Hello, and welcome to another episode of the Odd Blots podcast. I'm Tracy Alloway and I'm Joe Wisenthal. So, Joe, we are recording this on April nineteenth, and we are firmly in the middle of bank earning season, and so far it seems pretty good.
You always know it's going to be a good one when we have to state the data. That's a sign. It's like, Okay, we're right in the fi stuff is happening. We're talking about news. It's going on right now. This is not some big theoretical thing where we're going to be talking about some ancient economic theory from one hundred years ago. This is right now.
That's right.
So you know, obviously we had the banking crisis in March, and we have seen some signs of distress in the financial system start to fade since then, so things like borrowing from the discount when that has gone down from the peak that we saw at the end of last month. And then of course, if you'd been listening to all lots before then, you would have known that discount lending
was ticking up for months, even before March. But the point is that if you look behind some of these headlines, headlines about bank earnings, headlines about you know, discount borrowing starting to come down, some signs of strain beginning to evaporate. If you actually look into the guts of the financial system, there are still some issues and some maybe suggestions that there are more problems to come, right.
I think that's a really good summary. Early March with the Silicon Valley bank implosion and some other concerns like that was like fears of financial crisis, and it faded pretty quickly, like those acute fears. But then there are the other questions. It's like, okay, well, it's like all right, the banking system maybe is still chugging along, but what does it mean for credit and how much of a mark will it leave on the sort of broader economy
in general. That we had this moment and that all these sort of banks saw what can happen if they get on the wrong side of certain trends totally.
And you know, banks are obviously big players in a lot of different markets, but a big one would have to be bonds, all sorts of different types of bonds, so everything from treasuries to T bills to commercial mortgage backed securities, to residential mortgage backed securities. And so the question is, if there's more regulatory scrutiny on all of these things, if there's more concern about interest rate risk and duration exposure, is the appetite, the bank appetite for
those assets still going to be there. And even though we've seen some of the crisis headlines fade away, we know that use of the fed's reverse repo facility, for instance, the RRP is still pretty high, which means, you know a lot of money is still moving out of banks into money market funds and they're parking that at the FED. So the major disaster headlines may be gone, but there is still this evidence of strains in the background, worries
about a credit crunch, a possible collateral crunch. Of course, those two things are interrelated. So we need to talk about all this. We need to get deep into the guts of the financial system and talk about what's going on. And I'm very pleased to say we have the perfect guest. We are going to be speaking with, Ben Emmons. He is a portfolio manager over at New Edge Wealth, and before that, for a long time he was a portfolio
manager at PIMCO. I believe it sat fairly close to Bill Gross at the time, which must have been an interesting experience, to put it mildly, But someone who can talk to us about, you know, what is going on in this market? What do banks actually mean for bonds? Are we seeing signs of an unfolding credit crunch and collateral issues? So Ben, thank you so much for coming on all thoughts.
Hi Tracia, Hi Joe, it's great to be here. Thank you.
I'm glad we can finally get you on one thing I was wondering, just as I was sort of doing some of the prep for this episode, how do we actually measure credit in the banking system and what do we look at for signs of strains. I'm aware, for instance, that suddenly everyone has woken up to the fed H eight data, which hasn't gotten a lot of attention for a long time.
But what are we looking at here?
Yeah, the HA data, the arcane data. If you think about it, right, it's like, you know, you wouldn't really pay attention to it unless you We're in the nineteen eighties, a trader then and standing at the Xerox fax machine, eagerly seeing the money supply, A numbers coming off and then making assessment. Okay, what the FED is doing this with the FED is doing that, and that's a little bit what we deal with today too. Though you would say that that data now is important because this term
called bank credit that's in there. There's seventeen trillion or a change is currently that accounts for all the loans and securities that the banks have on that books, and that's ultimately how they extend credit or contracted. So if you look at that number and the change and that which happened over the last months or so, it's kind of a few on abilion that changed it. That know, that's what people look at. That's a credit.
Change, right. So every Friday, the FED releases this table called the HIGHT Data Assets and Liabilities of Commercial Banks in the United States. And it's interesting to get this historical perspective because back in the day forty years ago or whatever, the FED didn't give much in the way of communication about its policy. It just had some sort of money supply target and so people would look at
this data to see how it was doing. Now though it's you know, we get all this communication, but it gives us some additional information about the growth and contraction of credit.
