Jeff Cox | @JeffCoxCNBCcom
7/26/2017
Consider the Federal Reserve the Starship Enterprise of monetary policy: It went where no central bank had gone before, and now must plot the journey home.
The Fed already has begun one leg of the trip, as it has started raising interest rates from financial crisis-era lows. Now, it is preparing to embark on what could be the more perilous part — shrinking the $4.5 trillion of bonds it holds on its so-called balance sheet.
In an effort to jump-start the economy out of the financial crisis and the Great Recession, the Fed instituted three rounds of bond buying aimed at getting the financial markets going again and generating what officials call a "wealth effect" that would spread through the economy.
While it may sound like just arcane monetary talk, the stakes are high for both investors and consumers.
Get it right and the Fed will have pulled off what its critics thought impossible, namely embarking on unprecedented intervention in the markets with little consequence.
Get it wrong and the fallout could be dramatic, including a sharp rise in interest rates and tumult in the stock and bond markets.
The Fed on Wednesday is expected to provide more clues about when the operation will begin. In the obtuse world of Fed-speak, central bank watchers are looking for whether the official post-meeting statement changes the language from balance-sheet reduction expected before the end of the year to "relatively soon."
How it works
The Fed's balance sheet in total now runs $4.53 trillion, nearly all of which is either Treasurys or mortgage-backed securities. Of the total, $3.7 trillion came during three rounds of buying that began in response to the Great Recession of 2007-09. The program, known as "quantitative easing" or, more colloquially, "money printing," was aimed at injecting money into the economy and encouraging risk-taking following the devastation of the financial crisis.
The Fed bought Treasurys, now totaling $2.46 trillion, and mortgage-backed securities — loans packaged together as bonds now valued at $1.78 trillion — and they will be the focus of the balance-sheet operation.
Those bonds carry various maturity dates. When the bonds reach maturity, current policy entails reinvesting the proceeds. That helps keep demand in the market for government bonds and holds rates low.
Gabe Ginsberg | Getty Images
Under the current plan, the Fed will set caps on how much of the proceeds will be allowed to run off each month and reinvest the rest. The caps will raise in increments until they reach $50 billion a month, with $30 billion coming from Treasurys and $20 billion in MBS.
How long the process will last is unclear at this point. Goldman Sachs economists said they expect the balance sheet will come down to $2.6 trillion to $3 trillion in a process that likely would run until November 2021.
What could go wrong
Both the stock and bond markets have come to depend on the Fed's programs — both the low interest rates and the balance sheet expansion — in the post-crisis years. Stocks, as measured by the S&P 500, have surged more than 250 percent since the recession lows, while interest rates have remained low across the spectrum.
Any fiddling with a $4.5 trillion batch of bonds, then, could have major consequences if it's not done the right way.
Fed Chair Janet Yellen has insisted the process will have minimal impacts — "like watching paint dry" is her preferred metaphor. So far the market seems to agree, with Goldman projecting that the ultimate impact of the program will add 0.65 percentage points to the 10-year Treasury yield from the beginning until 2021.
But Fed critics have worried for years that the central bank's reluctance to unwind crisis-era policies long after the crisis passed poses substantial dangers. The day is coming, then, when that will be put to the test.
"I have a bridge to sell you if you think a rate hike cycle combined with a shrinking balance sheet will go smoothly," Peter Boockvar, chief market analyst at The Lindsey Group, said back when the Fed first began talking about the balance sheet operation publicly. "If the exit process ends up turning messy — defined as a recession and bear market in stocks — was all this easing worth it? Be bullish if you think both news stories will turn out just fine. Be very worried if they don't."
What else is at stake?
Either way the Fed works things, the process of shedding trillions of dollars in bonds will take a long time.
Greg McBride, chief financial analyst at Bankrate.com, sees the process ultimately lasting 15 or 20 years, with plenty of rests in between as the Fed goes back to asset purchases during economic downturns.
"When you look at the context of a slow-growth economy, productivity growth that is abysmally low — that all adds up to a Fed that's not going to be able to be aggressive with interest rates or downsizing the balance sheet," McBride said in an interview earlier in the year.
"Seeing slow progress on both of these fronts just brings us to the intersection of an inevitable economic slowdown at some point long before interest rates get to more normal levels and the balance sheet is reduced significantly in size," he added.
