It is that time of year again and I must admit, I find myself in a bit of a panic!  But as always, I am excited to see all of you.  The ALMEdge conference is scheduled for Friday, April 6th and you can find all the details HERE as well as the opportunity to register for the event.

With the tax package in the midst of passage, something very encouraging is taking place that bears discussion.  In the December ALCOTalk newsletter, I finished up the newsletter with the phrase, “let the good times roll,” because if what I am about to show you bears fruit, 2018 is set to be a pretty good year for not only the US economy, but bankers as well. 
 
The chart below is a modified version of a chart put out by Bank of America Meryl Lynch (BofAML).  The model utilizes survey data that covers the most important sectors of the economy as it relates to GDP growth.  It contains survey data from the Institute for Supply Management (ISM), University of Michigan (consumer confidence), the National Federation of Independent Business (NFIB) and the National Association of Home Builders (NAHB).  The chart shows the combined level of the survey data in terms of standard deviations above or below trend and GDP growth on a year-over-year percentage change.


 
As you can see, this model does a very good job of predicting GDP growth; the benefit of this model is it helps us try to predict the future path of GDP growth.  Each of the data sets are released monthly, while GDP is released quarterly.  The reason I bring this up today is, it’s very clear in the graph that if everyone represented in these recent surveys does what they imply, we are in for a nice boost in GDP growth in 2018.  The bonus for community bankers lies in the graph below.  It shows the same model relative to the growth rate of total loans & leases rather than GDP.  It clearly shows us to get ready for a nice pickup in lending activity.


 
I am crossing my fingers that this will be our reality for 2018.  However, as I layed out in the last newsletter, this has important implications for the glide path of interest rates in 2018. 
 
As a side note, I want to let you all know I/we really appreciate your business realtionships and thank you for a great year. Have a very happy holiday, and I am sure there will be plenty to discuss next year.
 
P.S. for those who are not aware, the ALCOTalk newsletter is a subscription-based newsletter which is published every other month, and has a subscription price of $300/year.  If you are interested in subscribing just let one of us in the ALM department know.
 

The FOMC began raising the Fed Funds rate in December of 2015.  Normally, I would say "the FOMC began tightening in December of 2015” but I didn't.  In our current environment, I feel this is a very important distinction that should be discussed because it will play a role in how 2018 unfolds.

In normal times, the FOMC would tighten monetary conditions by reducing the size of its balance sheet.  This should immediately take you back to your Econ 101 class; the less there is of something valuable, the more it will cost you to have it.  In the world of community banking, this means higher interest rates.  Because of the financial damage created by the “great recession,” the FOMC needed to change how this process works.  The FOMC adopted a “corridor” system that would prod financial markets to move the Fed Funds rate higher for the Fed.  The plan was to start paying banks a rate on their excess reserves (excess balance account rate or EBA rate).  By doing this, they created a competitive marketplace for the Fed Funds market and that shoud force the Fed Funds rate to move up near the EBA rate.  This system works great for its intended purpose but it has hardly led to a “tightening” of monetary conditions.  Why?  Well, because the FOMC has done nothing to shrink their balance sheet.  In fact, they have continued to ADD LIQUIDITY to the system by paying more interest on excess reserves.   The chart below proves this out.  This is the Chicago Fed National Financial Conditions Index that shows how tight (rising line) or easy (falling line) monetary conditions are.   The red box shows conditions have been getting easier since the FOMC began raising rates in December of 2015. 

 

The real tightening of monetary conditions has only just begun (yes, I suddenly hear that Carpenters tune in my head too).  The FOMC announced after their September meeting that they would start to reduce the size of their balance sheet beginning in October.  I presented the schedule of asset sales and dollar amounts established by the FOMC in my October ALCOTalk newsletter.  Below is a chart of the Treasury bond portfolio held by the Fed.  As you can see, they are keeping their promise and have begun the process of reducing the size of their balance sheet.


 
This may look ominous, but if we extend out our view to put this into the proper perspective, you will see there is little to fear, for now.  This is an insignificant amount of reduction relative to the overall size of the portfolio but remember, the amount of Treasury bond and MBS reductions (tightening) will only grow next year. 


 
I bring this up now because eventually history will repeat itself as it relates to the tightening of monetary conditions (think economic slowdown/recession).  We will start to notice the impact of the tightening process in the leading indicators first, therefor, I think its prudent to start watching these closely for clues about the how our future may unfold.  For now, enjoy the stable and profitable banking environment and I wish you all a very happy holidays!