hello my friends today is October 12th and this is Market's weekly so this past week was a really good week in markets we had the S&P 500 sore to new all-time highs now I think of price as a good indicator for sentiment and it's looking pretty euphoric out there but today let's talk about three things first let's talk about the 10year yield surging to above 4% let's talk about what could be driving that secondly now over the past two years many people have pointed to the rise in autoone delinquencies as signs that the consumer is
cracking and the FED has to cut rates ASAP well a few fed researchers took a deep dive into the data and they're coming away with a slightly different conclusion let's hear what they have to say and lastly this past week Vice Sher Jefferson of the FED gave not one but two speeches on the discount window he really liked the discount window so let's take a listen to what he has to say about the history and potential future of the discount window okay starting with the 10year yield well the 10year yield closed Friday at around 4.1%
marking a notable surge uh from for the past couple weeks actually now many people have been commenting how does it make sense for the 10year yield to rise even as the FED uh is cutting rates now there's a couple ways to think about this now if you are a Doomer you can say that the FED made a tremendous policy mistake inflation is going to Surge out of control and the chener Yoda is responding to that or you could simply say that because the FED has been more aggressive in trying to get ahead of a potential
recession there's less of a chance of a recession and so the market is pricing in pricing in fewer rate Cuts now the rise in the tenure yield started in a big way last week we had a better than expected jobs report again jobs created much higher than expected and that seemed to really calm the market fear of a potential us recession and if you if you you know have less of a chance of having a US recession then obviously the market is going to price in fewer rate Cuts now another interesting data point came this
past week and that has to do with inflation now we got CPI data and looking at CPI it was across the board High higher than expectations now if you take a step back and look at core CPI year-over-year over the past few years should also notice that core CPI basically seems to be in a different regime now we were around 2% before the pandemic and now we are comfortably above three and more recently it looks like core CPI on a year-over-year level seems to be moving higher now um let's say a year or two ago
the FED wanted to focus Focus not so much on core CPI or headline they wanted to focus on something that they created called super core which is um Services X shelter now if you look at Super core again Services service inflation excluding shelter excluding rent you'll notice that that measure of inflation also is pretty high and pretty sticky that is largely due to elevated wage growth which has moderated but is still higher than prep pandemic levels so on one hand in looking at the Cher yield you can say that you know there's less of a
chance of recession on the other hand you can also think of it as inflation looks to be a bit stickier above pre pre pandemic Trends now of course this has a direct impact on how the FED thinks about monetary policy now not too long ago the market was pricing in quite a bit of red Cuts throughout the end of this year uh today the market is pricing in just one 25 basis point cut in November and a 25 basis point cut in December so 50 basis points to go now this past week we had some
pretty interesting fed speak where one fed president actually said he was comfortable with skipping rate Cuts in November but that person is not terribly important and the more important people in the FED seem to be intent on their plan to continue to cut rates uh but at a gradual pace and so the market is no longer expecting 50 basis point Cuts now looking forward for the next few years when we're thinking about interest rates it's not completely that's not all about what the FED does but we also have basic supply and demand Dynamics as well
in the treasury market now there's some interesting work by a nonpartisan organization about estimates of what the fiscal deficit would be under a Harris Administration or under another Trump Administration now according to this work they're thinking that uh well both both of them of course will spend a lot of money but person Trump will spend notably more now of course uh we have to keep in mind that spending is largely a decision of Congress so it what really matters is who wins Congress and also there's a big difference between what a candidate says on the
campaign Trail and what they actually do in office but I think it's pretty clear that if you look at our political culture again president Trump the past week telling everyone that you know let's just cut taxes more uh this time let's cut taxes for Americans living abroad so they don't have to pay worldwide income tax which is I think a great idea but in any case it's more tax cuts and Harris as we all know would like to spend more on uh subsidizing housing and so forth so we are in a cultural context where everyone
uh is trying to get elected by buying votes either by giving you money directly or by cutting giving you money indirectly by cutting your taxes so going forward uh I think the future will be different from the past and a tenure below 4% has always been a bizarre phenomenon to me um okay now the next thing that I want to talk about is auto loan delinquencies now looking at this chart of autoone delinquencies you notice that they've gradually ticked up and are comfortably above where they were pre pandemic now many people have been looking at
this and suggesting that this is an indicator that the consumer is cracking fed needs to cut rate ASAP this is really really bad so some fed researchers took a deeper dive in the data and they're coming up with a slightly different conclusion now the first thing they did was to look at this one level lower not on an aggregate autoone delinquency level but by vintage now what that means is let's look at the uh delinquency rates according to when the loan was originated and what they found was there was a notable higher delinquency rate for