Yeah, indeed, And I think even so that you could think of that as you listen to FAT speakers and they pointed this data, they seem to be quite confident that there isn't really anything you know, materially going on. Sure, but everybody paying attention to it means, like, you know, I'm going to try to distract the signal from this because if it does show more material decline and credit in this case, then the FAT would react to this, right, And that's what happened to Marus just.
In terms of measuring credits. So this is volume, But then there are how do you incorporate the surveys of businesses we're having a harder time getting a loan that seems to be getting worse.
Or the loan officers survey where they have been reporting tighter fighting, Yeah.
Or spreads obviously we can look at you know, junk spreads or CNBS spreads, et cetera. So like, is it one of those things where like all of the we're all blind and like touching the side of the elephant and just trying to gather as much different pieces of it as possible.
Yeah, The idea of a dashboard right, you have all these different signals that come at you. Obviously what you're summarizing the at different parts of the credit markets, because if you were to look at spreads and you look at say, junk bonds, you know that's little to do with the bank credits itself, unless there's underwriting from an
investment bank in there. Even so, it's not really what we're looking at here today commercial bank credit, which is really about mortgages, about consumer loans, about credit cards and things like that. But you're right, you have to look at a broader spectrum of measures about what credit is really doing in the economy because it gets extended in different ways.
Right.
So I think if we take the Haight data and also the H four data, just don't mention that too, which is the fast balancy data every week, is the aggregate. The change in that does give us a sense where we are right now. Like we've risen rates a lot, it starts to affect the economy. People know that eventually banks will pull back, and the earnings from banks show this. To the start the provision for loan losses as a
sort of a precautionary measure. But I think what happened in March was a reaction to what ltimate happen where banks can extend credit through and that's deposits, right, and the posits have obviously declined.
Well, this is exactly what I wanted to ask you.
So let's step back for a second and talk about why a credit contraction could materialize. So what are the dynamics that are affecting banks at the moment. You know, I mentioned that if there's additional regulatory scrutiny on interest rate risk, then obviously that could affect appetite for certain types of bonds. But you also have a situation where banks may be nervous about the future, they may be increasing their or hoarding their reserves, and that would also
start to curtail on their lending. So walk us through how this materializes.
Yeah, I was looking at the other day Tracy of thinking of different channels that are currently showing some signs of that credit crunch stress. So one is then that leverage loans, which is you know, or syndicate loans. That has to client quite a bit, and that has to do with that. During the pandemic boom, fair bit of financing took place because of all the hive that bank sitting on a lot of like residual loans on that bound sheet and having a hard time getting rid of
those loans. You know, they have to be discound of low value, and therefore they pull back from that syndicate loan market and pushed it into the private credit market, which although have been lending, are lending at higher rates. Right, So it affects credit that way. Secondly, it's the commercial paper market, which is interesting that was mentioned in the FED minutes too. That's frozen, so to speak, meaning there's very little issuing is going on.
I always get bad flashbacks like two thousand and eight, two thousand and nine when we start talking about commercial paper and that seizing up.
Yeah, and that was happening in the twenty twenty as well, right, and then that's in March of twenty twenty the market community collapsed and I fat actually did something about it. This time it seems to be driven by, yeah, little appetite to issue these commercial paper this moment. As one one on a channel.
Can you talk about, you know, different slices of the credit market or you know, I think one of our longtime guests that we haven't had on a while ago Chris Whitet, you know, talked about these different slices of the credit market essentially each being their own world, each
being their own ecosystem. So when you talk about okay banks no longer being able to sell into the leverage loan market and having to move into the private credit market, I don't know what, like, what is the difference between these markets. Why do they have a different complexion? Why is the cost of funding in the letter higher?