However, there's a rather significant intangible in play.
Yellen may be winding down her career, with many Fed watchers figuring that President Donald Trump will not reappoint her when her term expires early next year. That means the chair may focus at least in part on legacy-building in the coming months.
"Unless renominated, Chair Yellen will leave her seat in February 2018 having defined her legacy as the first central bank leader to have successfully lifted off of the zero lower-bound and to have begun the process of post-financial crisis normalization," economists at Morgan Stanley said in a note. "If all goes well, it will be a gift to her successor.
To put all this in plain English, the ECB buys bonds (similar to the Federal Reserve’s Quantitative Easing program that started in 11/2008 and ended in 11/2014 to help keep the U.S. economy functioning). This puts downward pressure on rates around the world (more so in Europe than in the US, but we still get some indirect benefit). There was some concern at the end of June that the ECB was getting closer to announcing it would buy fewer bonds. While that day will likely come eventually, today's announcement assures markets that it hasn't been discussed yet.
Credit reports currently used in mortgage lending indicate only the outstanding balance, utilization and availability of credit, and if a borrower has been on
time or delinquent ...
The launch of Fannie Mae's D.U. (Desktop Underwriter- Fannie Mae’s automated underwriting software) Version 10.0 in September, 2016 will use Trended Credit Data in its credit risk assessment, which provides access to historical monthly data on several factors, including balance, scheduled payment, and actual payment amount that a borrower makes.
Below is a histotical glance at past Fannie Mae D.U. software updates. Currently, some lenders still use D.U. 4.0 for underwriting and approving residential Loans.
FICO 1 (1989)
FICO 98 (1998)
FICO 4 (2004)
FICO 8 (2009)
FICO 9 (2014)
Below is a photo of a Teltex device used in early credit reporting:
An example of using Trended Credit Data in credit valuations:
According to EquifaxEQUIFAX
“Trended data is the most important tool developed
by the credit reporting agencies since the advent of
the credit score.”
STEVE CHAOUKI, THE HEAD OF
TRANSUNION’S FINANCIAL SERVICES GROUP
“Trended credit will allow more consumers to
generate higher credit scores, he said. Roughly
three million “thin file” consumers, who may only
have one credit account, could now potentially
rank as prime or super-prime borrowers, he
said.”
FROM NCRA, TERRY CLEMANS
“Could an applicant with a 750 credit score now be
denied due to the new trended credit data
exposing the consumer’s steady rise in credit
consumption over the past 30 months?” said
Clemans executive director of the National
Consumer Reporting Association.
Founded in 1992, the National Credit Reporting Association, Inc.
(NCRA) is a national trade organization of consumer reporting agencies
For more information on Trended Credit Data reporting and Fannie Mae 10.0, please contact us at 408-315-2834.
Investors hit the sell button today as worries about global tensions and more bad news out of China overshadowed good news on the U.S. economy.
The Dow fell more than 230 points, or 1.4%. The S&P 500 and Nasdaq also were off by more than 1%. All three indexes were up in earlier trading.
Wall Street is waiting to see what happens in Sunday's Crimean referendum on joining the Russian Federation, and what that outcome may mean for markets.
In addition, China announced that retail sales and industrial production were both worse than expected and that helped add to worries that the story out of China won't be a good one for investors anytime soon.
European and Asian Stock Markets finished Thursday mostly lower due to the worries about a slowdown in China.
"For China, the question is whether the [government] authorities are in control of the slowdown, or if it starts controlling them," said Simon Smith, chief economist at FxPro.
The China and Ukraine concerns overshadowed a report by the U.S. government that retail sales in February were up 0.3%. This was the first increase in three months as consumers bought more autos and clothing. On the jobs front, initial unemployment claims fell by 9,000 to 315,000, a three month low.
Call it Chinese Taper.
China's holdings of U.S. Treasuries fell by $47.8 billion in December, the biggest one-month drop in two years, according to the latest figures from the U.S. Treasury. China remains the biggest foreign holder of U.S. Treasuries. The decline in its purchases comes at the same time that the Federal Reserve is pulling back on its own purchases of government debt, a withdrawal of stimulus popularly known as tapering.
