The days ahead:

  • News may be slow as bond and stock markets will be closed Friday when the job numbers arrive

This week:

  • Money on the move: how the Fed works with banks
  • Deregulation was a big enabler for Silicon Valley Bank
  • Bank deposits are shrinking
  • C&I loans haven’t dropped yet, but they will
  • U.S. port traffic is way down but should help inflation
  • Sunflower oil and seeds a year on from Ukraine invasion
  • Why bank deposit rates are so low and likely to stay that way
  • No progress on debt ceiling and there won’t be any until late April

Program note:

  • No blog next week. But if anything breaks, we’ll let you know. 

Where Does the Money Go? Errata

Last week we discussed the moving parts of the Fed’s new liquidity tools. First, we mentioned that if a bank is in trouble with depositors leaving, the Fed stands ready to provide liquidity through three programs: the discount window, the new Bank Term Funding Program (BTFP) and the FDIC. The first two are quick ways to turn assets, loans and securities into cash. Any bank can use them. A depositor says, “I would like my money back” and the bank then checks the cash drawer, notices there isn’t enough ready cash in there and says “Hang on a mo.”

The bank then calls the Fed and says “I have these bonds, and if I give them to you, will you give me the full face value in cash?”

The Fed asks “Are you a member of the Federal Reserve System?” and the bank says, “Yes” and the Fed then provides $100 in loans for every $100 in bonds owned by the bank. No haircuts. No discount. Everyone happy.

The third way to get money is from the FDIC. As with the new more lenient rules for the discount window and the BTFP, the FDIC offers a freshened-up facility to deal with the aftermath of Silicon Valley Bank (SVB).

The way this works is that the FDIC heads into a troubled bank and says “Look at me, I’m the Captain now.” Everyone stops what they are doing. The FDIC invites the C-Suite to clear their desks and they starts the process of liquidation and protection.

One of the first things it does is form a new bank separate from the troubled bank. In the case of SVB, the new bank is the Silicon Valley Bridge Bank. In the case of Signature Bank, the new bank is the Signature Bridge Bank. All customers end up in the new bridge banks and, in order to meet withdrawal requests, the FDIC lends money to the “bridge” banks. It loaned about $110 billion to the new Signature Bridge Bank and about $72 billion to the new SVB Bridge bank.

It doesn’t mean the FDIC has lost this money or that depositors are getting bailed out. The FDIC can extend a loan to a troubled bank without it applying for actual deposit insurance. The FDIC knows the bank has mortgages, loans and securities and so is quite happy to extend it loans. It will get it all back as the bank settles down or is bought.

The net cost to the FDIC of the SVB failure will probably be around $20 billion and will be recouped by a special assessment on banks. The cost to the FDIC for the Signature Bank failure will be around $2.5 billion.

The FDIC lends against bank collateral, just like the discount window and BTFP. The loan ends up in the bank’s deposit accounts and, because they’re part of the Fed system, it shows up on the Fed’s overall balance sheet.

Anyway, the chart we showed last week was the increase in the discount window only but what we meant to show was that the Fed’s balance sheet spiked up by $390 billion over two weeks. Here:

Source: FactSet 3/27/2023

We also wanted to show that the increase came from this:

Source: FactSet 3/27/2023

That $354 billion is the sum of the discount window borrowing, at $110 billion, the BTFP at $54 billion, FDIC loans at $180 billion and some small Covid-19 era payments.  

Sorry about that. But the conclusion is the same. The Fed engineered three sources of liquidity for banks facing deposit flight. All three worked seamlessly. There are no queues or moratoriums to withdraw money. The FDIC may only pay $22.5 billion in insurance claims, even though the combined assets of the banks were well over $277 billion. Finally, the $22.5 billion of claims will be recovered by a special assessment on banks. Taxpayers won’t pay any of the losses.

Finally, we’d note that the Fed and FDIC moved pretty darn quickly in all this. Tax payer losses are, and likely to remain, zero and depositors of all kinds got the money they wanted when they wanted. There will be some finger-pointing at regulatory supervisors and people asking “Who missed what and why?” The San Francisco Fed is likely to have a few uncomfortable moments responding. We’ll know when they report on May 1.

But our guess is that SVB was sticking to the less stringent regulatory requirements originally designed for banks under $50 billion in assets but which were extended to banks under $250 billion in 2018. It allowed SVB to operate under the same regulations as a community bank even though it was the 16th largest bank in the country.