Well, the two things there so one the private credit lenders that's special lending or direct lending. I mean, you know, they use different terms. They don't act like a bank. You have to think of like companies like Apollo or KKR or Blackstone. You know, they lend to mid size to smaller sized companies that cannot go to a bank or find it harder to go to a bank. Is in the lending centers are tighter a the bank than
they are at a private lender. Yet the interest rate that they pay, which is typically spread over the standard overnight funding rate of I'm secured overnight funding rate. Sorry, you know it's wider rights. The private lender will ask for more compensation on taking risks of a company that generates say fifty million ebitash you call that way per year. So on the other end, you have the syndicated low market, which you know is a bigger market, like there's a
bigger company involved. I really think there was what the leverage buyout boom that happened briefly in twenty twenty twenty one contributed to the banks puilding back and now provisioning for it too, as that's what showed up in the
earning data so far. And that's actually the point that you were asking about, Tracy, is that you know, what I really think where the crunch comes from is that if we're getting banks starting to accumulate more and more reserves, lend out less or less incentivized to lend, and then you're getting a really pressure on auto markets other credit markets that have to then no longer having the access to banks because they ultimately to provide the liquidity and
the credit for the system. Right. So I think this is where the real issue is. And people, if you rethink of back of history as you often do on the show, you think of treatment and sports studies about money supply, what they really looked at was like what banks in the thirties did too. They started to really cumulate reserves quite significantly, and that led to this huge contraction of credit and economy. Now we're not there here today yet because it's not like that at that time,
but we have had instances of this, you know. Twenty eighteen nineteen was an example where it turned out as the FAT kept pulling, you know, kept we're reducing its bound sheet. The banks in the meantime, we're worried about the economy and start pulling back and started accumulating reserves. Not every bank has access to the FAT reserves, by
the way, so there's another aspect of that too. So I think if you summarize it the different aspects of the credit markets, the private lending is really different from bank lending, clearly driven by different i think governance and underwriting standards and lending standards. But then the banks themselves are I think in a very precautionary mode currently, and therefore there is that possible risk of this, you know, further pressure on lending in the economy.
So one of the interesting things that we've seen, and again this is sort of in the background, and I haven't seen it discussed that much, but I think risk premiums on things that tend to be dominated by bank buyers, So you know, mostly securitized products like residential mortgage backed securities or commercial mortgage backed securities rmbs and cnbs, which
I mentioned in the intro. Risk premiums on those are higher than a lot of unsecured stuff, And I would guess the assumption is because people are thinking that banks may be less incentivized in the future to buy those types of assets given what we just saw in the additional regulatory scrutiny or caution that we're expecting.
Now, talk to us about.
Those markets and what sort of impact you see there.
Yeah, we rethink about the agency mortgage back secure this market in particular that that's as a class that you know, there's still government guarantee by the way manit so.
You're not worried about credit risk, just the rate risk, just.
The purely the rate risk. And you know, a simple math of mortgages is that if rates go up, the prepayment speed of mortgages goes down, and that actually extends the maturity of a mortgage backed security. But banks by those because they're yielding a bit higher than treasuries. There are liquid there's a big market and the fat is involved. Right then that's been part of the reason. Now as the feed is reducing his balance sheet and pulling away
from that market, the banks are left with buying more. Now, what's happened during this latest episode was that banks discovered that the duration of a deposit is actually a lot shorter than what has been estimated. You know, there's been real estimates out on this that this could be as
long as seven years. That's basically the idea of like the three of us have a bank account that X Y Z bank, we have a deposit in there, we trust that bank, we stay there for longly years, and we don't have a real to pull our money out unless we absolutely have to. Now, what happened and in margins obviously people got really worried to pull their money out really quick. In other words, it's not seven years,
it's probably seven hours, right. So if you think of that, the posit side of the duration much shorter, and you're having a lot of more expect securities on your bounce sheet that can extend the maturity as rates go up, you have this duration mismatch, and that I think is the issue here now for banks. They have to reassess that gap, and that will be regulatory scrutiny, as you say, coming in here, meaning they're going to be reevaluation of
banks risk management in the wake of Silicon Valley. Obviously, I think what then happens is that you could expect that banks will either decide to sell more more expect securities or let them run off like so to speak. That just what the fetid. Either way, more of that supply code quote comes on the secondary market in mortgages,
and it has to be repriced a higher spread. Indeed, nothing to do with the credit risk on the line, it's the government, but much more to do with I think the liquidity risk and the bank duration risk.
Yeah, super reminiscent of the conversation we had late last year about the sort of broken mortgage market and how banks, you know, they didn't really want to hold a lot of mbs as rates were going up last year, and I can imagine this year they're even less incentivized to do.
It on the mortgage front. Specifically, I mean, would their show up in sort of a straightforward higher spread relative to treasuries. I mean, all things equal in terms of like, okay, banks want to reduce their duration risk. They all saw what happened with Silicon Bailey Bank. The regulators come in, would this be expected to feed through in a sort of straightforward way to cost their mortgages.
