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1) As Fed tightening cycle progresses.. the early part of hikes are good for banks & economy can withstand as NII goes up & Deposit betas remain subdued.. credit is extended w final boom in credit bubble..then as “Bear Flattening” occurred in 2017 & accelerated in 1Q, 2Q & 3Q18..
2) The mega levels of regulated bank credit can’t withstand cumulative effects of 9 rate hikes + $600B of M Base cut (QT) & rejects them as $XLF Deposit betas rise to point NII decelerates sharply...Credit supply slows w lack of demand at peak leverage..
3) $TLT tells the Fed thx fellas u have done enuff by misjudging Leverage.. now GTOH I’m in charge now.. “Bull Flattens” in 4Q18 & in 2019 as growth starts to crater in 2019 in US & globally as $DXY rips higher as a result of previous QT + tightening...
4) Bull Flattening amplified by QT + Fed RRP usage rips higher in 2019 despite slightly lower pace of QT that isn’t fully offset by TGA cash deployment back into $XLF deposits.. This ends in curve inversion despite 1 rate cut & Deposit betas remain sticky - NIM contracts.
5) Possible Outcome:
4Q19 TGA is unleashed with T Bills.. $DXY liquidity gets drained.. Curve inverts further & Banks pull Credit sharply & within context of decelerating consumer/biz confidence..spreads blow out.. as we r in 3Q of profit contraction YoY.. conditions tighten..
4Q19 TGA is unleashed with T Bills.. $DXY liquidity gets drained.. Curve inverts further & Banks pull Credit sharply & within context of decelerating consumer/biz confidence..spreads blow out.. as we r in 3Q of profit contraction YoY.. conditions tighten..
6) Fed then finally panics with a battery of rate cuts w hints or outright QE4.. curve starts to revert back to Bull Flattening amidst Collateral damage.. & Bank NII gets slaughtered as 75% of NII sensitivity is to the front end.. more -Ve pro cyclicality as we end in recession.
7) Additional Post GFC Negative Amplifiers:
a) CCAR Stress Tests have a huge impact on banks tightening credit even further as Fed has to show tougher standards within a recession or close to..in order to be credible...exacerbates the credit cycle at a time jobs r lost.
a) CCAR Stress Tests have a huge impact on banks tightening credit even further as Fed has to show tougher standards within a recession or close to..in order to be credible...exacerbates the credit cycle at a time jobs r lost.
7 b) Fed RRP usage spikes way beyond Foreign CBs as $XLF Banks start to bleed Credit losses & 2a7s/GSEs drain deposits from banks on “credit stress” and invest at Fed RRP...this retires more $DXY out of system.. stresses system even more.. deepens downturn.
4) b)..Basel/DF amplifies Curve Inversions in 2018/Early 2019 as $TLT is purchased en masse (~$300B) to maintain LCR/RLAP $DXY liquidity ratios as QT drains...all this financed with GC Repo which pulls front end > IOER from 3Q18+...bank deposits decelerate sharply with loans.
7) c) Another -Ve Amplifier
CECL Accounting goes live on 1/1/20... Pulls forward a huge amount of Credit Provisions/Reserves for $XLF Banks increase +30-50% YoY in Credit Card book on Day 1 of adoption.. as jobs decelerate & Real losses continue..this slows Credit further..
CECL Accounting goes live on 1/1/20... Pulls forward a huge amount of Credit Provisions/Reserves for $XLF Banks increase +30-50% YoY in Credit Card book on Day 1 of adoption.. as jobs decelerate & Real losses continue..this slows Credit further..
CECL accounting forces $XLF to move from an “incurred loss” framework to a “lifetime loss” framework.. essentially this means in order 4 banks to manage their P&L they Have to reduce consumer loan growth in environment when losses r already elevated as jobs are potentially lost.
