Balance Sheet Shrinkage, Boom and Bust

With the hoped for Fed plan to hike interest rates two more times this year and a building swell of discussion on when to start allowing balance sheet shrinkage, I’m beginning to sense a pattern on what the preferred timing might just be with this all. Bill Dudley on Friday said “If we start to normalize the balance sheet, that’s a substitute for short term hikes…and we might actually decide at the same time to take a little pause in terms of raising short term interest rates.” Fed President and voting member Patrick Harker last night said they may start the shrinkage process “possibly by the end of this year, or beginning of next year” which “would be an appropriate time.” Well, if press conference meetings are truly the only ‘live’ ones (June, September and December) notwithstanding what Fed members say and they would like to possibly start letting their bond holdings run off by year end, it seems like they would want to get that 3^rd hike of the year in by September so they can shift focus. Then by December or January, Janet Yellen can see the full exit from an unprecedented one decade experiment underway as she rides off into the retirement sunset. Queue the violins.

Before those tunes are played though, they might have to watch another sequel of ‘Boom and Bust’ this time in the auto sector produced and directed by easy money. I say ‘might’ because as the writing is on the wall we’ll of course have to see how things play out. This is not tech in the late 1990’s and certainly not the housing boom/bust in the naughts in terms of dollar size but talk about sensing a pattern over the past 20 years. At $1.1 Trillion, the auto loan market is a size pretty similar to the student loan debt market which is another problem itself (See Dudley’s comments yesterday on the impact there). To move cars/trucks off the lot in March at a rate similar in size to the mid 2000’s with a US population that is much greater and at a pace last month that was the lowest since February 2015, it took incentives that totaled 10.3% of the sticker price, the highest since 2009. Days of inventory was 70 in March, the most since July 2009. We saw the stock action in US auto makers yesterday and those in Japan and Germany today are down between 1 and 3%.

Here is a chart attached overlaying the size of the auto loan market and the SAAR rate since June 2009 when the recession officially ended with sales in white and loan growth in orange:

Then in turn the potential ripple effect on growth has the 2s/10s US Treasury spread down to just below 109 bps, the lowest since the day after the US election, vs 113 on Friday and vs 122 bps three weeks ago. We need those tax cuts and we need them now.

Of course, if we don’t get the tax reform and we feel in a greater way the economic reverberations of the slowdown in interest rate sensitive areas of the economy, we won’t get two more rate hikes let alone balance sheet shrinkage.

At the end of the day, lower interest rates induced by central banks is all about encouraging leverage and disincentivizing savings. Central bankers claim nobility by believing they help to create jobs and contribute to price stability where all they do is induce excessive borrowing and higher prices. Let’s look at the Bank of England. They further ease after Brexit and the minutes today from their Financial Policy Committee meeting of a few weeks ago reveals they are now worried about excessive consumer debt. “Consumer credit had been growing particularly rapidly. It had reached an annual growth rate of 10.9% in November 2016, the fastest rate of expansion since 2005, before easing back somewhat in subsequent months. Growth had been broad based across different segments of the market. Dealership car finance had seen the fastest expansion in recent years, but credit cards and personal loans had contributed materially to the acceleration in consumer credit in 2016.” So the British citizens now have too much debt, rising inflation because of a weak pound and wages that aren’t keeping up. Thanks BoE.