In some way? It does, right, because it's a market functioning is in Okay, there's a it's a very liquid market, so people will price in this quote quote higher supply that comes naturally own the market, so to speak, because
there's continuous mortgage origination that are packaging these securities. Then you have to think about what happens also with other investors in this space, So the mutual funds and ETFs and foreign investors you know out of foreg mutual funds or foreign central banks even or foreign pension funds, what they do, how they respond. Now the analysis that's out there as an expectation that they're demand will pick up as that spread implicitly widens, you know, there will be
the moneymar money managers that will find it attractive. But I do think that's say, on average, it should become a wider spread. Really because banks in the United States have been the purchaser of these securities. In fact, with all my nose that brought with me here today.
I always love when guests bring data.
Yeah, there's data out actually really specifically by entity with most backed securities. You have, even credit unions, involved, community banks, smaller regional banks. They all rely on these most backed securities in part because their loan book is largely FHA. Now mortgage is not really non residential sorry, not non agency mortgages. It's it starts mostly government backed loans. So
I think there's that change potentially coming. How much it will be of spread mining is obviously a party, a bit of a market functioning ideas in you know, who will really be the buyer here? I can imagine that my former colleagues, as I may listen now, hey, you know you're right, Ben, this is interesting. We can you know,
mortgage are interesting to buy. But that's not going to fill entirely the voice in my sense, given what the Feathers doing too with their portfolio, which is large, large portfolio mortgages.
So would it be fair to say, summing it all up, that you know, Americans are in for higher mortgage rates thanks to a bunch of I guess venture capitalists who caught their money out of Silicon Valley.
Yeah, maybe on average who had their money, who had their portfolio oil companies' money in Silicon Valley Bank in parts, so they personally could get lower mortgages from the bank. I don't you know that seems to be part of the story. So thank you, and now we all have to pay higher mortgages. But into the interest owns the layer on to the ironing.
Yeah, the interest only mortgages that they that they have, right, they originate a low costs and you know, and all part of this idea if yeah, bring all your money in and we'll do more business with you. That's probably going to change to an extent. Now. I do think pointing to announced for Boomberg put out is really good, right, how mapping out where these interest only mortgages were in
California and the East Coast. Fortunately it's all high quality borrowers, right, people that can essentially pay all those loans without a problem. It's not subprime. But nonetheless it's I think that market has changed and that will add to you know, rising costs of credit. I guess can we.
Talk a little bit about what we're seeing in terms of collateral, because of course, you know, collateral, the availability of collateral will affect the availability of credit because it's the thing that's used to secure a bunch of loans. And we have seen some signs of like I don't want to say necessarily problems, but maybe weirdness in that market. So I think I wrote about this in the All
Lots newsletter. But for instance, the one month T bill is yielding like eighty basis points below the effective FED funds rate, for instance, which is something that you wouldn't expect to see unless there was a big scramble for T bills at the moment.
What is going on there?
Yeah, there is I think three things happening. So, as you said earlier, the reverse rebo facility of the Fed is very large, and that has been for a while now, and the main reason is that which are particularly money market funds that are in that facility, they cannot purchase enough T bills out there. So one, it's the Treasury that hasn't issues more T bills right because of the debt ceiling in their account of the fat and that
dynamic talk about it in second. Secondly, I think there has been indeed somewhat of a hoarding of these T bills now if it isn't by those money market funds, by other participants. And then it's about I think the way the foreign investors are involved in our markets, because you know, the latest data I looked up from the FAT TIC data showed actually increase of holdings of T bills by foreign central banks of foreign investors what they
call it, which can be could be others. Right, So if you take that to gether there is a i'd say a limited supply of T bills in the marketplace, then the Treasury is not issuing enough of it, or so to speak. By the way, the FAT owns about three hundred billion of A two, which not insignificant. So I think it gives you together a picture of that. And this is statistics. By the way data and the notes, there's four trillion of T bills outstanding. That's something like
two point two trillion is pledged as collateral. There's data from the FAT. Anything in between the sitting somewhere, someone's holding us and so it could be very different entities. I think this is constrained to supply of D bills. Why that yield is lower the effect.
Would you expect that premium to shrink a bit? I mean, I could see like Okay, if it's early March, and you're probably thinking two things. I don't want to take any duration risk because we just saw a bank get blown out by duration risk. And I don't want to take any credit risk because I just saw a bank collapse. But we you know, as we get as that recedes in the past, we see some of these emergency functions
start to recede again. Would you expect some of that to just sort of ease a little bit as people feel a little bit safe to hold something other than you know, one month government securities or something ultra short.
