Interest Rates And Recessions

Recently I took a look at interest rates (1 Yr CMT) and the relationship with recessions.

What I found was a consistent pattern of the 1 Yr CMT and recessions.

Based on the last seven recessions, including the recession ending June 2009, the 1 Yr CMT continued lower for an average of 11 months after the end of the recession and then began a sharp rise that took, on average 40 months from the official end of the previous recession to the ultimate peak in interest rates for that cycle.

The overall pattern of the interest rate cycle:
Step 1: End of recession
Step 2: Interest rates continue to drop after the end of the recession for an average of 11 months, with the average rate of the CMT continuing lower by 1.18%.
Step 3: Interest rates begin to rise, for 40 months from the end of recession to the ulimate rate peak, with a total increase in the CMT rate, from rate trough to rate peak, of 6.05%.


The analysis was based on monthly data, provided by the St. Louis Federal Reserve.

Period 1
End of Recession: Nov 1970
1 Yr CMT, Nov 1970: 5.51%
1 Yr CMT, rate trough, March 1971: 3.69%
Rate Decline at Trough: -1.82%
CMT Trough, Number of months from end of recession: 4 months

CMT Rate Peak: 9.36%
CMT Rate Peak, Date: August 1974
CMT Rate Peak, Number of months from end of recession: 45 months
Increase in Rates: End of Recession to Interest Rate Peak: 3.85% increase
Increase in Rates: Interest Rate Trough to Interest Rate Peak: 5.67% increase

Period 2
End of Recession: March 1975
1 Yr CMT, March 1975: 6.11%
1 Yr CMT, at rate trough, December 1976: 4.89%
Rate Decline at Trough: -1.22%
CMT Trough, Number of months from end of recession: 21 months

CMT Rate Peak: 15.82%
CMT Rate Peak, Date: March 1980
CMT Rate Peak, Number of months from end of recession: 60 months
Increase in Rates: End of Recession to Interest Rate Peak: 9.71% increase
Increase in Rates: Interest Rate Trough to Interest Rate Peak: 10.93% increase

Period 3
End of Recession: July 1980
1 Yr CMT, July 1980: 8.65%
1 Yr CMT, at rate trough, July 1980: 8.65%
Rate Decline at Trough: 0.00%
CMT Trough, Number of months from end of recession: 0 months

CMT Rate Peak: 16.72%
CMT Rate Peak, Date: August 1981
CMT Rate Peak, Number of months from end of recession: 13 months
Increase in Rates: End of Recession to Interest Rate Peak: 8.07% increase
Increase in Rates: Interest Rate Trough to Interest Rate Peak: 8.07% increase

Period 4
End of Recession: November 1982
1 Yr CMT, November 1982: 9.16%
1 Yr CMT, at rate trough, January 1983: 8.62%
Rate Decline at Trough: -0.54%
CMT Trough, Number of months from end of recession: 2 months

CMT Rate Peak: 12.08%
CMT Rate Peak, Date: June 1984
CMT Rate Peak, Number of months from end of recession: 19 months
Increase in Rates: End of Recession to Interest Rate Peak: 2.92% increase
Increase in Rates: Interest Rate Trough to Interest Rate Peak: 3.46% increase

Period 5
End of Recession: March 1991
1 Yr CMT, March 1991: 6.40%
1 Yr CMT, at rate trough, September 1992: 3.18%
Rate Decline at Trough: -3.22%
CMT Trough, Number of months from end of recession: 18 months

CMT Rate Peak: 7.14%
CMT Rate Peak, Date: December 1994
CMT Rate Peak, Number of months from end of recession: 45 months
Increase in Rates: End of Recession to Interest Rate Peak: 0.74% increase
Increase in Rates: Interest Rate Trough to Interest Rate Peak: 3.96% increase

Period 6
End of Recession: November 2001
1 Yr CMT, March 1991: 2.18%
1 Yr CMT, at rate trough, June 2003: 1.01%
Rate Decline at Trough: -1.17%
CMT Trough, Number of months from end of recession: 19 months

CMT Rate Peak: 5.22%
CMT Rate Peak, Date: July 2006
CMT Rate Peak, Number of months from end of recession: 56 months
Increase in Rates: End of Recession to Interest Rate Peak: 3.04% increase
Increase in Rates: Interest Rate Trough to Interest Rate Peak: 4.21% increase

Period 7
End of Recession: June 2009
1 Yr CMT, March 1991: 0.51%
1 Yr CMT, at rate trough, October 2010: 0.23%
Rate Decline at Trough: -0.28%
CMT Trough, Number of months from end of recession: 16 months

CMT Rate Peak: ?
CMT Rate Peak, Date: ?
CMT Rate Peak, Number of months from end of recession: ?
Increase in Rates: End of Recession to Interest Rate Peak: ?
Increase in Rates: Interest Rate Trough to Interest Rate Peak: ?

