", but we predict it will be at least another year before the fed actually raises rates. Not only is the FOMC worried about being able to control the fed funds rate, but the volatility in energy prices is causing FOMC participants to shy away from raising rates until they can feel reasonably sure that energy prices have stabilized. If the FOMC raises rates and inflation grows past 2% due to a rise in energy prices the decision to raise rates may be criticized which is exactly what the FOMC is afraid of.