The original Restoring American Financial Stability Act of 2010, said:

In order to prevent or mitigate risks to the financial stability of the United States that could arise from the material financial distress or failure of large, interconnected financial institutions, there [will be] the establishment and refinement of prudential standards and reporting and disclosure requirements applicable to financial companies supervised by the Board of Governors [The Fed] and large, interconnected bank holding companies”


Any standards recommended under subsections [above part] shall not apply to any bank holding company with total consolidated assets of less than $50,000,000,000.”

Fast forward to 2018 and the Economic Growth, Regulatory Relief, and Consumer Protection Act, swept this away with the simple language that the previous act would be amended

by striking“$50,000,000,000” and inserting “$250,000,000,000””

Super. This was all to “provide tailored regulatory relief” and it certainly did that. It was tailored to some of the worlds largest banks and allowed them to have the same, less stringent liquidity ratios, capital requirements, stress tests and supervision as a $25 billion bank.

I dunno, that looks like applying the road rules for a bike path to an airport. Fine, it may work for a while, and it can feel great to be rid of all those pesky regulations. But something will break. And it did.  

I think we’re going to find that SVB followed the rules for a $50 billion bank but found that they don’t work if you’re a $217 billion bank. And then we’ll have to learn the regulatory lessons all over again.

How Are the Banks Doing?

We also mentioned last week that money was moving from banks that don’t traffic in Fed reserves to large banks that do. Again, this is just a swap from banks outside the Federal Reserve System to ones inside and so aggregate liquidity remains unchanged. You may have read that all the new cash is pushing more money into the system and is inflationary. But this is not so. The total amount of money is the same.

We would note two things, however.

One, it doesn’t take a financial type to guess that if you’re worried about your bank, you should head over to one of the big banks. This shows up in the changes in bank deposits. We thought last week that the outflow from small banks may accelerate, and so it was. The chart below shows the drop (green line) in small bank deposits, which are probably heading to large banks, and in large banks deposits (blue line), which are probably headed to Treasury Money Market Funds.

Source: FactSet 3/27/2023

Two, the second piece of the puzzle is to find out what banks are doing with the money, especially with their commercial and industrial (C&I) loans to small and mid-sized businesses. We care a lot about these loans because 49%  of the U.S. workforce is employed by companies with 500 employees or less. Small banks account for 53% of all C&I loans, 80% of commercial real estate (CRE) loans and 30% of all real estate loans. If this source of credit dries up, large chunks of the economy are going to hurt.

We only have data up to March 15th2023, which is after the SVB failure but before the Credit Suisse problem. But there’s already a change.

Here are the recent changes in C&I loans:

Source: FactSet 3/27/2023

In the last few months, the level of C&I loans went up $10 billion in the large banks and $9 billion in the small banks. We’d stress that this is March 15th 2023 data. We’re always two weeks late with bank asset and liability data but only two days late on the Fed balance sheet. We always have quick access to Fed data, which is great because when bank problems arise, we want to know the Fed is lending, providing liquidity and doing all it can to keep the money markets functioning.

Here’s recent bank lending data for large and small banks for C&I and CRE loans:

Source: Federal Reserve

Although we show the growth in loans since December, half of the growth of $65 billion was from March 8th to March 15th. So, what’s going on? Looks like banks are lending and all is fine. No credit crunch to see. Move on.

Sadly, no. If businesses fear credit conditions will tighten, they draw down any unused lines of credit. Better to have the cash and not need it than run the risk of the lines being withdrawn. As the chart shows, this happened in 2007 and 2020 when loans increased by 15% and 30% in just a few months. These types of drawdowns don’t cause recessions or bank problems but usually mean a tightening of credit conditions with, for example, more restrictive loans or higher interest margins for the banks.

It’s likely we’ll see more loan drawdowns in coming weeks but we’d see it more as a sign of caution than optimism. It wouldn’t take much to push the Fed’s forecast of 0.4% growth this year into flat demand and mild recession. We’ll know soon enough.

U.S. Container Ships

In 2021, there were all sorts of problems with container ships in U.S. and particularly West Coast ports. It was the beginning of the post-Covid-19 recovery and the U.S. was buying lots of imported goods, while stretching supply chains thin. All those Amazon two-day delivery orders meant warehouses were almost being built by the zip code. Many of them restock daily. Home Depot, for example, built 150 warehouses in three years and started to use drop trailers, which means drivers didn’t have to wait around for things to be unloaded. So in 2021 and into 2022, companies restocked inventories as fast as they could and bottlenecks started to appear at ports, rail heads, trucking stops and air cargo locations.

Now things have changed.

Source: FactSet 3/28/2023

At the height of the post-Covid-19 supply chain problems there were 420,000 containers coming into the Port of Long Beach and Los Angeles and 110,000 leaving. Up to 30% of those were empty because much of what the U.S. exports, such as food, oil, capital goods or aircraft, do not fit into a container.