Yeah, and in some ways playing out as we speak, right, you know, the spread looks like like where we are in two thousand eights, But I don't that's not the same idea, even though people link it to the bank stress, you know, and parallels to the bank stress are like, yeah, okay, oh, seven of eight showld some much similar events that we just went through. But there's a difference. Maybe that one the feed is much more in position to do something
about it very really quickly. That's what we saw that that has definitely the fuse part of the crisis, And do as you say, there are a lot of alternatives now in terms of of T bills right that people want to invest in, you know, given that where rates are and fixed income, so I think that spread will not be so inverted for now for a long time, but that it is a combination of the technicality of T bill markets in terms of its supply and what the treasury is issuing and who's holding it, and the
dynamic of the treasury with that seating and it's accounted the fat against just a general sense of flight the safety that is temporarily and has receded again.
You've been a portfolio manager for a long time, which is one of the reasons we wanted to talk to you about this. But you know, you have experienced various financial crises from a sort of bond perspective.
Talk to us about I.
Guess what you saw in previous collateral crunches. So two thousand and eight Eurozone crisis. I mean, I remember writing about the repo market and the role of your Eurozone government bonds in the Eurozone crisis. Like these were financial crises that were basically caused by collateral problems and a big like crunch in that secured lending market.
Talk to us about that.
Yeah, and that was quite significant in twenty eight and twenty eleven. You know, on the one end, it was about people indeed literally holding safe bonds and by by quote quote holding them and not lending them out to the report market. You're getting this repostquisical other words. You know, so if there's not enough collateral to lend out there and people need that collateral, they have to pay more
higher interests as a results. So come in to their discussion about mortgage the same idea, but the reduction of that supply mortgages because banks don't want to hold it, push it up at the cost of borrowing. Then obviously the derivatives market play is a huge role here because that's experience I had from two thousand and eight. It was not just the Leman moment itself, but it was the recognition that Lemen was such an important play in
the derivatives market. And there's a collateral agreements that back those derivatives. And is that agreement International Security Data got the term is that the swap agreement. There's a collateral agreement and that's a quite quite detailed agreement, and it's important there is that if you are managing derivatives in a mutual fund or ETF. The banks that you have that derivtic agreement with, you agree on exchanging collateral as
margining against the mark the market of the position. And then two thousand and eight what happened was that the banks were not in the position to deliver that clatteral or vice versa, and that led to this huge crunch now on top game Lehman, which was this big counterparty obviously pulling that out of the system, no longer recognizing that who is facing who in the system. Also, people didn't know like where's my coladal? You know, can I
get it back? So from the experience of back then with PIMCO, you know, they did a really good job at that time to negotiate those cloudal agreements so that the banks had no choice that legally to actually return the cloudal unless they absolutely couldn't, because there was a lot of that going on too. It was like if you didn't have a good cloudal agreement, you would be
at significant risk. But all of that contributed to this huge pressure in funding markets and what we call claudal shortage that to extent repeated in the Euro crisis too, in particularly with German government bonds. And then maybe last point on that is that this repo market, the repurchase market, which you then get is that you know, if people cannot or are on link to lend out cloud, you
get a really functional market. Then it's not only that the bond straight what they say special were you're getting a significant squeeze, right, And that's.
I was going to ask, have we seen any like pick up and fails to deliver and things like that in the repo market this time around, Ben's smiling because he has the data right in front of him, excellent.
Grinning, grinning, grinning at you know. So at three four am this morning, I did look out that data the Treasury fails. It had picked up actually in March, you know, there was a little spike there.
So this would be a classic sign something else deliver.
You get buy something and they don't give it to you.
Yeah, it's it's literally death. As you know that there's people that are unable to settle securities or settle rebolt.
Transaction, deliver the bond that you said you would deliver.
Why is that not a default?
Yeah, because the.
Repo market is special in many ways.
And actually if it was, if I mean, Ben can talk about this obviously, but if it was considered a default, I think we would suddenly have a major seizure in credit because part of what happens is like you can kind of online credit that you've been promised, so you get this daisy chain of credit that lubricates the entire market. And if you start breaking the chain by saying this is a default rather than a fail to deliver, then that's a big issue.
Ben is showing me some cool charts that he has on his laptop, so we got to get them and then post them along.
Yeah too, you know, I have a question.
