Eight Months into Quantitative Tightening: Where Are We Now?

It has been eight months since the Federal Reserve began its balance sheet reduction program, affectionately adapted as "quantitative tightening (QT)" by Wall Street, the opposite of the "quantitative easing (QE)" program the Fed used to purchase securities after the 2007-2009 recession.

The pace of this balance sheet 'normalization' program was outlined in the Federal Open Market Committee's June 2017 policy meeting as an addendum, and was outlined as below:

For payments of principal that the Federal Reserve receives from maturing Treasury securities, the Committee anticipates that the cap will be $6 billion per month initially and will increase in steps of $6 billion at three-month intervals over 12 months until it reaches $30 billion per month.

For payments of principal that the Federal Reserve receives from its holdings of agency debt and mortgage-backed securities, the Committee anticipates that the cap will be $4 billion per month initially and will increase in steps of $4 billion at three-month intervals over 12 months until it reaches $20 billion per month.

So, for Treasuries, the Federal Reserve began "rolling off" $6 billion worth of securities each month in 2017 Q4, and then $12 billion of securities each month in 2018 Q1, now at an estimated $18 billion per month in 2018 Q2. In July, that pace will again accelerate to $24 billion per month for the third quarter. For mortgage-backed securities (MBS) and agency debt, the initial pace in 2017 Q4 was $4 billion per month, then $8 billion per month in 2018 Q1, followed by $12 billion per month now in 2018 Q2. Similarly, this will increase again to $16 billion per month in 2018 Q3.

Adding it all up, the second quarter of 2018 is seeing the Federal Reserve "roll off" $30 billion in securities per month, for a cumulative $90 billion in securities released for Q2. When Q3 rolls around in July, the total number of securities coming off the Fed's balance sheet each month will ramp up to $40 billion, for a cumulative $120 billion balance sheet reduction in 2018 Q3.

This process is not an exact science, of course, so these numbers are more reference points than anything. But data from the Federal Reserve shows that this process is already well underway.

Source: St. Louis Federal Reserve FRED

The size of the Federal Reserve's balance sheet has shrunk from $4.46 trillion on October 4, 2017 to $4.32 trillion as of June 6, 2018, for a total reduction of $140 billion. By the math and FOMC guidelines above, through May 2018, roughly $150 billion in securities should have already been subtracted from the balance sheet. In the broad scheme of things, this discrepancy is pretty minor, and the key takeaway is that the Fed is proceeding with its balance sheet normalization program pretty much as advertised.

One of the main worries about quantitative tightening is that this increased rush of Treasury debt supply would ratchet up U.S. bond yields, thereby tightening domestic (and, for all intents and purposes, global) financial conditions as interest rates on mortgages and other consumer debts rise as well. Has this worry panned out?

Source: St. Louis Federal Reserve FRED

It is not debatable that U.S. Treasury yields have increased since September/October 2017. The 10-year Treasury note yield (the red line above) has risen from ~2.1% in September 2017 to as high as nearly 3.1% in May 2018. That's an increase of about 100 basis points in just under eight months- a non-trivial increase. However, it is wrong to fully attribute this increase in bond yields to the Fed's balance sheet reduction program, no matter how enticing the above chart makes that conclusion.

First, global growth was seen picking up to end 2017. Indeed, the phrase 'global synchronized growth', or something similar involving the word "synchronized", became quite popular as both advanced economies (AEs) and emerging market economies (EMEs) saw economic output kick into a higher gear. 

Prior to this, the United States was holding the honor of comparatively-strong economic growth; the eurozone continued to shake off scars from both the financial crisis and sovereign debt crisis into the middle of this decade, while China took a hard stumble near the halfway point of the decade. India's sudden demonetization injected uncertainty into the minds of foreign investors, and a less-than-stable banking system continues to stand in the way of more sustained and confident economic growth. 

However, 2017 saw the core of the eurozone - especially Germany - regain its economic mojo, with German real GDP growing at an annual rate of 2.9% in 2017 Q4, the highest mark since 2011 Q3. Worries over the Italian banking system were soothed as the largest trouble spots - Banca Monte dei Paschi di Siena and two regional banks - were cleanly dealt with. Elections in several major EU countries saw populist candidates lose out, much to the cheer of investors. Outside of the EU, China beat expectations with 6.9% annual GDP growth for 2017, African nations continued to see infrastructure investment as part of China's Belt and Road Initiative (BRI), and protectionist fears around the globe, aimed primarily at the U.S., were put off ... until this year, apparently.