We still have about the same number of outgoing containers, at 110,000 per month (green line), but the number of incoming containers (the blue line above) has fallen 40% in less than six months. We’ve used the Los Angeles/Long Beach ports data but it’s the same elsewhere. Oakland handled 200,000 Twenty Foot Equivalents or TEUs, in October. In February it was 153,000. It’s the same at Charleston (down 21%), Seattle (down 20%), Savannah (down 29%), Houston (down 12%), Virginia (down 20%) and New York (down 39%). Sure, some of that is seasonal with October traffic carrying holiday inventory, but the swings aren’t usually that wide

Is it a bad sign? Probably not. Businesses are still trying to reduce excess inventories because of the change from spending on goods to spending on services, as well as a general growth slowdown. We’d read it as a healthy rebalancing of supply chains and good news for lower goods inflation in coming months.

Sunflower Oil

When Russia invaded Ukraine in February 2022, sunflower oil prices shot up. They’re now back to pre-invasion levels.

Source: FactSet 3/29/2023

That’s a big turnaround given that Ukraine produced 27% of the world’s sunflower oils in 2021 but 50% of the world’s exports.

Sunflowers are one of the toughest crops around. They’re planted around May and harvested around October. They’ll grow in drought conditions or in waterlogged soil. The oil is easy to produce and requires minimal heating. It’s used for cooking, butter, many snack foods, cosmetics, or, mixed with diesel, as cold-weather starter fuel. In the U.S. some 25% of sunflower seeds ends up in bird feeders.

Ukraine grows sunflowers in the east and south east of the country. Unfortunately, most of the fighting is also in the east and southeast. Total growing acreage for sunflowers dropped 26% and Ukrainian exports dropped 40% in the 2022 to 2023 season. Only 15 of the 100 sunflower oil processing plants were undamaged so 40% of exports in 2022 were seed, not oil. In past years, 100% of exports were in oil form, which, of course, carries a higher price.

The Black Sea Grain Initiative was launched last summer to unblock exports from Russia and Ukraine through the Black Sea and out to the Mediterranean. Russia has suspended it a few times but is now mostly complying. It was extended for another 120 days when it expired on March 18th 2023. This greatly helps Ukraine because getting sunflower oil out of the country by barge or truck is both expensive and capacity constrained.

Ukraine is keeping the value of its grain and sunflower exports close to its chest. That’s not surprising given the economic risks at stake. But we do know this. About 900 ships and 23 million tonnes of grain and food have come through the Black Sea since last June and 11% of that is sunflower products. If we assume Russia accounts for half of that (they grow it too), then Ukraine is exporting around 2.5 million tonnes compared to 5.8 million tonnes pre-war. That comes out at a value of around $2.9 billion, which is about 60% less than 2021.

So, does this have a big economic impact? Well, supplies are up compared to last summer and Ukraine is getting what remains of its production out of the county. We won’t know for a few months if more supply will come online, after all, it takes less than six months to grow the stuff and it’s easy to grow. But we’d doubt it, given current prices.

The U.S. Department of Agriculture (USDA) expects Ukraine to provide 21% of global production in 2023, unchanged from 2022 but down from 27% in 2021. It also expects Ukraine to provide 34% of exports, which is a great improvement from mid-2022 when exports fell 80%.

So, yes it does have some economic impact. I mean, it’s not about to move the Treasury or stock market, I’ll give you that. But the good news is that prices have fallen which helps inflation, especially in emerging countries in the Middle East and through to Pakistan. But it also helps inflation in the U.S. and EU given that many food oils are substitutes. Ukraine’s production is up from the 2022 lows but its infrastructure remains badly damaged. Lower prices mean we’ve moved from the crisis it looked like just six months ago and food prices are easing everywhere. Yes, it’s a good thing.  

Why Are Bank Deposit Rates So Low?

Because banks can’t afford to raise them.

For many years after the GFC, the federal funds rate, and all short term rates bounced around the zero line. The 6-month Treasury Bill fell to 0.4% in 2008, to 0.2% in 2013 and only recently hit 5% for the first time since 2006. Banks could compete on mortgages, credit cards, services, cross-selling (Wells Fargo take a bow), and ATM fees but they couldn’t, and didn’t need to, compete on rates. If you had a checking, savings, personal or corporate account or used Certificates of Deposit (CDs), you were highly unlikely to see a yield north of 0.5% for the last 15 years.

That has changed.

Source: FactSet 3/29/2023

The top two lines show the 6-Month and 1-Year Treasury bills, yielding 4.8% and 4.3%. The bottom two are the average 6-Month and 1-Year bank CD rates, trailing Treasuries by over 2%.