But other foreign countries are stepping into the breach, pushing the volume of Treasuries held outside the U.S. to a record high. Belgium actually posted an increase in holdings greater than China's decline, while Hong Kong, Ireland, Norway, South Korea and the Netherlands all significantly boosted their holdings as well.
China is clearly trying to diversify its holdings of foreign government debt, and it will likely make fewer purchases of U.S. Treasuries going forward, Nick Stamenkovic, fixed income strategist at RIA Capital Markets in Edinburgh.
"If the U.S. can't rely on China to be the biggest holder, it might mean than yields have to rise," he said. He expects the yields on the benchmark 10-year Treasury, now at 2.71%, to rise nearly 1 percentage point by the end of the year due to the pullback in purchases by both the Fed and China. The 10 year treasury moves in the same direction as mortgage rates.
But Stamenkovic said he doesn't see China dumping large quantities of Treasuries on the market. He said there will probably still be months ahead when China's holdings of Treasuries increase once again.
"I'd be very surprised if this is a long-term trend," he said, "but the size of the move [in December] certainly caught the markets off guard.
There is a lot of conversation around mortgage rates lately, especially the 30 year fixed loans.
Below is a graph from FRED (Federal Reserve Economic Data) that gives us a good perspective as to where 30 year mortgage rates have been since the 1970’s along with an article I found very informative from Bill Conerly of Forbes.
As he states, interest rates will remain low, but long-term rates are not quite as low as they have been. That’s the nutshell. Before explaining the numbers and the reasoning, let me explain my view of interest rate determination.
Short-term interest rates are largely determined by the central bank. For those of us in the United States, that’s the Federal Reserve.
Long-term rates are much more market driven. The global average interest rate for long-term debt is the result of global demand for credit compared to global supply of saving. The key item here is the global business cycle, because demand for credit goes up in booms, while the saving rate tends to fall at the same time. I emphasize “global” because capital moves around the world seeking its highest risk-adjusted return.
Long-term interest rates in any particular country result from the interplay of the global average interest rate and some local factors. Expected inflation is the largest factor that shifts one country’s interest rate away from the global average. Expectations of future short-term interest rates also influence the long-term interest rate.
Intermediate interest rates, such as 2-year or 5-year bonds, are a mix of the two sets of factors.
With that framework, here’s what to expect through the remainder of 2014. Short-term interest rates will remain very low, at about the current level.
When the Fed starts to get nervous about inflation, they will first stop buying long-term securities, and then only later they will raise short-term interest rates. That won’t be any time soon, though. The best estimate we have of the economy’s potential shows that actual performance is more than five percentage points short of where we should be, and we are not growing very fast. With large and persistent underperformance of the economy, the Fed won’t tighten any time soon.
Long-term interest rates are a different story. Global demand for credit will expand as the world economy grows. This assumes that Europe does not melt down, a significant risk. It also assumes that China continues to grow, which is quite likely. Global economic expansion will put upward pressure on long-term interest rates worldwide.
Will United States inflation expectations rise? With the large and persistent underperformance of the economy, inflation expectations won’t go too high, though they may edge up from current low levels. Certainly they won’t fall.
Finally, as the economy improves investors will start to wonder if a Fed tightening isn’t around the corner. Right now that corner is very far away, so far away that nobody can see it through the fog of statistics. However, in a year or two, we might reasonably make out the dim outlines of the corner around which the tightening lies.
The result is that I expect gradual increases in long-term interest rates through 2014. I could see that interest rate rising above three percent by the end of 2014, maybe up as high as 3.5 percent. They were as low as 1.72 percent in April, 2013. They are now hovering around 2.75 percent nowadays (For those of us who lived through the era of double-digit rates, roughly from 1979 through 1985, it’s a joke to say “maybe as high as 3.5 percent.”)
This gain in long-term rates will push the 30-year mortgage rate up around 5.5 percent, which is still a low interest rate. However, the move from the threes to the fives will discourage people with cheap mortgages from moving.
Risks to the forecast are fairly simple. I think the chance of short-term rates rising over the forecast time horizon is very, very low. Long-term rates could remain at today’s low levels if the economy re-slumps. However, a surprise rebound in economic growth worldwide could add another percentage point to my forecast. But the high interest rates of 20-30 years ago will remain but a distant memory no matter how surprising next year’s economy turns out to be.
