Interchange - the drama continues

Yesterday, the Federal Reserve cut the maximum debit interchange fee to about $0.24 for the average debit card transaction, which was recently about $38. Currently the fee for the average size debit transaction is $0.44, so the new rule represents a 45% decline. However, this new $0.24 cap is much better for financial institutions than the initial $0.07 to $0.12 cap the Fed proposed back in December-2010. As a result, free checking may continue to be offered by big banks. If you recall, back in Feb-2011, the WSJ reported that some of the largest banks were starting to remove rewards programs on debit cards while others began charging $3 monthly fees to have a debit card.

Source: Brick and Associates

Forget Freddie Krueger. QE3 is scarier

On 6-22-11, the Fed left the fed funds target at a range of 0.0% to 0.25% and continued to say they will hold rates at “exceptionally low levels” for an “extended period.” At this meeting, Federal Reserve officials made the following revisions to their economic forecasts for both 2011 and 2012: lower economic growth, higher
unemployment, and higher core inflation. This brings the Fed’s forecasts more in line with private economists. The Fed’s post-meeting statement said, “The slower pace of the recovery reflects in part factors that are likely to be temporary (our emphasis), including the damping effect of higher food and energy prices on consumer purchasing power and spending as well as supply chain disruptions associated with the tragic events in Japan” The day after the Fed meeting the WSJ wrote, “Federal Reserve officials see the US economy settling into a disappointingly weak recovery this year and next, and say they have done all they are prepared to do to spur growth for now.” However, in his post-meeting press conference, Bernanke actually did leave the door open to a possible QE3 or other Fed action if the economy performs much worse than expected when he said the Fed would be “prepared to take additional action, obviously, if conditions warranted.” Following today’s end of the Fed’s $600b QE2 Treasury purchase program, the Fed’s balance sheet is currently $2.8 trillion, or four times its pre-crisis level. About $900b of their balance sheet is currently in Agency Passthroughs.


Generally speaking, the Fed’s broad goals for QE2 were to lower long-term Treasury rates, avoid deflation, and improve financial conditions in order to boost economic growth and lower the unemployment rate. In speeches last fall, Fed officials publicly said they wanted to boost stock prices in order for the so-called
wealth-effect to boost consumer spending. On a much more technical level, the Fed was trying to boost inflation expectations in order to avoid potential deflation. In general, inflation expectations have risen by about 100BPs since Bernanke first hinted at QE2 on 8-27-10. Inflation expectations over the next ten years
(10-year Treasury yield - 10-year TIPS yield) have risen about 100BPs since August-2010 to 2.5% currently.

Source: Brick and Associates

Freddie and Fannie wind down?

The Treasury Department released a long-awaited “white paper” on 2-11-11 that calls for winding down these GSEs. Basically the Treasury wants the mortgage market to be mainly private and they feel it will take 5-7 years to transition to a new housing finance system. The Treasury said they would make sure
Fannie and Freddie have the resources they need to meet all their commitments. Note that the last three US Presidents have tried to reign in Fannie and Freddie but Congress has taken virtually no action thus far. Also, it was recently reported that last fall, the widely respected CEO of JP Morgan Chase referred to Fannie and Freddie
as "the biggest disasters of all time." Interestingly, after this “wind down” proposal, Fannie and Freddie spreads tightened. The reason was that the Treasury department wants Fannie and Freddie to shrink their balance sheets; less supply of bonds means tighter spreads, at least initially. Whether Fannie and Freddie can be wounddown remains to be seen. MBS investors, which actually determine mortgage loan rates, say mortgage rates will be much higher (say a few hundred BPs) without some form of government backing. Could politicians really handle mortgage rates of say 7% instead of say 5%, holding everything else equal?

From Brick and Associates, Inc Commentary

Inflation Watch

The head of the European Central Bank said on 3-7-11 that he is ready to raise rates because inflation is too high. (That was before Japan’s earthquake.) Bill Gross, the biggest bond fund manager in the world, dumped all of his Treasury bonds in February because he feels the rates are too low and he wonders who will buy all the Treasury debt (at today’s low rates) when QE2 is over. He said Treasury yields are artificially low by about 150BPs because of QE1 and QE2, based on expected nominal GDP growth of 5% this year.



Exerpt from Brick & Associates Commentary

Economic stress continues but Midwest improves

The nation's economic stress inched up in December because higher foreclosures outweighed lower unemployment, according to The Associated Press' monthly analysis.

Bankruptcy levels remained largely unchanged from November. But the depressed housing market took a toll. Foreclosure rates rose in 33 states, most sharply in Utah, New Jersey, Nevada and Arizona.

Most analysts expect the economy to gain momentum this year, in part because of a tax-cut package that lowers workers' Social Security taxes and puts more money in their paychecks. But two straight months of higher stress to end 2010 marked a setback after the nation's economic pain had eased since the start of last year, the AP Economic Stress Index showed.

The AP's index calculates a score from 1 to 100 based on unemployment, foreclosure and bankruptcy rates. A higher score signals more stress. Under a rough rule of thumb, a county is considered stressed when its score exceeds 11.

The average county's score in December was 10.4, up from 10.3 in November. Slightly more than 40 percent of the nation's 3,141 counties were deemed stressed, up slightly from November.

For all of 2010, economic stress eased in every state but five: Colorado, Florida, Georgia, Nevada and Utah. Stress fell most sharply in the Great Lakes states and the Southern states of Alabama, Mississippi and Tennessee. Those states have large manufacturing bases, and the AP analysis showed that stress dropped most in counties with large proportions of workers in manufacturing.

U.S. manufacturers are finally adding jobs after years of shrinking their payrolls. They added 136,000 workers last year, the first net increase since 1997. And in January, the manufacturing sector added 49,000 jobs -- the most in any month since August 1998.

From AP
Tom Dluzen

Bond Market Bubble

Acccording to Martin D. Weiss, Phd., when the bond market bubble busts, the inevitable and immediate consequence is that interest rates surge — not only on bonds, but also on mortgages, auto loans, business loans, and almost every kind of financing imaginable.

If you hold fixed-income investments locked in at today’s low interest rates, you will almost definitely get hurt, regardless of what kind you own — Treasury bonds, Ginnie Maes, municipal bonds, mortgage bonds, corporate bonds, long-term bank CDs.

Either …

You’ll get stuck with miserable, below-market yields for years to come, or …
You’ll have to pay a tremendous price — losses in principal and/or stiff penalties — to switch to higher yielding investments.

At least consider selling your longer term investments while you can still get a small premium.