The rebound in global economic growth provided a very convenient excuse for investors to diversify their portfolios and pursue investments in the eurozone, Africa, and other regions. The comparative decrease in the attractiveness of U.S. assets was likely a factor in sending U.S. interest rates higher.

Second, the new U.S. spending bill passed at the tail end of 2017 requires a significant uptick in the issuance of U.S. Treasury debt. This is an added supply burden to the increased supply already in place from the Federal Reserve's balance sheet runoff, and it's quite likely both the expectation and reality of increased Treasury debt supply due to the spending bill boosted U.S. bond yields.

Thus, while the Federal Reserve's "quantitative tightening" program is more than likely raising U.S. interest rates (and will likely continue to do so as the program's pace accelerates), there are other factors at play that have helped to keep interest rates elevated.

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So, where are we now? The Federal Reserve Bank of Chicago's Adjusted National Financial Conditions Index (ANFCI, a preferable acronym to that whole mouthful), a good way to see how easy or tight financial conditions are, has indeed increased since November 2017, but remains solidly in negative territory. In the ANFCI, negative values imply easier financial conditions.

Source: St. Louis Federal Reserve FRED

Warranting more attention than the ANFCI is the rise in mortgage rates, which have jumped from 3.90% to start December 2017 and peaked at 4.66% on May 24, 2018- a rise of 76 basis points in about six months, again a non-trivial movement. 

Source: St. Louis Federal Reserve FRED

I believe this rise in mortgage rates will eventually hurt housing, but I could (and probably will eventually) write a whole separate post about the reasons why and why not these higher rates could hurt housing this year. For this post, though, it's likely that the Federal Reserve's "quantitative tightening" program has helped increase mortgage rates, again combined with other factors.

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In general, these effects of higher U.S. bond yields are not yet significant, particularly when compared to yields of over 5% as recently as the eve of the financial crisis. It's plausible that there is some "sticker shock", particularly with respect to the higher mortgage rates, but aside from this the effects of the Federal Reserve's balance sheet runoff have not been debilitating, or even so much as notably inhibiting to the financial system. Indeed, "cov-lite" leveraged loans remain a hot commodity in global financial markets.

For now, "quantitative tightening" is more akin to a few gentle turns of the screwdriver than an electric drill. Perhaps in another eight months, the screws will have tightened even more... or perhaps too much more.

Andrew

Economic Data Continues to Suggest Late-Stage Business Cycle

A review of economic data continues to suggest the United States is in the late stages of the current economic expansion of the broader business cycle. We'll begin analysis of the economic data with monthly job openings for total non-farm jobs.

Source: FRED of St. Louis

Shown above are total non-farm job openings for the United States since just before the recession that began at the turn of the century. Increasing job openings indicates increasing opportunities for the unemployed to find a job, and thus signals a healthy (or at least improving) economy. This phenomenon is seen in the aftermath of both the dot-com bubble recession and the 2007-2009 recession (shaded gray areas).

I input a trend line (red), from the nadir in job openings after the 2007-2009 recession to around the value reached in April 2017. This is to show the general slope of job openings so far, and can be used practically by watching for any sudden deviations from the trend line, for example if the number of job openings were to suddenly skyrocket or plummet.
I also input a shorter-term trend line (green), which begins January 2015 and ends May 2017, the last recorded data point. Note how the slope of this new line is notably lower than the slope seen throughout the entire economic expansion. While we can visually see the values still oscillate around that red slope line, the recent trend has been to see momentum in job openings slow. The green trend line is meant to show that while the number of job openings still appear to be expanding, indicating some slack in the labor market, the momentum of this upward trend may be beginning to falter, a typical symptom of the late stage of an economic expansion of the business cycle.

One data set is not nearly enough to validate such a claim, of course, so we'll now expand our view into a few more parameters.

Source: FRED of St. Louis

To broaden the scope of parameters that generally track the business cycle, I created a graph composed of total non-farm job openings, levels of commercial and industrial (C&I) loans from all commercial banks, total vehicle sales, and the unemployment rate. These parameters are shown in the lines colored blue, red, green and purple, respectively. Additionally, note that these lines do not use the raw data numbers (e.g. job openings in thousands of people or unemployment rate in percentage), but instead are made into an index. In other words, I have set each parameter to show an index value of "100" at their respective nadirs during or immediately following the 2007-2009 recession. By using this index format, we are better able to track slowing momentum and potential turning points in these business cycle-sensitive parameters.