Those bank CDs are for all banks but here are the rates for some large, regional and online banks:

Source: Goldman Sachs 3/29/2023

The bank rates can’t match Treasury rates and you can only get close by investing in an Online bank and locking up your money in a CD.

Money market mutual funds are also back in the game. They yield around 4.1% to 4.4%, depending on whether it’s a Treasury or Treasury Obligations Fund (the latter will use repurchase agreements via the Fed repo window.) Tax-Exempt money market funds are also newly attractive. They yield around 3.3% to 3.8% which, depending on your tax bracket and state is equivalent to 5.8% to 6.0%…just don’t use them in your IRA.

Will banks increase their deposit rates? Not any time soon. Apart from all the problems we describe above, banks rely on inertia. For many people it’s not worth the hassle to move a cash balance to pick up extra yield, especially if you have all your checking accounts, deposits, and bill-pays in one place.

Many banks lived off a very simple business model for years. They took in deposits, paid 0% and went out and bought Treasuries and mortgages which yielded about 2.5% at the time. They didn’t even have to find anyone to lend to and go though all the bother of credit checks, loan covenants and chasing repayments.

Some banks made the mistake of buying very long Treasuries and mortgages. According to SVB’s last SEC 10-k filing it was holding $117 billion in securities of which $93 billion was in bonds maturing in over 10 years. Some 40% of its balance sheet was in securities, 34% in loans and 6% in cash. So, on the one side of the balance sheet they had deposits that could leave any time of day and on the other securities maturing in the late 2030s. Ouch. That made SVB very vulnerable to changes in long-term yields.

There are no banks that we know of that took quite those risks but many do have a problem in that they can’t really afford to raise rates because their margins on the securities in their balance sheet are already very low. Some banks will, and can afford to, rely on inertia. Some will raise capital and some will use the discount window and the stuff we mention above to meet depositor withdrawals.

Just don’t expect them to raise deposit rates.    

Debt Ceiling Update

Again, this is our list of things we’re watching

  1. Thursday Bill auctions
  2. 10-Year Treasury
  3. U.S. dollar
  4. Rise of safe-haven assets
  5. Treasury short positions
  6. Bonds, Bills, and Notes maturing in June and July
  7. Stock performance of companies with 90% of revenues from the government
  8. Credit Default Swap (CDS) prices

I have a feeling this section is going to be nothing, nothing, something, panic, resolution and back again for a while. The next few months are big tax report months. In 2021 and 2022, March to May tax receipts, accounted for 28% and 32% of all receipts so any big number will push the “X-date” out beyond June 5th. Treasury Secretary Janet Yellen has been asked if June 5th is her final, final answer a few times but she has not changed her forecast.

We’ve seen a “Freedom Caucus”, which is 40 House members, and White House budgets but nothing yet from House Republicans. The next one from the Republican Study Committee which comprises about 170 members, was promised for mid-April. The full House GOP budget may be some weeks after that. But Congress is in recess from March 30th to April 17t,  so we may not hear anything. The best guess we’ve seen is that Republicans move to extend the debt limit and link it to the September 30 deadline to fund the government and avoid a shutdown.

But, hey, we’re market and finance guys, not political types, so FWIW. Meanwhile, we don’t see any stresses in the financial indicators we track.

The Bottom Line

In like like a lion and out like a lamb. Ok that’s March weather but it looks the same for markets. The S&P 500 and bonds eked out a gain of 1.7% and 1.9% in March, despite a huge bank scare, hawkish talk from various Fed governors and slow progress on economic data. The good news is that employment remains healthy. Nothing much to see in claims data, and, while hiring intentions are down a bit, there are no sectors that are cutting jobs. The layoffs in tech continue and they’re already 98% of what they were in for all of 2022. But it’s only 157,000 out of a workforce of 166 million and many find jobs quickly.

Some regional bank stocks have taken a hit, the S&P 500 is up 5.2% so far this year. Most European stocks in the Euro area, are up around 15% for a U.S. investor. The 2-Year Treasury has settled in just above 4% but some 0.20% to 0.25% below where it started the year.

For the next quarter, we’ll slightly rephrase the two questions we had last week. One, will we see credit tightening, especially by small and mid-sized banks to small and mid-sized companies? And two, will the successive rate increases start to show up in other sectors of the economy? So far it’s been manageable with no big surprises, other than that bank we’re all talking about, but that hasn’t tipped over into the larger part of the equity market.   

That’s a good sign. See you in two weeks.

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Art: Zoey Frank (b. 1987)

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