Averages for 7 Periods:
Average Initial Drop in Rate: -1.18% , 11 months
Average Rate Increase From Trough to Peak: 6.05% Increase, 40 months After End of Recession

Target of 1 Yr CMT, based on 2001 Recession/Recovery: 4.44%
Target Date of Next Peak, based on 2001 Recession/Recovery: Feb 2013

Manufacturing Jobs and the Economic Recovery

Recently I had an online chat regarding the excruciately slow economic progress begin made during the current recovery.

One of my chat-mates made the assertion that the problem with the recovery is that we've lost most of our manufacturing jobs.

It's very true that we've lost a number of manufacuting jobs in the past 25 years, but the loss of manufacturing jobs has nothing to do with the slow recovery this tie around.

Here's how the conversation went.

We're having trouble recovering because we have lost most of our manufacturing jobs. All the rest is smoke and mirrors. During all previous recessions, we've had a healthy manufacturing economy that could pull us out of the recession, without having to mortgage our future further.

And here was myy response:
Well, this sounds good. However, for this to be true, we would have to demonstrate that this recovery is somehow different from past recoveries, that we are bleeding more manufacturing jobs this time versus the previous recoveries. So let’s take a look at the evidence to see if your assertion stands up to scrutiny.

So what we’re going to look at is: 1) the number manufacturing lobs lost during the previous two recessions, 2) the number manufacturing lobs lost or gained 1 year after the official end of the recession, 3) the number manufacturing lobs lost or gained 2 years after the official end of the recession.

What’s clear, based on the data, is that the post-recession “recovery” period this time around has been much more favorable. The negative job loss in manufacturing is much less negative. As far as being a drag on the recovery, the loss of manufacturing jobs is clearly not the answer.

Last three recessions according to the NBER:

Recession Period: July 1990 – March 1991
Recession Began: July 1990
Employees on Nonfarm Payroll Manufacturing, July 1990: 17,703,000
Recession End: March 1991
Employees on Nonfarm Payroll Manufacturing, March 1991: 17,141,000
Total Nonfarm Payroll Manufacturing Job Loss during recession: - 562,000
Number of Nonfarm Payroll Manufacturing Jobs 1 Yr after end of recession, March 1992: 16,805,000
Manufacturing Job Losses March 1991 (Recession End) to March 1992: -336,000
Number of Nonfarm Payroll Manufacturing Jobs 2 Yr after end of recession, March 1993: 16,795,000
Manufacturing Job Losses March 1991 (Recession End) to March 1993: -346,000

Recession Period: March 2001 – November 2001
Recession Began: March 2001
Employees on Nonfarm Payroll Manufacturing, March 2001: 16,939,000
Recession End: November 2001
Employees on Nonfarm Payroll Manufacturing, November 2001: 15,825,000
Total Nonfarm Payroll Manufacturing Job Loss during recession: 1,114,000
Number of Nonfarm Payroll Manufacturing Jobs 1 Yr after end of recession, November 2002: 14,992,000
Manufacturing Job Losses Nov. 2001 (Recession End) to Nov. 2002: -833,000
Number of Nonfarm Payroll Manufacturing Jobs 2 Yr after end of recession, November 2003: 14,315,000
Manufacturing Job Losses Nov. 2001 (Recession End) to Nov. 2003: -1,510,000


Recession Period: December 2007 – June 2009
Recession Began: December 2007
Employees on Nonfarm Payroll Manufacturing, December 2007: 13,726,000
Recession End: June 2009
Employees on Nonfarm Payroll Manufacturing, June 2009: 11,782,000
Total Nonfarm Payroll Manufacturing Job Loss during recession: 1,944,000
Number of Nonfarm Payroll Manufacturing Jobs 1 Yr after end of recession, June 2010: 11,672,000
Manufacturing Job Losses June 2009 (Recession End) to June 2010: -110,000
Number of Nonfarm Payroll Manufacturing Jobs November 2010: 11,648,000
Manufacturing Job Losses June 2009 (Recession End) to November 2010: -134,000

Sources:
• Recession Dating: NBER: http://www.nber.org/cycles/cyclesmain.html
• Employees on Nonfarm Payrolls: Manufacturing: Federal Reserve Bank, St. Louis, taken from U.S. Department of Labor, Bureau of Labor Statistics: http://research.stlouisfed.org/fred2/series/MANEMP/downloaddata?cid=11

Quantitative Easing Explained

Buy The Dip

The language is salty, but a very funny video.