Commercial and Industrial Loans, All Commercial Banks
Since the total non-farm job openings parameter has been analyzed above, we now take a look at commercial and industrial loans created by all commercial banks, as aggregated by the Federal Reserve. For this parameter, the index value of "100" was set for October 2010, the lowest point in C&I loans resulting from the 2007-2009 recession.

Loan growth was originally negative following the end of the recession, as seems to generally happen following economic recessions (see a similar phenomenon occur following the early-2000s recession). Loans picked back up around 2011, and has been on the uptrend since. While I have not drawn out a trend line, you can see the relatively steady upward slope in C&I loans from ~2011 to the start of 2016. From 2016 until today, however, we note that the level of commercial and industrial loans given by commercial banks has plateaued. It is possible this stems from businesses not needing any further credit, having had the last eight years to enjoy economic growth. It is possible loan growth has slowed as businesses are no longer as confident about the future to significantly invest in long-term plans via loans. There is a wide variety of possible triggers for this plateau, but no matter the true reason(s), C&I loan growth has indeed appeared to hit a plateau.
This is similarly symptomatic of a late-stage economic expansion, as companies (again, for unknown reason(s)) begin to curb their loans. Should this be a protracted phenomenon, the lack of strong investment in long-term growth plans could hamper the current economic expansion.

Total Vehicle Sales
Vehicle sales are seen as another indicator of the business cycle, for their widespread usage by consumers but also their position as a durable good. As a durable good, vehicles will generally be purchased when consumers are upbeat about the economy and have ample funds. Consequentially, vehicle sales track the business cycle. For this parameter, the index value of "100" was assigned to February 2009, the nadir of sales amidst the recession.

Similar to C&I loans, it is not difficult to visually draw a line from February 2009 to roughly mid-2015 where the growth / slope line of vehicle sales was stable and strong. While 2015 and 2016 both saw record vehicle sales, the years also saw the emergence of a plateau as vehicle sales jumped from 16.9 million in 2014 to 17.8 million in 2015, followed by 17.9 million in 2016. Analysts have noted poor vehicle sales numbers so far in 2017, at least relative to the prior record-setting year. The apparent retreat of consumers from vehicle purchases may suggest less confidence in the economy, a preference to save money, or other reasons. Again, the reasoning may be unclear, but the data once again shows a characteristic of a late-stage economic expansion.

Unemployment Level
This parameter isn't shown here to be scrutinized for a plateau so much as a slowing in momentum. Note in the early-2000s recession and the 2007-2009 recession that the unemployment rate only began rising notably in roughly the middle of each recession. Consequentially, the unemployment rate appears to be a bit of a lagging indicator. Thus, to identify a late-stage economic expansion, we would be seeking continued downward movements (signaling lower unemployment) but at a slower clip than before. The unemployment rate index was set to "100" for October 2009.

It's not difficult to see that we have entered a lower grade of momentum for a decreasing unemployment rate, the expected signal of a late-stage economic expansion. Since this is more of a lagging indicator, analysis is somewhat less clear than C&I loans or vehicle sales, but we can still see here that the labor market is approaching full employment, which would likely signify the peak of the economic expansion.


We've now gone over a handful of broad economic indicators and seen that there are some red flags pointing towards the United States currently in the ending stages of the economic expansion. A personal favorite of mine is to look at delinquency rates for various types of loans, as delinquency rates typically increase prior to the official start of a recession, as defined by the NBER. Once again, I have set the parameters to indexes and set the index value of "100" at each parameter's respective nadir during or immediately following the 2007-2009 recession.