Also going back from the portfolio manager perspective, and we were talking about mortgages and mortgage spreads and maybe what is sort of a worse situation for a bank because they don't want to get a tap on the shoulder from a regulator. Maybe that's an opportunity for an asset
manager like a PIMCO or something else. In general, how much of the opportunity to pick up alpha or extra gains for an asset manager, whether it's the size of Pimco or maybe a smaller one, comes from essentially the constraints that are imposed on other types of potential holders that don't exist for the asset manager.
Yeah, what comes to mind immedia is like that these securities have I liquidity risk and therefore that's priced into the spread right as a risk premium. Because if the banks are somewhat called called natural holders of these mortgages, as they originate the mortgages, they have MORGS backed securities to manage to repayment risk, and so I could imagine that that therefore the spread could add alpha to your portfolio.
The other part of it is more about that It isn't that again liquidity, I guess, but it's the dislocation idea, like you know, how do you generate alpha as you jump on these opportunities where there's some level of dislocation and you expect it to reverse right, and therefore you're
getting price return out of those securities. The other part could be is that as much as the FAT is continuing with its quantitative tidening policy, and I guess the commercial banks have to pull back or because of duration risk, that you're getting this more permanent, higher level of mortgage backed securities yielding higher more permanently. Then it becomes an income opportunity, and I could see for that reason certain
funds allocate to these type of securities. But from my own experience with mortgages is that the challenge of managing them in your own bump portfolio is duration. Because of the repayment movements. You know, they have coveccity. They can sometimes be very positive if rates go up really quick, but then the other way around it, you'd start to decline.
The convectionity on these securities get quite negative, and that could actually adversely strength and shrink your duration of your portfolio versus your index, and then your alpha argument isn't really there because you'll be lagging.
Yeah, you touched on this already briefly, but I think there's probably more to say. How would you expect the FED to react to all of this, because this is also one of the things that is going on at the moment. Seems to be a lot of volatility and almost day to day changes in expectations for future hikes maybe even future cuts. You know, people are trying to figure out what potentially lower credit circulating in the economy
actually means for things like inflation. How would you expect the FED to handle this?
So the One of what they did in March was I think, as expected, you know, your lender of last resort, you should provide this liquidity. So that term loan facility was a new facility, but it wasn't to me a surprise because the FED is the ability now to put those up those facilities in twenty four hours?
Can I take them off a shelf basically pretty much?
So the market knows this right. So it means that if we're getting autocredit stresses that we saw in March twenty twenty, for example, yeah, with a visit corporate bump purchase program, a commercial paper purchase program and so on, that is an alphabet soup of these facilities. So I think that will be the first reaction. The other reaction is is that it is interesting how LA Guard looks at this crisis and saying this is not affecting us, but we're on guard right because it does correlate with
their banking system. You know, if bank stocks go down here significantly, so will they do so will they in Europe? And the ECB would have to react to that. So that's another I think an element of the total reaction function central banks. Lastly, people probably look at this by the two yields as being so volatile, Will there be a raycod will there be a pause? And that sort of idea. It turns out not right. It turns out that this was for the FED not the reason to
shift policy at this point. But it isn't to say that that could be the case. And that's what we've been discussing, right.
Yeah, Well, that's that's what I sort of wanted to follow up on specifically, And again I'm thinking back to how we started the conversation, which is that sort of measures of total bank credit or at one point the sort of central the central data points that bond traders would look forward to see where the FED was and
hitting its goals, et cetera. And one other thing, you know, we talked about this with Matt King and City recently, which is this sort of return of monitorist thinking on some level, to what extent is there a sort of clear relationship between the volume of credit, the so called money supply, and the actual change to price, the price
level that we see in the economy. The idea that money supply and prices were correlated went out of fashion pretty hard, I would say, in the twenty tens, but could it come back and do fashion And I don't know, is there a like how much is the FED or economists at the FED looking at these credit numbers as being early warning signals in one way or another about what inflation will be doing three months or six months down the line.
Yeah, And I think it touched there on like how people behave with money, meaning what happened with these deposits at Silicon Value Bank, for example, and how quickly that went out of Silicon Valley within forty eight hours, like you no, forty fifty billion or whatever was requested. That's I think what they would be looking at that behaviors change.
That money went elsewhere. It went to money market funds, but the part of it is not known where went The data shows only only half of the depositive fly it went to money market fund So to your point, the money supply analysis, And I actually read the transcript from the early eighties because I was looking at when they rates speak and what was the fat focus on. Obviously they were focused on M one and M two.
