Beware the Sting in the Tail

Beware the sting in the tail.

In the context of today’s reckoning, beware the sting in the banking tail.

Beginning March last year, the banking system absorbed a substantial clout.

A score of regional banks sank to their knees… and plunged into receivership.

By way of background:

Their portfolios were loaded through with long-term Treasury bonds. The banks purchased these “safe” bonds in a period of severely depressed interest rates.

In such a period as that bonds maintain an elevated value. They are lovely jewels. That is because bond prices and interest rates exist in antagonism… as the polar ends of the seesaw exist in antagonism.

When interest rates take to the downswing bond prices take to the upswing. When interest rates take to the upswing bond prices take to the downswing.

Thus these bonds represented beautiful portfolio assets in the period of severely depressed interest rates.

These banks expected this period of severely depressed interest rates to run and run.

Yet this period of severely depressed interest rates did not run and run.

As inflationary prairie fires began fanning in 2022 the Federal Reserve unfurled the fire hoses and commenced a heroic firefighting operation.

It got good water on the flames — flames which the Federal Reserve itself helped kindle.

It undertook the most aggressive and dizzying interest rate raisings ever.

In March 2022 the Federal Reserve’s target rate guttered along between 0.25% and 0.50%.

Within 14 months the Federal Reserve’s target rate scraped the sky between 5% and 5.25%.

Today it dangles between 5.25% and 5.50%.

Thus the bonds that were oaken assets in the period of severely depressed interest rates… turned to sawdust assets in the period of rapidly elevating interest rates.

Hence the subsequent unpleasantries.

The regulatory authorities engineered a rescue to halt the contagion.

Yet Jim Rickards warned the virus would break the cordon. He climbed upon his rooftop and shouted it would propagate in successive phases:

Investors are relaxed because they believe the banking crisis is over. That’s a huge mistake. History shows that major financial crises unfold in stages and have a quiet period between the initial stage and the critical stage. 

Is the banking crisis entering the critical stage? Reports the heralded Kobeissi Letter:

Unrealized losses on investment securities for banks jumped to $517 BILLION in Q1 2024.

This is $39 billion higher than the $478 billion recorded in Q4 2023…

Q1 2024 also marked the 10th consecutive quarter of unrealized losses, an even longer streak than during the 2008 Financial Crisis.

As “higher for longer” (interest rates) returns, unrealized losses are likely to continue rising.

Did the banking crisis ever really end?

It has not ended — evidently.

Thus the Federal Deposit Insurance Corporation chews its fingernails… and warns that 63 lenders verge upon the condition of bankruptcy.

And so the Federal Reserve is crammed into a pickle jar.

It is aware of the banking wobbles. They inform Mr. Powell and his fellows that they must dial the liquidity faucets rightward — that is, to the open position.

Yet they have failed to cage the inflationary impulses they themselves set forth.

They have gotten their hands upon inflation’s shirt. They have maneuvered it backwards.

Yet they have failed to get it under lock and key, to reincarcerate the thing.

They therefore hesitate to loosen up.

A gorgeous conundrum!

As reports the American Enterprise Institute:

In 2021, the Fed chose to ignore the markedly expansionary fiscal policy stance when it kept flooding the market with liquidity. The net result was a surge in inflation by June 2022 to a multidecade high of over 9%. Today, it seems to be making the opposite mistake of keeping monetary policy tight on the eve of a banking crisis… Unfortunately, this raises the risk of a hard economic landing within the next year or so.

Beware the sting in the tail…

The Daily Reckoning