Source: FRED of St. Louis

In this chart, I have shown a number of delinquency rates:

• Delinquency Rate on All Loans, All Commercial Banks (dark blue, index=100 at 2010 Q1)
• Delinquency Rate on Loans Secured by Real Estate, All Commercial Banks (red, index=100 at 2010 Q1)
• Delinquency Rate on Credit Card Loans, All Commercial Banks (green, index=100 at 2009 Q1)
• Delinquency Rate on Commercial and Industrial Loans, All Commercial Banks (purple, index=100 at 2009 Q3)
• Delinquency Rate on Consumer Loans, All Commercial Banks (turquoise, index=100 at 2009 Q2)

These various delinquency rates cover a rather broad area of delinquent loans (e.g. the Delinquency Rate on All Loans), but also on more focused portions of the economy (e.g. Delinquency Rate on Credit Card Loans). I won't go into detail on each individual parameter here because they're all not too dissimilar from each other, but it's quite apparent that prior to the last two recessions, we have seen delinquency rates across the board first lose downward momentum, and then begin rising in the months before the recession's official start. 

This trend of a trough, followed by rising delinquency rates prior to the official start of a recession is seen across the board for the five delinquency rates graphed above. In recent months, we have seen mixed indicators. For instance, the Delinquency Rate on All Loans and the Delinquency Rate on Loans Secured by Real Estate are exhibiting some slowing downward momentum, but the delinquency rates on credit card loans, C&I loans, and consumer loans appear to be rising. With these mixed signals not allowing us to say that a recession is definitely on the horizon, these delinquency rates do appear to show a late-stage expansion.

There are other economic data we could observe that both support and deny the assertion that we are in a late-stage expansion of the business cycle, but with the consensus seeming to revolve more around the confirmation that we are in a late-stage economic expansion, it's worth more to see if that is indeed the case than to decide otherwise and potentially be burned by that ignorance.

In sum, I do believe we are in the late stage of this economic expansion- an accusation that has been made before to no avail, but this time supported by economic data. 

Andrew

Libor Increases At Quickest Month-over-Month Pace in Over 12 Months

The 3-month London Interbank Offered Rate, or Libor, has recorded its strongest month-over-month increase from the start of June to the start of July in at least twelve months.

Note: Dates are meant to signify the start of each month, and the first of each month may not necessarily have been a business day.

From the first business day of June to the first business day of July, the 3-month Libor rate increased by 8.266 basis points, from roughly 1.22% to about 1.30%. Previously, the strongest increase in this rate had been from August to September 2016, when the rate saw a rise of 7.657 basis points from ~0.76% to ~0.84%.

The magnitude of increases in that period and the current period may have been similar, but the consequences are different. An increase in the Libor rate to 1.3% at this magnitude of over eight basis points signifies tighter financial conditions, tightening at a respectable pace. To be sure, a Libor rate of 1.30% today is well below the 4.54% rate seen at the start of January 2006, just before financial markets began seizing up as the financial crisis commenced.

Thus, a Libor rate of 1.3% still reflects rather loose monetary conditions - however, these conditions are certainly tighter than those seen in fall 2016, going strictly by the three-month Libor rate. Indicators such as the St. Louis Fed's Financial Stress Index show incredibly accommodative monetary policies, ascertained by a broad variety of financial instruments and indicators. I don't disagree with this, hence the emphasis on how monetary conditions appear somewhat tighter only relative to last fall.

From the start of June 2017 to the start of July 2017, the three-month Libor rate increased at a magnitude not seen in over a year, indicating a quickening pace of tightening monetary conditions. However, when zooming out to broader indicators (e.g. St. Louis Financial Stress Index) and broader timeframes (e.g. 3-month Libor in January 2006), monetary conditions remain quite accommodative. For now, this is merely something to keep an eye on.

Andrew

Dollar Bulls Will Ride Again... If Not Now, Then Soon...

Dollar Bulls Will Ride Again... If Not Now, Then Soon...

MyFxBook

There's some shifting going on in the currency markets, especially in major currency pairs. The first image shows latest readings of the Euro (currency pair EUR/USD), which is currently in the retesting phase of a true 'head-and-shoulders' pattern. This pattern is identified by a rise in the value of a security, followed by a dip, followed by another rise, followed by another dip, and a final rise and a final dip to give the appearance of a head and two shoulders.
In the finance world, this is a 'bearish' pattern, a pattern that anticipates the value of the security will fall soon. The 'retesting' is shown right now, as we see the value of the security hovering just under that red line, called the 'neckline'. When this retesting is complete, which will happen soon, the Euro is expected to fall in value yet again, likely into the rest of January and February.

