The chart above shows the progression of Libor since the Fed’s first rate hike in December 2015. The progression was smooth until QT (discussed twice before this year) started to kick in at the end of 2017.
Now Libor has taken off to the point that its spread to the Fed Funds rate has reached the highest levels since 2007/09, as shown below.
Trey Reik explains why this is a development that needs some attention:
“ … while the Fed has hiked rates 25 basis points so far in 2018, Libor has jumped 66 basis points during the same span. Credit analysts can philosophize all they want about whether the current Libor-OIS blowout technically constitutes credit-market stress, but we are pretty sure that cranking up the interest rate on $350 trillion of financial obligations at a pace two-and-a-half times the speed of FOMC tightening is the dictionary definition of financial market stress!
We believe Libor’s unruly ascent is an important signal that the Fed’s delicate attempts to vacate the zero bound have finally triggered a domino sequence of evaporating market liquidity. We interpret the Q1 2018 explosion in Libor-OIS as tangible evidence that the Fed’s dual policy objectives are straining global USD liquidity. U.S. bank credit and M2 money supply are slumping towards unacceptable growth rates. The Fed’s scheduled Q4 2018 QT amounts to 4.4% of U.S. M2 outstanding, exceeding the aggregate’s 3.9% growth rate in Q1 2018. We find it implausible the Fed will permit its QT program to inflict outright contraction on U.S. money supply.”
As shown in the chart above Charles Hugh Smith points out that the Fed is leading the central banks to redeem or reduce their asset purchases.
“Central banks have been running a grand experiment for 9 years, and now we’re about to find out if it succeeds or fails. 2018 is the first test year.
The reality nobody dares acknowledge is that a “recovery” based not on improving productivity and innovation but on cheap credit and an artificially stimulated “wealth effect” was inherently weak, for the stimulus effectively hollowed out the productive economy in favor of the financialized, speculative economy and created perverse incentives to over-borrow and over-spend, stripping future demand to create the illusion of growth in a stagnating economy of rising wealth and power inequality.”
For the central banks to be right the private sector needs to step up as the central banks step down. However, as the chart above shows productivity has collapsed to the weakest levels for decades.
So where will the sources of private sector growth come from?
Richard Duncan surveys the options.
“Less Savings, More Debt, Increasing Vulnerabilities
Total debt in the United States increased by $2.6 trillion last year. This year it will increase by roughly $2.9 trillion. For every debtor, there is a lender. The new Macro Watch video shows who acquired the new debt that was sold in 2017 and who is likely to acquire the new debt that will be sold in 2018. It also considers the three sources of the money that are now financing US borrowing:
2. Money Creation by Central Banks
3. Credit Creation by Banks and other Financial Institutions
As recently as the 1960s, US Savings funded all US borrowing. Those days are far behind us. Last year, Savings funded only 21% of all US debt. Personal savings as a percent of disposable personal income fell to 2.6% at the end of 2017. Other than during mid-2005, it has never been lower. Net National Savings as a percent of gross national income was also near a record all time low, at 1.3%. In 2018, Net National Savings is likely to fall further as the government borrows heavily to finance its expanding budget deficits.
The “Rest Of The World”, primarily foreign central banks, own 17% of all US debt. The Fed owns 6%. With the US trade deficit widening, foreign central banks can be counted on to print more money and buy even more US debt this year. The Fed, however, will, in effect, be a seller rather than a buyer of debt for the next three years as it allows its bond portfolio to mature and wind down. Consequently, Quantitative Tightening will largely offset the debt purchases made by the Rest Of The World.
That means if Credit is going to expand enough to keep the US out of recession this year then it is going to have to be financed through Credit Creation by the banks and other financial institutions. There is no limit as to how much Credit the banking system can create through fractional reserve banking – other than the ability of the borrowers to pay interest on the money they have been lent.
And there, of course, is the problem. The private sector remains heavily indebted and the growth in real disposable personal income remains depressed. Income is not expanding as rapidly as debt. All of this points to the increasing vulnerability of the financial sector.
Now that Borrowing is funded primarily by Credit Creation, the economy is much more sensitive to interest rates than it was in the past. If the Fed continues tightening monetary policy through interest rate hikes and Quantitative Tightening, it is very likely to set off a new wave of loan defaults. Should that occur, Credit would contract and the economy would quickly slide back into a severe recession.”
With so much at stake from bank credit it is worth considering if this could do the job. The chart above does not provide much inspiration. Ever since the Fed began tightening bank credit growth has been falling.
Something does not seem to add up and so far QT seems to be leading the S&P 500.