Oct 8 - CNBC Fast Money Interview with Christopher Whalen

CNBC Fast Money Interview with Christopher Whalen

Interview begins at 7:02 of the segment

Transcription:

Fast Money
October 8, 2010
Interview with Christopher Whalen, Institutional Risk Analytics

Melissa Lee is the host.

ML: Let’s move on and talk banks a little bit. Bank of America announcing today that it will stop foreclosure proceedings in all 50 states as the housing market struggles to find its footing and the nation’s largest loan providers deal with sorting our their documents. Our next guest says a new crisis is actually on its way. Christopher Whalen, of Institutional Risk Analytics, joins us on the Fast Line.

Whales, it is great to speak with you.

CW: Hello Melissa

ML: Alright, you say the banking industry is entering a new period of crisis. Why? Because they are generating a lot of cash; I mean, in fact, JP Morgan’s Jamie Dimon just said that it’s going to generate $75 billion, I think by 2013, that’s about half of it’s market cap, what’s the problem here?

CW: Well, they say they’re generating cash based on their GAAP statements, but if you look at the presentation that I gave at AEI earlier this week, the dollar amount of net interest coming through the banks is falling. It has fallen 35% since the peak in 2007. It’s right in the FDIC quarterly for everybody to look at, okay.

The other issue is operational expense of dealing with foreclosures, what you’d call servicing, which is going through the roof. So you have declining interest income on one side of the house and you have rising non-interest expense on the other.

And my guess is, my projection for my clients, is that we’re going to see the efficiency ratio, which is the dollar cost of revenue, go up close to 100% for the large banks. That means they’re going to be bleeding cash, Melissa, they’re not going to be generating cash.

ML: Alright, so uh, this projection of $75 billion in excess capital, out the window. According to your projections, Whales then, when do the chickens come home to roost? What kind of time frame are we looking at?

CW: Well, we’re looking at, I think, the next 3 – 6 months. The reason we’re seeing foreclosure moratoria is partly because of the legal and the political issue, obviously right; but really what’s going on here is that the banks can’t handle any more foreclosures. Their servicing departments don’t have the capacity to own and operate real estate. What we need to do is create some new vehicles, REITs really, to take ownership of these properties because the banks can’t handle it. I think we’re going to end up restructuring these banks using the Dodd-Frank legislation ironically.

Joe Terranova: Hey Chris, it’s Joe. You know, listening to what you’re saying here, I’m thinking two things: number one that banks are going to continue to horde cash; number two, probably more problematic, would be that home price values themselves have another leg down, do you see that?

CW: Well, definitely. Fannie and Freddie are the biggest sellers of real estate in the United States. Fannie Mae is the biggest landscaping company in the United States, now, too, by the way. And, as I say, banks are not equipped to be owners of real property. When their assets get illiquid, they can’t lend. And the expense of… believe me, in the 90’s this was a serious problem, but where we are today, and looking at the backlog of foreclosures, the mind boggles. When you start thinking about the expense of dealing with these properties. But what’s happening is that the banks are walking away from these properties.

ML: Chris, we have to leave it there…

AEI Slideshow Presentation: Here

Fannie Mae/Treasury Spread Stabilizes at Higher Level

As of May 21, 2010: Fannie Mae 30 Day Commitment/10 Yr Treasury Spread: 1.18777

Notes: The spread is still historically very low, however, in the wake of the discontinuance to the Federal Reserves MBS Purchase Program on March 31, 2010, the spread has been rising persistently, from a low of 0.85006 on March 24, 2010 (one week before the official ending of the program) to the current spread of 1.18777, on May 21, 2010.

I expect this spread to continue significantly higher throughout the year.