MyFxBook

The second image shows the value of the Yen (currency pair USD/JPY). Notice another neckline shown by that red line, but this time it is an INVERSE head-and-shoulders pattern. It's that head-and-shoulders pattern, but turned upside down. Similarly, instead of being 'bearish', this pattern is 'bullish', anticipating the value of the security will rise soon. Thus, the Yen is expected to decrease in value again in the near future.

Teletrader.com

It's no coincidence that these two things are happening at the same time. When the Euro and Yen both fall in value, as is projected to happen per this technical analysis, it's typically due to the U.S. Dollar strengthening. The third image (the Spot Dollar Index, symbol DXY) shows what may well be a very messy inverse head-and-shoulders pattern in the short term, using the same time intervals as the first two images, but again it's very messy. The messy quality of this pattern throws into question a strengthening dollar.

But this question exists only briefly.

In my fourth and final image, I show you what will be a news story for the next several years. We are currently going through, if not just exiting, the retesting phase of an inverse head-and-shoulders pattern in the Spot Dollar Index, but this time it's a 20-month-long pattern instead of just a couple of days, like the first three images.

Teletrader.com

It will be a consistent news story, because it could very well usher in the next recession. A stronger dollar for the long term is favored strongly by this technical analysis in the fourth image. While it increases purchasing power of the U.S. consumer, it will increasingly trim profits of multinational companies, especially those who make the majority of their revenue from other countries. Converting those currencies into a stronger US Dollar will take more of that country's currency to make 1 USD. Over time, that hurts companies' earnings, and by extent their stock prices.
The stronger dollar will force the Federal Reserve to hike overnight lending interest rates faster than they want to, something that will squeeze the bond bull market (which is already looking shaky post-election). For companies that have been living off of easy monetary policy put into place by the Fed since the Recession, this is a big threat. If it comes to fruition is another question and another story for another day, but the threats are very real.

To summarize:
1) Short-term weakening is expected for the Euro.
2) Short-term weakening is expected for the Yen.
3) Simultaneously, strengthening is expected for the U.S. Dollar.
4) Long-term, the U.S. Dollar is expected to strengthen, and may very well be the catalyst for the end of this already very-long economic expansion.

Andrew

Yellen's 'High-Pressure Economy' May Pressure Stocks

Janet Yellen laid out her take on current monetary policy in Boston on Friday at a luncheon, describing how a "high-pressure" economy may be necessary in order to boost growth. The speech comes at a time when the Federal Reserve is divided on whether to raise benchmark interest rates this year, or keep them steady at their historically-low levels. (More information on her speech can be found in this link from Reuters).

I have a few concerns about letting inflation run temporarily hot.

FRED - Federal Reserve Bank of St. Louis

Shown above is the civilian unemployment from January 1948 to the most recent data point, September 2016. Shaded gray areas indicate economic recessions. There are two main take aways from this graph:

1. When looking at past economic expansions, a common signal that the expansion is coming to an end is when we start to see the slope of the unemployment rate line go to zero. This was seen prior to the recessions of 1970, somewhat in 1973-1975, again in ~1979 and ~1981, and notably just before the early 1990s recession, the early 2000s recession, and a bit before the Great Recession back in 2008. While one could nitpick and say the slope never did get to zero, merely eyeballing it shows that before recessions, the unemployment curve generally becomes flat, if not close to flat, as the economy reaches full employment.
Taking a look at our current position on the curve, we're right around (if not at) that point where the unemployment line's slope hits zero-ish. The table below illustrates this quite well:

The attached table shows civilian unemployment data from FRED, compared year-over-year for September of each year during the current economic expansion. We began the economic expansion in September 2009 with a change of -0.3% from then until September 2010. The YoY change in the unemployment rate from September 2015 to September 2016 was the smallest change throughout the entire economic expansion when looking at September YoY changes. I haven't run the data for all the months' YoY change, but going through a few more data points, it appears this could very well be the smallest YoY change throughout the entire expansion, including all months' YoY changes.
What does that tell us? Right now, the only thing we can plausibly assert is that the labor market is near full employment, based on how the slope of the unemployment line is getting closer and closer to zero. I don't believe this shows that a recession is barreling our way, primarily because the Fed is keeping monetary policy extremely accommodative and investor sentiment remains more-or-less high, though we saw an unexpected drop on the Consumer Sentiment Index on Friday. However, given the Consumer Sentiment Index is a lagging indicator, and by most other measures the domestic economy is still chugging along, I don't believe a recession is pending in the short-term.

