Here Is What The Fed's Advisors Really Think About The US Economy
Five months ago, in May, in a release that stunned markets, the Federal Advisory Council (FAC) which is composed of twelve representatives of the banking industry (including the CEOs of Morgan Stanley, TD Bank, State Street, PNC, BB&T, First Horizon, Commerce Bank and Discover), and which "consults with and advises the Board on all matters within the Board's jurisdiction" said something very disturbing: the truth.
To wit: "There is also concern about the possibility of a breakout of inflation, although current inflation risk is not considered unmanageable, and of an unsustainable bubble in equity and fixed-income markets given current prices."
This took place just as the Fed launched its PR campaign to "taper" or rather see what the market's response would be to concerns that the Fed may be, slowly, pulling out of the monthly monetization business. The outcome as we all know, was not good, and it certainly punctured the equity and fixed-income bubbles, if only for the time being. A few days ago, the same Fed Advisory Counsil met again, and once again shared its views on current banking conditions, the economy and markets, with the FOMC Board.
Contrary to the all "rose-colored glasses" reports by the Fed released in the past year, which constantly talked up the "economic recovery" only to punk everyone - economists and market participants alike - when it stunned markets with its no taper announcement in September, over fears what this would do to the economy, the Federal Advisory Council's view on things is decidedly less "rosy."
This is a the summary of how the various bank CEOs that tell the Fed what it "should" do, see the US economy and financial system currently:
- Loan demand is tepid due to uncertainty around the economic outlook, regulatory burdens, health care and tax reforms, geopolitical risk, and sovereign deficit spending.
- Senior bank leaders at the recent Barclay’s investor conference consistently noted that loan demand is softening and mortgage banking revenue is evaporating faster than expected. This consensus has led some analysts to lower quarterly earnings forecasts for several regional banks.
- Both consumers and businesses have deleveraged over the past few years and remain more selective about new borrowing and capital expansion.
- Loan volumes are dominated by refinance activity. New loan volumes are concentrated in mergers and acquisitions, capital distributions, and share repurchases.
- Excess capacity remains in the banking sector and in the institutional markets. Loan tenor, structure, and pricing continue to drift negatively. With large inflows of funds seeking yield and variable pricing, there is greater structuring weakness in the institutional markets.
- The outlook for the loan markets is uncertain and no near-term changes are expected.
- The financial markets appear to be dominated by decreasing liquidity as some dealers are no longer making a market in certain asset classes. It is clear that dealers are less willing to hold sizable inventories of bonds.
- The financial markets have been adversely impacted by ever-changing regulatory metrics, such as leverage capital requirements, Basel III’s Liquidity Coverage Ratio (“LCR”), and the liquid asset buffer. The response to these ratios may cause downstream implications for other financial institutions and municipalities, with SIFIs less willing to use their balance sheets to provide secured funding (repurchase agreements) or to book municipal deposits.
- While many analysts have argued that a small reduction in monthly asset purchases still represents an extremely accommodative monetary posture, the markets’ recent price movements suggest otherwise. Thus far, even the threat of lower Federal Reserve purchases paired with an increase in selling has had a major negative impact on the bond market.
- Increases in longer-term rates have caused a flip from unrealized gains to unrealized losses in longer-duration investment portfolios, which could ultimately impact consolidation in the industry.
Still think anything is recovering, and that stocks reflect anything more than the unprecedented liquidity tsunami the same ill-advised Fed has created (and which by implication means that said liquidity is likely never going to me removed voluntarily)?
Didn't think so.
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