Spread History: 12/03/2007 to 05/21/2010

Spread Average: 1.655390178

2 Std Dev: 0.944344144

U.S. Treasury Issuance May 2010 - $191 Billion

Total New Issuance of 2 Yr, 3 Yr, 5 Yr, 7Yr, 10 Yr, 30 Yr Treasuries for May 2010: $191 B

Total New Treasury Issuances Jan. '09 to May '10 (2 Yr. - 30 Yr Maturitues): $3.023 Trillion

Breakdown by Maturity:

Jan '09 To May '10 Treasury Issuances:

Fannie Mae 30 Yr/10 Yr Treasury Spreads Widening

The recent Greek debt crisis may be doing wonders for the 10 Yr Treasury yields, but it's having very little effect on Fannie Mae 30 Yr mortgage rates. As a result, the spread is widening significantly, to the highest spread level this year.

USDA Loan Activity

A very interesting chart from the USDA Rural Development (Washington) website on annual loan activity for the USDA Rural Development loan program. In the absence of subprime lending, the 100% LTV (102% including funding fee) program is simply exploding.

Mortgage Spread Update

I will agree that following the Fannie Mae/10 Yr Treasury is a bit like watching paint dry...But we are seeing a bit of an uptick in the spread at the end of this past week.

Key Metrics as of April 16, 2010:

30 Day FNMA Mandatory Commitment: 4.80205%

10 Yr Treasury Yield: 3.77%

Current Spread: 1.03205%

Mortgage Spread Update

Mortgage rates are moving higher, but that's because of the underlying move higher in 10 Yr Treasury rates at this point. The spread between the Mortgage Backed Securities and the 10 Yr has remained relatively constant in the last few weeks.

Treasury Issuances January 5 2009 thru April 1 2010

You can find the Treasury Auction Announcements here.

I've been accumulating the results of the 2 Yr, 3 Yr, 5 Yr, 7 Yr, 10 Yr, and 30 Yr US Treasury Auction Results since the January 5 2009 auction announcement. For the period of January 5, 2009 through the most recent announcement on April 1, 2010, the Treasury has issued $2.714 Trillion in new debt.

Total Treasury Issuance Jan 2010 Through April 1, 2010 Announcement: $657 Billion.
Total Treasury Issuance for 2009: $2.057 Trillion
Total 2009 Issuance Thru 1st Auction in April: $491 Billion

The Treasury has issued 33.8% more debt (counting only the 2 Yr, 3 Yr, 5 Yr, 7 Yr, 10 Yr, and 30 Yr issuances) in 2010 verus 2009.

Skyler Buys A New House

Congratulations Skyler. It took 9 months of work to get an approval and then find a house. But as of yesterday, it was all worth it.

Update: MBS - Treasury Spread

Update: MBS - Treasury Spread

End of MBS Purchase Program

End of Fed’s $1.25 Trillion Mortgage Backed Purchase Program: The Effect On 30 Yr Mortgage Rates

Timeline:

November 25, 2008: The Federal Reserve Initiates Mortgage Purchase Program

Fed announces that it will initiate a program to purchase the direct obligations of housing-related government-sponsored enterprises (GSEs)--Fannie Mae, Freddie Mac, and the Federal Home Loan Banks--and mortgage-backed securities (MBS) backed by Fannie Mae, Freddie Mac, and Ginnie Mae.

Purchases of up to $500 billion in MBS will be conducted by asset managers selected via a competitive process with a goal of beginning these purchases before year-end. Purchases of both direct obligations and MBS are expected to take place over several quarters. Further information regarding the operational details of this program will be provided after consultation with market participants. link

March 18, 2009: The Federal Increases Mortgage Backed Securities Purchase Program

To provide greater support to mortgage lending and housing markets, the Committee decided today to increase the size of the Federal Reserve’s balance sheet further by purchasing up to an additional $750 billion of agency mortgage-backed securities, bringing its total purchases of these securities to up to $1.25 trillion this year, and to increase its purchases of agency debt this year by up to $100 billion to a total of up to $200 billion. link

September 18, 2009: “The Fed’s cumulative MBS purchases have reached $840.1 billion, and it has announced plans to purchase up to $1.25 trillion by the end of the year.” link

December 14, 2009: Fed MBS Purchases: Over 85% Complete: “In the last two months, the average weekly amount of MBS purchased has been smaller, averaging $17 billion over the last 10 weeks versus the average of $23.4 billion before that period.” link

January 10, 2009: Fed MBS Purchases: 90% Complete link

January 28, 2009: Fed MBS Purchases by Week: link

Current Spread between Fannie Mae 30 Yr Historical Required Net Yields (link) – 10 Yr Treasury Bond (link)