They knowed by the way back then at M two and then one were really rising a lot, and that was part of the economy growing and doing actually well that this does matter to the fat today too, meaning if they don't see in these eggo good significant contraction at points to a change in the economy going out of the direction. That means that there's money from commercial banks that went to money market funds and elsewhere. It's
just recycled and gets ultimately out in the economy. So I do think that they pay attention to it because there is that link. We came out of a pandemic at a production capacity was hugely shut off right and had to turn it back on, so that equation monitors the equation plays an our role because if you have price level higher reproduction best you could say to be higher, the movement of money will only drive into the economy.
I think so because velocity is funny, is that the toughest that is the measure is probably higher given what's happened with is depositive flights. So I think if I think of a Joe, I think of it that within the fact they're going to try to model OUs. Not only would the New York I put out the other day how sensitive deposits are to change an interest rates.
It was an interesting research piece but also then you know, if people change their mind about holding it the positive the bank and using it in a different way, say money market fund, will that ulto spending behavior and therefore affect the economy.
So the overall dynamic that we're seeing is that deposit flight from banks and rotation into largely money market funds cash like instruments, who are then parking it at the reverse repo facility because they probably don't have enough t
bows to invest in things like that. Is there a point at which the RRP becomes problematic for the economy, Like the Fed created it, I think it was in twenty fourteen or twenty thirteen as a way of better managing interest rate hikes or preparing for interest rate hikes around that time. But is there a point at which like it becomes competition for banks?
Basically yeah, and that may be happening. You know, if you raise rates to a certain level, that attracts money to alternatives to deposits, and the banks have a hard time you know, catching up, as that announcement New York Fed shows, and we're seeing it through earnings by the way, coming through now that banks are adjusting somewhat but not significant enough then a bloated a very large reverse repo facility indicates that the money markets are getting way too
much money in that they cannot deploy in T bills directly and have to go to the Fed's facility to get sort of a quasi T bill. There By they post money to defend and get an interest back on that money, and it's a collaborized transaction. But it's lily they're getting just interest paid on that money like the
T bill. But that becomes a problematic as much as too that the money marks are funds are happy, right they go out there market and you know, we are higher heels and you know, and but at some point this creates this, I guess, this tension in the system, just like in twenty eighteen when the FED discovered, like there's a natural level of bank reserves that we cannot go under or we're getting major attention in the system because if we're getting any major tax payments that are
not coming in or cash withdrawals or any sort of that sort of dynamic causes this friction and then they have to do other things. At that time, they had to actually they bought E bills at that time to try to reverse the situation. This case, you probably see more of these landing facilities being initiated in order to upset the friction of the reverse repubs.
Because this kind of it reminds me of like, you know, you bring in like a cat to catch a mouse, and then you have to bring in, like, I don't know, a dog to catch the cat, and then.
Like it just keeps going.
Right, It's like one lending facility and to fix the tensions or frictions caused by the other lending facility.
Yeah, and they've long said that they wanted to use the permanent repo facility as a way to control all of this, but people have said, like, well you do that, then everything will converge to that facility, because that's the safest points that you in the system that you can go to. Right.
It's almost like they're creating like different tiers of money, right, because the RRP suddenly becomes like a specific type of money that's in competition with like money in bank deposits and that sort of thing, but.
It's considered to be safe. So that's the safest acid you can have, is that reverse repo facility. So it's obviously a really complex issue, not easy to solve. I think for markets, it continues to mean like we're going to phase another episode like this for sure. I mean I think the more that facility grows, as one indicator to our earlier discussion, that's a sign of stress.
So just sort of a big picture, I mean, we have I've not seen credit fall off a cliff yet, Like we're seeing some signs of stress difficulty getting but it's not been fall of a clip. Nonetheless, there's something, but it sounds like from this conversation there's like a few distinct stories. So there was the acute shock at
the beginning of March related to Silicon Valley Bank. But also, as you point out, like twenty twenty one was just sort of an insane year and when everyone sort of got drunk on line go up and then some of that naturally has to be unwound. Then there is the stress of rising rates creating competition for deposits, and so it's particularly at the smaller and regional banks where they may have been doing very well in that interest margin. Suddenly they might have higher funding costs if they want
to keep their deposit base. Each of these seem like slightly different sort of strange putting stress. But like, how would you sort of I don't know if weight is the right word, but like sort of like think about all these things we're talking about and sort of like, I don't know, rank them in terms of top of mind or like what sort of the most salient factor here at this point in terms of what could drive the availability of credit.