2. Despite claims that the labor market is not yet at full employment, recent recessions indicate it could be. Referring back to the FRED unemployment rate chart, note how the minimum unemployment rate, or at least the point when the slope of the curve begins to flatten to zero, has been creeping up ever since April 2000, when it hit an expansion-low of 3.8%. The expansion-low prior to the Great Recession was 4.4%, hit multiple times from Fall 2006 to Summer 2007. Our expansion-low in our current economic expansion is 4.7%, from May 2016. The gradual uptick in apparent minima with respect to the unemployment rate could be a signal that our labor market is at full employment, in addition to the signal from the flattening slope of the curve.

                    ______________________________________________________________

My other main concern resides in the fact that the stock market is already near record highs, and broke record highs this past summer. Allowing inflation to run hot could create a bubble, if one hasn't already been formed.

Big Charts - Marketwatch

The chart above reflects the DJIA's history through early 1988 or so, on a weekly scale. Note how we are currently just below record highs reached earlier in the summer. Record stock prices generally come about around the peak of a bull market, and it's been my belief for some time that we are either at the peak or just past the peak of this current expansion's bull market. But that's not my primary point of discussion relating to the stock market.

Extraordinarily-accomodative monetary policy in the U.S. for the last many years, and expectations of continued accommodative policy, has led to prolonged risk-on sentiment, as reflected in the record highs for all three major equity indices this past summer, and the near-record-high valuations at present date. Many financial analysts promote the idea that this accommodative policy has led to the 'Central Bankers' Bubble', named after central banks' continued enforcement of such monetary policy that some believe has blown a bubble in more than just one specific asset. To be sure, this is by no means a prevailing opinion, as far as I can tell, and the theory that we are mid-bubble does not stand for all financial analysts. However, I do personally believe that this is the case, at least to some degree, and this is where my concerns over a 'high-pressure economy' come to light again.

In a general sense, inflation is bearish for the stock market. When inflation begins to ramp up, typically the Federal Reserve will act to tighten monetary policy by hiking interest rates, thus placing a more risk-off sentiment across financial markets as investors leave stocks and seek safer investments, like bonds. However, if the Federal Reserve were to maintain low interest rates while allowing inflation to rise, the 'lower-for-longer' concept (the idea that interest rates will stay lower for a longer period of time) that has boosted stock prices over the last few years would persist. Inflation would begin to eat away at the stock market, and at that point the Fed would begin tightening monetary policy, but until then it would be a continuation of low interest rates and more-or-less tepid inflation, until the 'high-pressure economy' kicks in and inflation rises.
Why the worry? With inflation expectations so low, we could be talking about a number of years in a low interest rate, low inflation environment, which would almost certainly blow an equities bubble, if one hasn't already begun forming. Consequentially, if/when inflation reaches a point that the Fed deems as conducive to hiking interest rates, the pullback in stock markets would be far sharper than it would be if the Fed were to hike rates today.

In my eyes, the Fed has dug itself into a hole by maintaining interest rates for so low. To be fair, this was a good choice when you see how steadily the unemployment rate fell. However, good cases could have been made for a rate hike in the last few FOMC meetings, particularly after some FOMC members began taking far more hawkish viewpoints. Then, when they didn't hike, the Fed began losing credibility, but that topic is for another write-up. By allowing a low-inflation, low-interest rate environment to persist, possibly for a prolonged time period (longer than Ms. Yellen believes, as the FOMC is notorious in recent history for being too aggressive in their inflationary expectations), equities would almost certainly enter into a bubble, and if other assets also enter into bubbles as ultra-accommodative monetary policy continues, the pullback if/when tightening occurs could be nasty.

Lucky for us, all of this is hypothetical, and assuming the FOMC goes along with Yellen's ideals. While she posed the high-pressure economy as a 'question that needs more research', it's quite frank that she is looking for every excuse to not hike interest rates, and it's entirely plausible that the chairwoman is able to convince the FOMC to follow suit.

