Too Much Sun Can Lead to Overheating
Today, because of recent developments, I wanted to give you a brief introduction to one of my favorite tools I use to prepare my discussion topics when I consult with ALCOs. I was going to introduce this at the ALM
Conference in April, but I wanted to give you a heads up now.
I refer to this tool as my “Business Cycle Model” (BCM). The beauty of this model is it has zones. In each of these zones, there are discussion topics that are derived from researching the different economic data that tends to occur in each zone. Some of the topics researched in each zone are things like credit spreads, loan growth, interest rate changes, credit risk and the unemployment rate. Why am I bringing this up today? Well, we recently crossed an important threshold in the BCM that implies that the business cycle should accelerate and put more pressure on the FOMC to increase rates, and in today’s testimony to Congress, Janet Yellen seemed to confirm what the BCM is indicating. She specifically mentioned her fear of the consequences of waiting too long to raise rates. In the chart below, you can see the model crossed above the upper threshold for the first time since the summer of 2007.
The chart below is the interest rate section study from the BCM, and as you can see, we have two developments of note. The first happened in October 2015. When the green bar appears, the model is alerting to an environment where the FOMC typically changes directions on interest rate policy. Low-and-behold, the FOMC raised rates at its December meeting. We got an even more important red bar in August of 2016 when we crossed the upper threshold on the BCM (chart above). This is when we typically should expect a pickup in inflation and a tightening in the labor markets such that the FOMC needs to continue its new trend with interest rates (in this case, higher). Again, the Fed raised rates at its December meeting. Now, the BCM has breached the 90 level which means the FOMC is typically “behind the curve” and may need to pick up the pace of its rate increases.
Remember, we have been waiting a long time for the normalization of rates, and this sure beats the heck out of having to talk about negative interest rates. Thankfully, that discussion topic is in the rear view mirror.
02/14/2017 02:27:52 PM
A Ray of Sunshine
Now that oil prices and commodity prices have rebounded and stabilized, we can pretty much say the manufacturing recession has ended. This is great news and it is confirmed by some recent strength in a very important model of mine. Those of you who can’t take hearing some good news from me, don’t read on.
According to my Future Production Barometer (below), we are set to see continued improvement in industrial production and this should improve U.S. GDP numbers in Q1 of 2017. We may even be able to achieve 2.5% growth in Q1. The supply/demand setup looks primed to take us to some of the best YOY% growth rates in production we have seen in a while.
The great news for us as bankers is this will greatly improve our credit risk for the foreseeable future (see chart below) as well. Now, this is a broad-based, generalized comment. There are still pockets of weakness in the oil, Ag and restaurant sectors but a future pickup in production should begin to minimize the credit risk in the trucking industry.
Under these conditions, we should see some overall earnings improvements which should improve company cash flows this year and we will hopefully enjoy a pickup in lending later this year. I will have more on this at the ALM
conference in April. Sorry to disappoint, but that is it, no gloomy “on the other hand” for you today.
02/01/2017 09:31:09 AM
Now that the election is behind us, all eyes are on the future. The shifts in sentiment since the election have been dramatic and they are measurable. There have also been cumulative changes going on in the US political structure over the last decade that, combined with the November election results, will have an impact on our long-term economic future, we just don’t know what that will be yet. This is important for us to remember, and reinforces my message of the last couple of years, that we need to continue to be bankers and not manage our balance sheets based on speculation about how things may unfold.
In the context chart below, we can see the changes in sentiment measures. The context chart measures a current data point relative to its cycle high. When you are at 100%, it means you are at a new high for the cycle. Small business sentiment, consumer sentiment and the stock market are all setting new highs for this economic "recovery" cycle. What are we to infer from this…exactly, we don’t know. Positive sentiment does not automatically equal new business.
Notice in the chart though, that the bond market is nowhere near it highs (in yields) for this cycle, and this is an important message I think a lot of analysts are missing. The bond market has clearly priced in some future reflation for the US economy but it has remained focused on what it does know, not what it thinks it knows. As bankers, we should follow the lead of the bond market, but that does not mean we lose our focus on risk management. Big changes are likely headed our way and your ALCOs need to have contingent strategies in place for them. Ben and I will be discussing these topics and potential strategies at length at the 2017 ALM
Users conference in April. We hope to see you there!
01/11/2017 09:43:33 AM