The five mortgage servicers involved in last year's $25 billion settlement over servicer errors and abuses have now distributed an average of $82,000 in relief to each of 550,000 homeowners. Joseph A. Smith who heads the Office of Mortgage Settlement Oversight said this is a total of $45.83 billion that has been distributed in less than one year following the settlement agreement between the servicers and 49 state attorneys general, the Departments of Justice and Housing and Urban Development (HUD).
Smith's office released an interim report on the progress of the settlement distribution today. Smith said he is required to file his first progress report with the courts in the second quarter of this year but he is providing this, a second interim report, as part of an ongoing effort to inform the public about the steps the banks have taken to implement the settlement.
More than $22.48 billion of the overall completed consumer relief has come in the form of debt forgiveness. Because of the settlement, the principal reduction helps borrowers stay in their homes, lowering monthly payments on over 266,000 loans and reducing homeowners' loan balances by more than $84,000 on average.
This is in addition to the funds that states allocated for settlement-related purposes, including over $250 million for housing counseling and another $50 million to legal aid.
HUD Secretary Shawn Donovan said that at the one-year anniversary of the settlement, "We have already surpassed our initial expectations and the settlement is testament to the fact that large scale principal reduction can be used as an important to in our efforts to prevent foreclosures without incurring negative results." The job, however is not done he said and "we will continue to watch the banks like hawks to ensure they live up to their obligations as they complete their consumer relief requirements and we measure their progress on implementing new and improved servicing standards."
Smith said that since his last progress report he has continued to receive valuable input for counselors, lawyers, advocates and others which have highlighted continuing areas of concern such as dual tracking and issues relating to single points of contact. As a result he has engaged the banks to address these complaints and will continue to use feedback to inform his oversight responsibilities.
Interest rates, especially mortgage rates move very closely with the yield on treasuries (mostly the 10 year treasury yield).
Here is a very interesting article from CNNmoney about the direction bond yields should take to be in line with the gradual economical growth in the United States.
By Paul R. La Monica @lamonicabuzz
NEW YORK (CNNMoney) -- Yields on benchmark 10-year U.S. Treasury bonds are back below 2%. They really shouldn't be this low. Most fixed income investors agree that's the case. Yet, people keep clinging to long-term securities like Linus Van Pelt does to his baby blue security blanket.
Cue the Vince Guaraldi soundtrack, and welcome to the bizarre world of bonds -- where bad economic news from America only makes Treasuries look even safer!
Even though the latest ADP job figures for April point to a potentially disappointing payrolls number from the government Friday, investors still take solace in the fact that the U.S. isn't Europe.
The yield on the 10-year Treasury dipped as low as 1.9% on Wednesday morning. That's not too far above the low for 2012 of about 1.8%. It's not even out of the realm of possibility that yields could soon test last September's all-time low of 1.68%.
Since bond rates fall when prices rise, many investors apparently still find something attractive about Treasuries. And it can't be those puny yields.
"Clearly, the push into bonds is coming from exogenous factors. And it's primarily concerns about Europe," said Pat McCluskey, senior fixed income strategist with Wells Fargo Advisors in St. Louis.
McCluskey argues that if not for the debt crisis in Europe, the 10-year Treasury would probably be yielding something closer to 3% than 2%. But as long as investors remain worried about the growing list of eurozone nations falling into double-dip recession and unemployment that remains in the double digits, the U.S. still looks relatively healthy by comparison.
Sure, there's a lot to hate about the U.S. economic situation right now. The latest jobs numbers, most notably the much weaker jobs gains in March, are a step in the wrong direction. The housing market is still a mess.
And unless the nitwits in Washington take a break from campaigning to actually do some real work on Capitol Hill, there is a huge risk of the U.S. falling off a fiscal debt cliff shortly after the election.
Nonetheless, the U.S. is still the best of a sorry lot among the key developed markets. Treasury bonds may be the equivalent of a Ford Pinto or AMC Gremlin. But Europe's debt is a Yugo.
Stephen Hammers, chief investment officer of Compass EMP Funds in Brentwood, Tenn., said he thinks Treasuries look like good short-term bets right now because nervous investors are fleeing European stocks and bonds in favor of dollar-denominated assets.
Hammers said there are two compelling reasons for U.S. bond yields to spike higher in the near-term: strong economic improvement or more concerns about the federal budget deficit further getting out of hand.
