Notes From Underground: Is The Greenspan Put KAPUT?

I am borrowing this phrase from a Bloomberg Radio interview Thursday in which bond reporter Alexandra Harris (my daughter) used these phrase to discuss the speech today delivered by FOMC Governor Lael Brainard titled, “Safeguarding Financial Resilience Through the Cycle.” Alex noted that the tone of Brainard’s speech was spattered with references to the concept of LEAN or CLEAN. The binary analysis of monetary policy analyzed by BIS Chief Economist William White, led to White criticizing Chair Greenspan in a speech at Jackson Hole in 2003.

The recent flattening of the yield curves in the U.S. has precipitated discussion that the FED is moving too fast in raising rates with the market action predicting an impending recession. The discussion has been centered around recent FED speeches utilizing the White use of countercyclical capital buffers (CCyB) to slow the increase of leverage in the financial by having banks build up capital ratios to insure increasing financial vulnerabilities.

In a previous post I noted how this language had appeared in another Brainard speech. Governor Brainard noted that the recent action by Congress to invoke a fiscal stimulus in times of above-trend growth has few “historical episodes of similar pro-cyclical fiscal stimulus to draw upon as we assess the outlook. But in the few cases where resource utilization has been near the levels we may soon be approaching, there have been heightened risks either of inflation,in earlier decades,or of financial imbalances more recently.”

From this situation, Brainard draws out concern about financial vulnerabilities: “asset valuations and business leverage.” Because of the increase in vulnerabilities the Fed Governor believes this is no time to embark upon policies that could aggravate the present economy in a pro-cyclical manner.

  1. “At this point in the cycle, it is premature to revisit the calibration of core capital and liquidity requirements for the large banking institutions”;
  2. “If cyclical pressures continue to build and financial vulnerabilities broaden, it may become appropriate to ask the largest banking organizations to build a countercyclical buffer (CCyB) of capital to maintain an adequate degree of resilience against stress”; and
  3. Countercyclical capital requirements can lean against rising financial vulnerabilities at a time when the degree of monetary tightening that would be needed to achieve the same goal would be inconsistent with the dual mandate goals of full employment and price stability.”
This third point brings to light the discussion of White’s thesis about leaning into potential financial stress points. It proposes using macroprudential type tools rather than the hammer of continuing to increase fed funds, which could damage the entire economy instead targeting the areas of potential concern (i.e. the irrational exuberant rise in equity prices or the low risk premiums assigned to high yield bonds). This fits very well with recent FED officials’ comments about February’s drop in the stock market (Bill Dudley referred to as “small potatoes”). The POWELL FED seems to be more concerned about financial risks rather than the daily machinations of the stock market. If capital ratios remain high it will act as a brake on the unwarranted rise in financial assets. If the FED is changing course from the Greenspan/Bernanke fear of equity markets and not dealing with financial bubbles then markets are going to have to deviate from long time correlations based on the FED always having the market’s back.
If Brainard’s recent discussion concerning countercyclical buffers over increasing the fed funds rate gains steam, traders are going to have to adjust. The current flattening of the yield curve will reverse if the market senses that the FED is utilizing other tools with a greater time lag to prevent overheating. On Thursday, in reviewing the yield curves of Germany and the U.S. I noticed that in the early months of 2017 the 2/10 curves were both at 125 basis points. The U.S. curve is currently at 47 basis points while the German curve is at 115 basis points. This flies in the face of conventional wisdom as the ECB continues with QE  while the FED hasn’t been buying assets for years (and is in the process of shrinking its balance sheet). The reason for the flattening in the U.S. seems to indicate a fear about the FED curtailing system-based liquidity too aggressively. Except, why  doesn’t the DOLLAR rally? There are more questions than answers abound but this is a discussion we need to sustain. Let’s hope that Powell has rescinded the GREENSPAN PUT.

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4 Responses to “Notes From Underground: Is The Greenspan Put KAPUT?”

  1. kevinwaspi Says:

    Amen on the hope that Powell has suspended the Greenspan put. I may also remind readers, that there is (in our new tax bill) a hidden “counter-cyclical buffer” on corporate leverage. That limit on interest deductions for calculation of income to be taxed will begin to bite hard and fast for those highly levered companies that either used floating rate debt, or were borrowing at the short end of the curve, and will have significant maturities to refinance in 2019 through 2022. Amazing how this stuff has more tentacles reaching through the maze of money than a convention of cephalopods!

    • yraharris Says:

      Professor—good to hear from you and a great insight on the coming implications of the new tax bill for the LIBOR impacted forward earnings

  2. Arthur Says:

    In plain English?

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