Date: July 22, 2019
Fed Leaning Toward a Quarter-Point July Rate Cut Led by Powell
“Federal Reserve Chairman Jerome Powell and his colleagues look primed to cut interest rates by a quarter percentage point later this month, eschewing a bigger move in what would be their first reduction in borrowing costs in more than a decade. Faced with slow global economic growth and elevated trade tensions, the policy makers are also likely to leave open the possibility of further cuts down the road as they seek to sustain the record-long U.S. economic expansion. “I’d like to go 25 basis points at the upcoming meeting,” St. Louis Fed President James Bullard, a 2019 voter and one of the central bank’s most dovish policy makers, told reporters Friday. Bullard characterized such a move as a recalibration, rather than kicking off multiple cuts. “I think easing cycle is a little bit strong for this situation,’’ he said, instead citing episodes in the 1990s when the Fed made downward adjustments in the policy rate to take out insurance against external shocks and keep the economy growing. Investors are fully pricing a quarter-point cut at the July 30-31 Federal Open Market Committee meeting. But they scaled back bets for a half-point reduction after the New York Fed took the unusual step of walking back comments made on Thursday by its president, John Williams, that were interpreted as a call for a more aggressive policy move. The action convulsed financial markets in Asia, and President Donald Trump waded into the confusion Friday with tweets that renewed his criticism of the central bank for having raised rates in the past, while saying he agreed with Williams’s first comments “100%.” Expectations for a rate cut had already been clearly signaled by Powell during congressional testimony on July 10 and 11, where he discussed the uncertainties stemming from Trump’s trade policies and slowing global growth. Speculation for a more muscular half-point move grew after Williams spoke at an academic conference about the benefits of acting swiftly when rates are already near zero. His prepared remarks didn’t discuss the current economic outlook but the context — the Fed’s target range for its policy rate is 2.25% to 2.5% — caught people’s attention. The message appeared to be reinforced a short while later by Fed Vice Chairman Richard Clarida. “You don’t need to wait until things get so bad to have a dramatic series of rate cuts,” Clarida, a Trump appointee, told Fox Business Network. “We need to make a decision based on where we think the economy may be heading.”
Brexit May Have Already Triggered U.K. Recession, Niesr Says
“The U.K.’s planned exit from the European Union may have already pushed the U.K. into a technical recession, according to the National Institute of Economic and Social Research. In a gloomy set of new forecasts, Niesr predicted that, even assuming a smooth exit in October, the nation will grow 1% in 2019 and 1% in 2020. There’s an around a one-in-four chance that the economy is already shrinking, the think tank said. The outlook worsens if there is a no-deal Brexit, with Niesr seeing the possibility of a “severe” downturn in the event of a disorderly departure. Even if an “orderly” no deal exit is secured, Niesr says the economy will stagnate next year, with inflation accelerating to 4.1% as the pound drops about 10%. “However we look at it, there will not be much economic joy in a no-deal Brexit,” said Niesr director Jagjit Chadha. The pound fell after the report and traded at $1.2464 as of 10:08 a.m. in London. GDP falls by around 2% following an orderly no-deal Brexit under the Niesr forecasts, but remains flat if there is a policy response. The long-term impact will still be that output is 5% lower “in a permanent way” relative to a soft Brexit or remaining in the U.K., the think tank said. Niesr sees a 30% chance of the economy shrinking in 2020. In an orderly no-deal Brexit, the BOE will cut the key rate to 0.25% by end of 2019, but then it rebounds sharply to 1.75% by end of 2020. The budget deficit rises to 2.7% of GDP in an orderly no deal, breaking the rule that structural borrowing should be below 2% in 2020-21.”
China’s $40 Trillion Banking System Learns a Lesson on Risk
“Two months after China shocked investors with the first government seizure of a bank in two decades, market confidence in the nation’s smaller lenders has yet to fully recover. That may be just what the country needs. When it took control of Baoshang Bank Co. on May 24 and imposed losses on some creditors, China’s government upended the long-held assumption that it would always provide banks with a 100% backstop. The result has been a wholesale repricing of risk for all but the largest Chinese lenders, a development that analysts say was long overdue in a country rife with moral hazard. While the upheaval has underscored the fragility of some smaller banks and adds to short-term headwinds buffeting the economy, it may ultimately put China’s $40 trillion banking system on a more sustainable path by forcing markets to differentiate between weak and strong lenders. “The long-term implications are actually very positive,” said Jason Bedford, a Hong Kong-based analyst at UBS Group AG who was among the first to highlight Baoshang’s troubles in 2017. Before the takeover, funding costs for small- and mid-sized Chinese banks were remarkably similar to those of blue-chip names like Industrial & Commercial Bank of China Ltd., the world’s largest lender by assets. The rationale for a lack of differentiation was simple: When times got tough, authorities would always make sure that even the smallest banks fulfilled their obligations to depositors and other creditors. That assumption kept money flowing to banks — and by extension the Chinese economy — even as critics warned that it was fueling excessive risk-taking and a dangerous buildup of bad loans. Now — even though Baoshang has reportedly made good on almost all its obligations — a government backstop is seen as no sure thing. “The corporate bond market is currently reducing the probability of an implicit government guarantee on all liabilities of small banks,” Kelvin Pang, a credit strategist at Morgan Stanley in Hong Kong, wrote in a report last month. “We continue to believe that government support for banks (including small banks) remains strong, but it’s using a differentiated approach.” The China Banking and Insurance Regulatory Commission didn’t respond to a fax seeking comment. It’s hard to say if this is the outcome authorities anticipated. The Baoshang takeover was complicated by the fact that the bank was part of Xiao Jianhua’s Tomorrow Group, an investment conglomerate that’s under investigation in China. Regulators were at one point arranging for a state-owned firm to buy a stake in Baoshang, before realizing that the lender’s financial situation was more precarious than they thought, people familiar with the matter said in May. A lack of detail in the government’s early communications on the takeover gave some investors the impression that it was hastily arranged. Market participants were also left guessing about the extent of losses facing Baoshang creditors, leading some to dramatically cut their exposure to other smaller lenders. In the interbank funding market — a critical piece of China’s financial plumbing –- some strong banks began rejecting collateral from all but the most creditworthy counterparties. Repurchase volume tumbled by 43% in a week, according to data cited by JPMorgan Chase & Co. Funding stress was also apparent in the market for negotiable certificates of deposit, where the interest-rate gap between lower-rated and AAA banks soared to the highest level since Bloomberg began compiling the data in 2015. Authorities tried to ease concerns about a sudden pullback of government support, highlighting Baoshang’s links with Tomorrow Group and portraying the case as unique. They also pumped cash into the nation’s money markets to bring down borrowing costs, injecting a net 250 billion yuan ($36 billion) in a single day on May 29. Other assistance was targeted at individual banks. To help one mid-sized lender sell bonds in June, a state-owned insurer struck a rare agreement to provide credit protection for the issuance. As for Baoshang, officials appear to have imposed much less draconian haircuts on creditors than first feared. About 99.98% of the bank’s corporate creditors received full principal and interest payments, China’s central bank said in June. All of Baoshang’s individual savers were made whole. Even so, creditors aren’t taking any chances. The yield gap between low- and top-rated NCDs, a key measure of the market’s wariness toward smaller Chinese banks, is still more than four times wider than it was before the Baoshang seizure. “Although the actual loss for creditors is negligible, this is the first time in almost 20 years that a bank default in China almost became reality,” Helen Huang, a fixed-income analyst at HSBC Holdings Plc in Hong Kong, wrote in a July 9 note. “The takeover of Baoshang Bank can be seen a big step towards more credit differentiation.” ”
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