GDI Double Dip
Toxic bank policy, crunch time for Fed policy, a GDI double dip, credit supply and capital investment
Toxic Bank Policy
Bank stocks came back under pressure this week due to a toxic mix of policy issues. During the second week of heavy Treasury issuance following the debt ceiling/budget deal, the draining of liquidity was more balanced between the Fed’s reverse repo program (-$66.8bn) and bank reserves (-$73.7bn). Consequently, after the first week where the bulk of the financing of the Treasury rebuilding their checking account (TGA), now at $292 billion, primarily came from Fed reverse repo programs, the second week was closer to our expectation of a 50/50 split between RRP and bank reserves. We remain convinced that reserves are likely to fall to the lowest comfortable level later this year.
The Fed Chairman’s semiannual monetary policy report to Congress and post-meeting FOMC participant speeches, was generally consistent with our view that the 50bp increase in their terminal rate forecast was primarily forward guidance intended to persuade market participants that the end of the cycle did not imply a quick reversal of the policy hikes. But in combination with Treasury’s front-end concentrated issuance, it deepened the inversion of the 2s10s real rate curve below the pandemic panic low. The reiteration of this dangerous forecast is more than an idle threat (forward guidance) for some FOMC participants, and they may get their way if the data over the next four weeks doesn’t cooperate. Republicans in Congress were rightly concerned about a procyclical increase in bank capital requirements and Democrats about a Fed policy rate overshoot that causes unnecessary weakness in a labor market that is sorting out the supply demand imbalance through a combination of increased supply and reallocation.
Consequently, the structure of Treasury issuance and monetary policy focused on rate hikes rather than balance sheet management are causing a deepening of the Treasury curve inversion. In turn, that is further impairing the banking system, and in response to political scapegoating, the Fed is considering a procyclical increase in bank capital requirements. Next week’s bank stress test results seem likely to reflect regulators licking their wounds after the large regional bank failures. As we will discuss later, bank earnings revisions are below the pandemic low.