Notes From Underground

While the markets are busy digesting the January FOMC minutes it is a splendid opportunity to muse on recent events.

First, pay attention to the recent letter from hundreds of “prominent economists” on the issue of carbon tax credits. In my opinion, the release of this letter was done to head off the efforts of the Green New Deal and some of its silly recommendations. (The Atlantic has a piece today that tries to take the shrillness out of the headlines.) In any case, the carbon tax proposal is out there and to become a significant part of the narrative during the next presidential election. Here at NOTES, I am going to watch for any discussion on carbon sequestration, which will provide a qualitative, scientific approach to the issue of carbon taxes.

Second, last week Bank Santander was feeling the heat from creditors as it pulled back from an announced call on Contingent Convertible Bonds (otherwise known as COCOS).

As Jim Grant reported, a Santander spokesperson said: “When making call judgements we have an obligation to assess the economics and balance the interests of all investors.” Translation: Owners of COCOS got “screwed” as the bank was able to save some money by reneging on the call and forcing the bondholders to accept a floating-rate instrument at a lower rate than the CALL. In August 2013 when financial institutions were gaga about COCOS to shore up the TIER 1 capital, NOTES FROM UNDERGROUND wrote a piece on August 18, 2013 warning about the shortcomings of these bonds (“COOCOO FOR COCOCS”).

The Santander decision is just a variation on this theme. The European banks haven’t come close to financial health and will continue to struggle under the ECB’s negative interest rates. The discussion about central bank policy is always about the STOCK MARKET but the outcome for the entire financial edifice is far more complicated.

Third, regarding the issue of DEBT, the concerns raised in the previous BLOG POST are leaking into many research pieces. However, with a RISING STOCK MARKET the DEBT NARRATIVE has no traction. In an unusual fashion, the highly regarded LISCIO REPORT (Philippa Dunne and Doug Henwood) raise concerns about the growing deficit. In their breakdown of data, they did a regression analysis of the BUDGET BALANCE ON UNEMPLOYMENT RATE HAS, which has a pretty sound historical relationship (an R2 of 0.54).

The relationship breaks down in 2014 as the unemployment rate began to drop while the deficit continued to grow. “If the old relationships had continued to hold, the federal budget should now be roughly in balance and not over 4% of GDP in the red,” the pair said. This is non-partisan, just based on the data, and it is currently worse than all previous measures.

Finally, the release of the FOMC minutes did not cause much market volatility. The minutes were not released early on Wednesday because of inclement weather in Washington D.C. I would write about the minutes but my efforts would pale compared to the reporting of Alexandra Harris at Bloomberg News. (Sorry, I’m a proud papa.) In her appearance on Bloomberg Radio, Alex made the world laugh when she said about the minutes, we can now “sit Shiva for the Fed’s DUAL MANDATE.” In her reporting, she noted analysts who noted that the Fed provided very little clarity surrounding the central bank’s balance sheet, but it also suggested that the Fed — for all it’s rhetoric that the unwind would be like watching paint dry — the committee was uncomfortable with the idea that a shrinking balance sheet could impact financial markets.

The discussion about the balance sheet unwind is far from over as there are many unresolved issues, but there’s also a greater conversation to be had about the Fed’s mandate beyond unemployment and price stability. Maybe we’ll get more when Fed Chairman Jay Powell sits before Congress next week.

Tags: CoCos, Debt, dual mandate, FOMC minutes, Santander

This entry was posted on February 20, 2019 at 8:37 pm and is filed under Debt Market, Fed. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.