Spreads
Current 10 Yr Treasury Rate: 3.61%

12/03/2007 to 11/25/2008: 2.091644
11/26/2008 to 01/29/2010:1.455505
Current Spread (Jan 29, 2010):1.13166

Articles:
June 5, 2009: (link) Rising Rates: The Next Fed Meeting Will be Interesting“This graph shows the relationship between the Ten Year yield (x-axis) and the 30 year mortgage rate (y-axis, monthly from Freddie Mac) since 1971. The relationship isn't perfect, but the correlation is very high. Based on this historical data, a Ten Year yield at 3.84% suggests a 30 year mortgage rate of around 5.75%.”

September 17, 2009: (link)“Sure enough mortgage rates have been below expectations for a number of months (the last 5 months in blue triangles). Although this is a limited amount of data - and the blue triangles are within the normal spread - this suggests the Fed's buying of MBS is reducing mortgage rates by about 35 bps.”

January 5, 2010: (link)

Pimco's Bill Gross Sees 2010 as Year of Reckoning

What does this say about the Federal Reserve's hopes to start pulling its added liquidity out of the markets, either by raising short-term rates or just getting out of buying bonds, which has been keeping long rates low?

I think the Fed's statements suggest that they really want to exit in some fashion from the buying program. The first step in that direction, logically, would be to stop buying, and our sense is that they're at least going to try that. But based on our forecasts for the second half of the year, they may have to reinitiate it, and that will be difficult to do once they stop because it then becomes a political hot potato.

All that said, I think they'll stop buying mortgage-agency securities, and the trillion-and-a-half-dollar check that's been written over the past nine to 12 months basically disappears. It's significant from the standpoint of interest rates and interest-rate spreads in certain sectors. And I would even go so far as to say it might be a mistake.Won't that put upward pressure on interest rates?I think it will. I mean, the mortgage market would be your first place to look, in terms of something that's overvalued that would become normalized. Nobody knows what the Fed's buying is worth — we think about half a percentage point on rates, but we don't know.

Won't that put upward pressure on interest rates?

I think it will. I mean, the mortgage market would be your first place to look, in terms of something that's overvalued that would become normalized. Nobody knows what the Fed's buying is worth — we think about half a percentage point on rates, but we don't know.

(emphasis mine)

January 29, 2010: (link) : Fed's Kohn says impact from end of Fed MBS purchases matter of uncertainity

Says:

- predicting Fed policy impact on rates especially hard

- especially important for banks to limit rate risk

- impact from ending MBS purchases likely to be modest- ‘volatilities’ unlikely to return to ‘quiescent state’- foreign capital may decline for US in coming years

Comments From Dan:
On the one hand we have comments from Calculated Risk blog (35 bps rise), Bill Gross of Pimco (50 bps), and the Fed’s Kohn indicating a relative modest increase in rates once the Fed’s MBS purchase program is completed. Based on a 35 bps to 50 bps rise in mortgage rates, this would point to a 30 Year Fixed mortgage rate of roughly 5.250% to 5.625%, based on recent mortgage rates (4.75% on a 30 Year Fixed Rate Mortgage).

However, if we applied the average spread from the time period preceding the MBS program, and experience an average spread of 2.09%, this would imply a slightly higher rate range, from 5.750% to 6.125%.

The risk, and in my opinion it is a significant risk, is that the comparison’s being made in the pre-Nov ’08 MBS period, had a significantly lower foreclosure/default rate. It would not be surprising to see the spread between 10 Yr Treasuries and 30 Yr Mortgage rates to initially spike to the higher end of the boundaries (the Nov 20, 2008 spread was 2.739%, which would imply a 30 yr mortgage rate in the 6.375% to 6.500% range, based on the 01/29/2010 close at 3.61% on the 10 Yr Treasury), in order to account for higher foreclosure/default risk.

In my opinion, I have not seen forecasts which adequately adjust for foreclosure/default risk in the projection of rates after the purchase program ends. My personal opinion is that it would not surprise me to see spreads widen beyond the upper bounds of the spread in the pre-Purchase sample period, i.e. above a 2.739% spread. It is conceivable that we could see 30 Year Fixed Mortgage Rates approaching 7% after the end of the Fed’s MBS Purchase Plan, even with a relatively flat Treasury yield.