loans that originated in 201 22 and as everyone recalls 2022 was kind of the height of the postco boom everyone was happy spending money stock market going to the Moon interest rates really really low so it seems that that cohort seems to have more problems um paying down their debt now then they took another us look at this data in another way and looked at it uh according to the amount borrowed and also by interest rates now what they came out with was that well one thing that that stood out about the 2022 cohort is
that they tended to borrow a lot more uh principle for their auto loans than they did in the past so from their reading that reflects the tremendous amounts of inflation we saw back then now from 2020 in 2022 again we were still suffering Supply chains from Co so there wasn't a very big supply of new cars and that meant there there was a massive com ition for them so car prices Rose and also used car prices Rose a lot as well so if you wanted to buy a car at that time you needed to borrow
more money and so at that time uh the people had higher loan balances which of course implies higher monthly payments and if you have higher monthly payments that means um it's more likely that you default because maybe uh you can't pay it the next thing they looked at is interest rates now looking at this chart what really interesting well first off it's a chart where on the xaxis you can see the interest rate you have to pay depending on your credit score very clearly lower credit score people pay higher loan rates on their auto loans
and on the y- axis is the loan interest rate now what's really interesting about this chart is as you can see uh over the past few years interest rates have gone higher for for auto loans but what's really noteworthy is that among the borrowers with low credit scores so on the uh leftand part of the x-axis you'll notice that in any case whether loans whether interest rates were zero or were there were 5 a half% they had to pay really high interest rates the bigger difference had to do with people with very high credit scores
for them uh the fed's rate hiking campaign had more of an impact on their autol loan interest rates so U basically if you have a low credit score no matter where the FED is setting interest rates you have to pay a really High really high interest rates because you uh are a higher credit risk and so the researchers are looking at this and says that because most of the delinquencies are in people with low credit scores and these low credit score people have to pay high interest rates regardless of whether or not the FED is
has rates at zero or 5% it's unlikely due to the fed's interest rate campaign that's causing this rise in delinquencies the rise in delinquencies seems to be driven by the inflation we had in the price of Autos which forced them to take out bigger auto loans Even If the Fed were had interestes very low they would as this chart shows still have to pay very high interest rates um so given that fact they look at the data today and they notice that car prices have come down a lot and banks have also tightened up their
credit standards and so because of these two aspects we're unlikely to see a rerun of this uh surge in autol Loan delinquencies in 2022 for auto loans originated today so the overall amount of auto loans from my perspective that delinquency rate seems to basically maybe be along its Heights and rather than worsen it's probably going to Trend lower going forward so maybe this surprising well this rise in not alone delinquencies overall seems to be due more to the idiosyncratic inflation secondary effects rather than anything to do with interest rate policy or as a clear sign
of what's happening in the labor market especially in the context of the broader data where GDP growth continues to be strong and at least by official data standards jobs continue to be created um okay now the last thing that I want to talk about is the discount window now Vice chair Jefferson at the FED gave two Spees on the discount window the past week talking about its history and its potential future now the backdrop of this is that the FED is thinking about revamping its discount window policy but first let's listen to some history so
now before there was a Fed now the uh the nation was under a gold standard and it was heavily agaran now today most maybe one or two% of the people are in agriculture back then a big chunk of people were in agriculture it was a big sector in the economy now when you have when you're under the gold standard again and you don't have lender of Last Resort banks are a little bit more constrained in the amount of loans they can provide because there's a real risk that they could be suffer a run after all
you can run out of gold and there's no one to back stop you now in that context when you have an agrarian economy uh credit demand is very cyclical especially around Harvest around Harvest Time Farmers would have to uh take out loans hire a whole bunch of people to to harvest and then they could sell the crop and get their money back and pay um pay back their loans so there is some cyclical demand in credit and credit was less elastic and so around say seasn no times money would flow from the Financial Centers at
that time say New York to the regional Banks and there would be some tightness of credit and maybe some fragility as well because if you have a harvest that's not very good maybe you have trouble paying back your loans and so that system didn't seem to be ideal and so they wanted to have a Federal Reserve as a central bank lender of Last Resort uh to be able to backs up credit and make sure that they wouldn't have these um so much seasonal tightness now so the Federal Reserve was born now at that time you
know you have this fed backstopping and it seems like the banks uh were pretty active in borrowing the discount window and maybe that contributed to some of the bad loans made by the banking sector in the 1920s and maybe some of the speculation and so starting in the 1920s the FED became a bit weary of making discount loans and wanted to discourage their active use again this is going to be a long-running theme throughout the fed's history whereas the FED wants to back stop the system but also doesn't want to create moral hazard where Banks