Andrew

Deutsche Bank: TBTF Edition

Over this past summer, I had the pleasure of reading Andrew Ross Sorkin's book 'Too Big To Fail', a beautiful reconstruction of the financial crisis at its roots. The book claims to have been based off of many interviews & previously-secret pieces of knowledge, and the material inside confirms it; it really is a fascinating book about the crisis.
The other day, I received in the mail another book titled 'Too Big To Fail', this one penned by Gary Stern and Ron Feldman, published in 2004. This book was essentially the 'warning shot' for the 2008 financial crisis, as it spoke of the dangers of bank bailouts. I have yet to dive into the book, but I'm very eager to do so. Aside from all the literature, while we thought the era of TBTF was more-or-less over, if not heavily reduced, Deutsche Bank this week proved that this is not the case.

Yahoo Finance

Attached from Yahoo Finance is a chart of Deutsche Bank's stock price from somewhere early in the trading session Tuesday, to the end of the trading session Friday. The Dow Jones Industrial Average is superimposed in green. You don't have to have a paid subscription to fancy charts and graphs to tell that DB was under some intense pressure both Thursday and Friday.

Thursday was not a good day for the banking sector. Two prominent events contributed to this general malaise, the first stemming from Commerzbank and the second from Deutsche Bank. Commerzbank announced that it would be eliminating nearly 10,000 jobs and suspending dividends for its stock on Thursday, news that sent a chill throughout the financial markets. This news came about prior to the start of the trading day, if my phone alerts are to be believed, and more or less set the tone for the financial sector before the American trading had even begun.

Trading kicked off for Deutsche Bank on Thursday pretty stationary from where it had closed Wednesday, hovering right around $12.25 per share. However, at around 12:20 PM ET Thursday, word got out that a handful of hedge funds were either pondering, or already commencing a cut in exposure to Deutsche Bank. This, of course, is not what investors wanted to hear, after the news about Commerzbank was already promoting a little more Advil than normal on this trading day. In a span of 40 minutes, from 12:20 PM to 1:00 PM ET, Deutsche Bank's stock plummeted from $12.22 per share to $11.39 per share, a 5.37% drop. The Dow responded similarly, dropping from 18,315 points to 18,151 points in that same timeframe. It eventually scraped the 18,100 mark right before 2 PM, but bounced back to close down over a hundred points on the day.

There are a lot of editorials out there with far more knowledge and experience than I possess, and that's fine; ideal, actually, as it gives people like me an opportunity to keep learning. And something that's been made a point of in some of these articles is that Deutsche Bank may remain Too Big To Fail. The financial markets certainly believe that; the CBOE'S VIX index jumped over two points in that same 40-minute time span we looked at above.

The nice thing here, though, is that this isn't Lehman Brothers 2.0. You'll notice that DB is sitting on a large quantity of cash reserves, has bonds that can be converted into equity if needed, and after Lehman in 2008, as well as observing the current state of our global economy, it would be nonsense to even imply that a bank as significant as Deutsche Bank would be allowed to fail. Deutsche is not Lehman 2.0, and is far from it.

StockCharts.com

After Thursday's scare, Friday brought a heavy dose of optimism back to the overall market, and especially Deutsche Bank. Its stock ended the day just over $13, a jump of over 10% compared to its Thursday closing price. This jump came on the heels of reports that the US government's settlement with the bank may come in around $4-6 billion, a fraction of the ~$14 billion charge initially levied against Deutsche Bank. I'm practically hitting my head on the wall at how I didn't realize that the settlement would be lower than the initial charge, leading to a rally like this; the bears got trapped and the bulls are running free in Deutsche Bank's stock, for now.

Technical indicators like the MACD and Bollinger Bands as portrayed above indicate that another, certainly more modest drop could be in the cards over the next couple days until the MACD crosses above the signal line again. What might be a bit alarming is how even despite Deutsche Bank's stock hitting an all-time low Thursday, it still stayed within the Bollinger Bands, which delineate the +2 and -2 standard deviations. Friday's rally has brought the price back just below the middle of these Bollinger Bands, but when you put together the still-iffy MACD and now-very-wide Bollinger Bands, a non-zero chance for further selling remains. I don't see it anywhere as severe as Thursday's selloff, but similar to the gradual downward trend we've seen since about May, depicted in the chart above.


Deutsche Bank is a Too Big To Fail bank, but it's a strong TBTF bank compared to the position Lehman Brothers was in when they started taking big beatings from hedge funds cutting exposure. Even if, for whatever reason, DB ended up needing government assistance to survive, common sense all but guarantees the bank would not go under, unless the end goal here was another significant shock to the system, and we know no one wants that.

Andrew