Yeah, I do think it's it is the depositive story that was I think the significant change because what it did was that as we're seeing it coming through the earnings, bank become cautious, so they start to build up reserves. I think is really important underlying trend there against you know, the fact that you have an economy that's uncertain, so the opportunities to lend are by definition diminishing. Right, that's natural,
I guess. But I think the fact that the way people responded to what happened at Silicon Valley Bank has woken up markets right and saying, wait a minute, you have actually an ability to withdraw money so fast, so quick through an app, and you know the digital age of our money, as you covered crypto laws. Fact that's actually at this time that much to do with this. But it's in the context, right, a digital payment system could cause more shocks going from here is my sort
of broader take. I would think, yeah, it's good interesting years that we're waking up.
We did a episode again right before SVB with Joe Baldad Barclays, who put out a note recently talking about SVB waking up so called sleepy deposits, which is suddenly people waking up to the fact that it's like I can get higher yield and higher safety in one move, Like what's the catch?
Exactly it?
Yeah, I remember I actually pitched a story idea after It was after our conversation with the New York landlord where he was like, why do I want to be in the business of renting out apartments when I can get six percent on like a money market front or like a bank deposit. And I remember pitching a story going we should do like how higher rates are kind of changing everything.
It's like, what's the catch? Yeah, it's like no credit, no bank run risk, and higher rates Like who wouldn't want?
You know?
But I think a lot of people would wake up to that.
That's exactly what we're seeing, right, It's like the reconfiguration of money because of the higher rates that we haven't seen for many, many many years anyway, and we're gonna leave it there, but so glad we could have you on. That was an amazing discussion.
So thank you so much, Thank you, Tracy, Thanks Joe.
It's wed be great to be.
Yeah, this is really fun. Thank you so much. Ben, Thank you.
So Joe. I thought that was fascinating.
I can see a headline about, you know, venture capitalists pulling money causing higher mortgage rates for millions of Americans, just doing absolute number we could get in lots of traffic. Maybe we won't do that, but there is something there, right, you know, you have seen this deposit flight set in motion, and it seems natural to assume that there is going to be some sort of impact on the banks who may pull back from certain markets.
No, it's really interesting, and there are like so many like different factors, Like getting a handle on what's going on with credit at any given moment is really tough, and I thought Ben sort of explained why. I mean, one is, there's no one credit market. There's bank credit, there's entities like Pimcode, there's private credit entities like Apollo, et cetera. So like, there's no one thing. Spreads are different from volume. You have surveys of private borrowers, you
have surveys of bank lenders. You're trying to get a handle on it, and I you know, it does seem like we're not in like a crisis by any stretch, but it does seem like, you know, money is less freely available than it was maybe several Once.
Again, well, this is the other thing.
I think people naturally they hear the word credit crunch or the term kind of crunch, and they think two thousand and eight, and they think, you know, sharp dramatic pullback in credit availability, And that's not necessarily the way it has to play out. You can have these sort of slow moving crunches that maybe affect certain markets more than others. And I would imagine that's probably what we're going to see.
And you know, again that's what the Fed's going for in some sense, I mean, what is what is interest rate policy but an attempt to make credit more expensive with the goal of stealing the economy for fighting inflation and so like, to the extent that all these things are coming together to put pressure on credit availability. And again it goes back to the mad King conversation and the sort of like prety like straightforward return of like
monitorist thinking. On some level, we're watching the plan.
Yeah, I mean, it's the reconfiguration of money in the financial system based on these new sort of rates that are available in different ways or at different places.
Shall we leave it there, Let's leave it there.
Okay.
This has been another episode of the All Thoughts podcast. I'm Tracy Alloway. You can follow me on Twitter at Tracy Alloway.
And I'm Jill Wisenthal. You can follow me on Twitter at the Stalwart. Follow our guest Ben Emmons on Twitter. He's under the handle at Marco Madness to post a bunch of great charts. Maybe he'll post some of the charts that we talked about today on the show. Follow our producers Carman Rodriguez at Carman Arman and Dashel Bennett
at dashbot. And check out all of the Bloomberg podcasts under the handle at Podcasts, and for more Oddlots content, go to Bloomberg dot com slash Oddlots, where we post transcripts. We have a blog. We have a newsletter that comes out every Friday, and go check out our discord listeners hanging out and chatting about all these topics and more twenty four to seven discord dot gg slash odlots. It's really fun. Thanks for listening,