AFMC - Temporary Good News On The Banking Front

2023-04-04 03:30:00 ET

Summary

• This banking crisis may be past its peak, but the bad news is that it is surely not over as there is a flight of deposits out of banks and into money market mutual funds that SVB’s failure simply accelerated.
• The differing effect on inflation between giving money to the banks and giving money to the general public is quite stark.
• The total amount of money in the system is shrinking now, as there are no more COVID giveaways – like PPP loans and extended unemployment benefits.

The panic in the banking system seems to be abating as the Fed's balance sheet went down about $28 billion, from $8.7338 trillion to $8.7059 trillion, indicating that less collateral valued at par is being pledged to the Federal Reserve in order to obtain financing. As far as we know, the Federal Reserve never stopped its balance sheet run-off, to the tune of $95 billion per month - that's where they let Treasuries mature and don't reinvest the proceeds, dubbed QT. At the end of March, in the third week after the SVB failure, there was very little need for banks to borrow from the Fed - which is the good news.

This banking crisis may be past its peak, but the bad news is that it is surely not over as there is a flight of deposits out of banks and into money market mutual funds that SVB's failure simply accelerated. MMFs have a respectable yield, while many checking accounts don't. A savings account over the insured limit of $250,000 is better off in short-dated Treasuries backed by the U.S. government than in a smaller bank that has only an implicit backstop from Treasury and the Federal Reserve, as per recent Fed promises.

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

How long this flight will last is hard to say, but it may last at least until there are rapid Fed fund rate cuts that will aggressively bring down the yield on MMFs, which may be a lot sooner than the majority thinks.

I think the Fed is done raising rates. If Powell keeps hiking on top of the unnecessary hike he did in March, he will be compounding his errors. Why hike rates further, as most economists feel the banking crisis creates more tightening than is needed at this point in the cycle, while inflation is trending lower?

Money supply in the U.S. is shrinking (year-over-year) for the third month in a row, which is a historic first, as it had never shrunk before, since M2 data became available in 1959. (See M2 chart, below)

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

Money supply used to shrink regularly, before 1913, before there was a Federal Reserve, when there were huge swings between inflation and deflation; but we have no reliable data on M2 then, as there was no central monetary authority. Since we have had data, though, now is the first time that M2 has shrunk - coming in at -2.4% for February 2023, on top of the declines in December and January.

Deflation was more common before 1940, as this chart shows the Y-o-Y change in CPI since 1801:

Graphs are for illustrative and discussion purposes only. Please read important disclosures at the end of this commentary.

The total amount of money in the system is shrinking now, as there are no more COVID giveaways - like PPP loans and extended unemployment benefits. Covid spending of around $6 trillion is a lot of money to shove into the economy in one year, 2020, while GDP was stagnant, which is what caused the inflation at a time of supply chain bottlenecks. That heavy deficit spending was then monetized by the Fed.

The difference between Bernanke's post-2008 QE and the Powell Covid-era QE is that Bernanke's QE was shoving money into the accounts of financial institutions only. They then had the choice to make loans or buy financial assets, thus loosening up credit conditions. Powell's COVID QE shoved money into the bank accounts of the general public, via monetizing PPP loans and unemployment benefits, which were being aggressively spent at a time of constrained supply chains. The differing effect on inflation between giving money to the banks and giving money to the general public is quite stark. I don't think Powell had a choice in 2020, but the choices he made in 2021 and 2022 could have been much better.

All content above represents the opinion of Ivan Martchev of Navellier & Associates, Inc.

Disclosure: *Navellier may hold securities in one or more investment strategies offered to its clients.

Disclaimer: Please click here for important disclosures located in the "About" section of the Navellier & Associates profile that accompany this article.

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