see that the FED is there to backtop them and begin to make riskier loans or speculate now starting the 1920s the FED began to do something called open market oper uh we call them you know basically go out and buy Securities that was a potential solution to this dilemma whereas instead of making adding liquidity through uh Emergency Loans the discount window maybe they would go out and buy Securities adding cash into the banking system and just let the markets work and distribute that liquidity throughout now over the next few decades the FED will try would
try to struggle to strike that balance between back stopping the system and also um preventing moral hazard now in the 1960s the FED actually set the uh discount window loan rate to below market and what they would try to do to prevent Banks from abusing that was basically regulation and moral suion they would tell the banks heavily discourage them to not tap the discount window unless they needed to they would create different types of lending to make it clear that you know you only do this if you if you really need it and some of
this is meant for shortterm and so forth but in the end and it it wasn't very successful now Jefferson has this chart where looking at discount window loans as a percentage of fed balance sheet you can notice that 70s and 80s a lot of banks were barring uh in the discount window um pretty regularly oh and I forgot this really cool chart from the 1920s that shows that again back then uh many banks were borrowing from the Fitz this account went all the time and so uh some of them were basically were having using the
FED regularly a huge number of Banks and so that's part of the reason why the FED became worried about moral hazard anyway back to the 1970s and 80s so the FED realized that their moral suion was not super useful in discouraging Banks because again discount window loan rates below Market Banks were just leveraging up and borrowing but then we will come into the '90s and we realize back then there was a kind of a big banking crisis many banks went bust and as they were getting into trouble uh they would borrow heavily from the discount
window and so the market began to associate discount window borrowing with the bank uh doing very poorly there became a very strong stigma attached to boring out the discount window and so you can see from this chart again that say in late 80s and 90s not much borrowing in the discount window because all the banks were aware that if they borrowed from that uh given all the bank barers at the time they would be uh they would be tired and so the bank account bank discount window is basically not used now the FED looked at
this and began to realize well if we have a discount window and no one's using it then it's not very useful and so they revamped again in the AR 2000s and the way that they're doing this since then is that rather than have below Market rates and then just disuade you they would have the discount window set at above Market rates and let you borrow uh whenever you want no question asked provided of course you know you're in good standing and not uh let's see there aren't any solvency concerns now that did seem to be
helpful um we saw that during the great financial crisis tremendous surge in discount window borrowing and more recently in the Silicon Valley Crisis Silicon Valley Bank crisis as well but one other thing that happened in after the 20 C8 financial crisis that we had new legislation called the dodf Frank act which actually mandated the FED to disclose in detail after 2 years who borrowed from the discount window and so it seemed like there's a return of discount window stigma given that if you borrow from the discount window uh people are going to find out eventually
so recently when we had that Silicon Valley Bank uh Panic the FED realized that something really strange was that Silicon Valley Bank they had a liquidity problem but they didn't really borrow from the discount window because they weren't even set up to borrow from the discount window they were borrowing from the home loan Banks and they didn't really have the documents in place to borrow from the fed and that set out alarm Bells because that tells the FED that we have this discount window no one's using it not just that but no one a lot
of people are not already even set up to use it so what they're trying to do now is one make sure that everyone is at the very least set up to use it and two they're finding ways to try to reduce the sigma um so that you know make the discount window useful again now during Co they did lower the discount window borrowing rate so that it's not really far above Market um but right now they're working on the stigma one making sure that all the banks are able to borrow it from it and two
there seems to be some uh news suggesting that the FED is going to make it mandatory for at least some of the bigger Banks to make periodic test earings from the discount window and recall I think during their most recent panics um in Co for example they were strong arming big Banks to borrow from discount window just to remove that stigma and so that seems to be the current campaign for the FED trying to create make the discount window into something that's a bit more useful and maybe throwing in some regulatory sweeteners as well recently
um bar of the FED uh was suggesting that you can uh if you have treasuries you can borrow against treasuries with a discount window and that can count against your your liquidity regulations in a good way but that could really just be to encourage greater treasury Holdings as well by making them more fible with reserves in any case that seems to be the fed's new project more discount window usage and we'll see if that's successful at the next banking crisis all right so that's all I prepared for today thanks so much for tuning in again
if you're interested in hearing more about about my thoughts uh check out my blog fed guy.com and if you're interested in learning more about markets check out Central Banking 101.com where I have online courses again if you don't like the courses you get a full refund no questions asked talk to you all next week