The former doesn't seem likely. But the latter is a possibility as we approach the end of the year.
After all, the reason that bond rates are so high in places like Italy, Spain and Greece isn't because of overheating economies and runaway inflation. It's due to a lack of confidence in those nations' abilities to get their debt under control.
With that in mind, experts say U.S. bond rates should eventually spike higher. But it's going to be difficult to pinpoint when that will take place and how high that will go .. especially since the Federal Reserve is still buying bonds.
The central bank is currently in the process of completing what's known as Operation Twist, swapping short-term bonds on its balance sheet for longer-term securities. Twist is set to expire in June and is unlikely to be extended.
Prior to Twist, the Fed propped up the financial markets with two rounds of quantitative easing, programs where the Fed has bought up long-term debt to try and keep rates low. So with each new negative data point about the economy, there is likely to be more cries for a third dose of quantitative easing, or QE3.
Those calls may fall on deaf ears. Many experts think the Fed won't act that aggressively unless there is more concrete data of a major slowdown. A couple of months of payroll gains below 200,000 is not great news. But it's not a reason to panic either, especially if more Fed stimulus creates inflation pressure.
"A sudden spike higher in yields would be something the Fed would want to fight. But bond yields are still low and following the path of the data," said Rob Robis, head of fixed income macro strategies at ING Investment Management in Atlanta. "There is no reason for the Fed to act just yet."
If the Fed doesn't hint at more easing anytime soon, that could spook the market and cause rates to shoot higher. Many investors may be looking for the merest excuse to finally unload bonds.
"Treasuries are richly priced right now," Robis said. "And if the market starts to wonder who will be buying bonds that the Fed won't be buying, that could put upward pressure on yields."
McCluskey agreed. He noted that the Fed can't adopt a policy of permanent QE. And sooner or later, investors from China, Japan and other countries that hold a lot of U.S. debt could tire of owning assets that yield relatively nothing.
"The combination of Fed policy and foreign demand for bonds has kept rates low for a while. You can't count on that forever," he said.
But Hammers said the key for investors is timing, getting out before sentiment starts to shift. For now though, the market still has faith in the United States. So the bond bubble that many think has to pop at some point could wind up getting a little bit bigger before it finally bursts.
"Eventually, people will feel sorry for bond investors. But for now, Treasuries and the dollar are still considered safe," Hammers said.
July 1 | Fri Jul 1, 2011 12:33pm EDT
July 1 (Reuters) - A Washington think-tank has produced the first detailed study of what a U.S. default would look like by the numbers.
The Bipartisan Policy Center looked at projected cash inflows, and payment obligations for the U.S. Treasury for each day from Aug. 3 until Aug. 31.
The Treasury says that if the government's $14.3 trillion borrowing authority is not raised by Aug. 2, it will have run out of money to fully meet its financial obligations and the United States will enter default on Aug. 3.
Below are the center's key projections.
-- Inflows between Aug. 3 and Aug. 31 would be $172 billion, bills due will be $306 billion, leaving a shortfall of $134 billion.
-- Averaged out through August, 44 percent of bills and obligations could not be paid.
-- $500 billion of maturing debt must be paid in August. New securities will need to be auctioned off to raise enough cash to pay the maturing debt. It is unclear if enough new debt could be sold if the United States is in default.
-- The Treasury makes 80 million payments per month, or about 3 million a day. Government computer software is programmed to pay obligations as they fall due. How these would be overridden to prioritize debt payments is unclear.
-- On Aug. 3, the day of default, inflows will be $12 billion, but obligations will be $32 billion -- including $23 billion in Social Security payments.
-- On Aug. 15 there will be $41 billion of committed spending -- including $29 billion in debt interest payments. But there will be just $22 billion in revenues.
-- If Treasury tries to prioritize payments, in whatever order, it would be impossible to avoid deep cuts to popular programs and government departments.
With $172 billion of revenue between Aug. 3 and Aug. 31, Treasury could fully fund Social Security payments, Medicare and Medicaid, interest on the debt, defense vendor payments and unemployment insurance.
But that would leave entire government departments -- such as Labor, Commerce, Energy and Justice -- unfunded, and many others unpaid, like active-duty troops and the federal workforce. (Reporting by Tim Reid, Editing by Xavier Briand)