Control Panel: Where Financial Risk Lies

The Federal Reserve raised the fed funds rate only 0.25% at their last meeting instead of the 0.5% they hinted at because the last inflation report was higher than they wanted. The Fed is caught between the banking crisis and inflation. They are on thin ice and tip-toeing carefully. They even reversed their QT program, which is probably the reason that long-term Treasury yields plunged last week.

Until a couple of weeks ago, the Fed seemed to be on a stable glide path toward a soft landing. As all METARs know, a financial crisis can ruin the best-laid plans. There’s a lot of financial risk built into conventional and shadow banks right now. A huge amount of money from Covid-related fiscal and monetary stimulus.

As the Fed kept the fed funds rate near zero by extending their Covid-related emergency suppression until 2022, many financial interests bought long-dated bonds, including Treasuries, mortgage-backed securities and others, in a stretch toward even a little yield. Even the AAA-rated bonds with no default risk had significant duration risk. Those bonds lost value throughout 2022 as the Fed raised the fed funds rate.

Although fiduciaries (including the Fed itself) are allowed to report the par value of bonds as long as they are held to maturity the market value has dropped significantly. This risk is spread throughout the financial system.

Where Financial Risk Lies, in 12 Charts

Data show worrisome trends in real estate, banks and private markets

By Shane Shifflett and Danny Dougherty, The Wall Street Journal, March 26, 2023

[The first chart shows that the market value of securities has plunged to 89% of cost in 2022 and early 2023. The second shows a loss of $550 billion, mostly in mortgage-backed and commercial mortgage-backed securities. Unrealized losses on banks’ mortgage-backed securities were $368 billion at the end of 2022. ]

A growing share of the funds deposited with banks exceeded the Federal Deposit Insurance Corp.’s insured limit of $250,000. Nearly $8 trillion of deposits at the end of 2022 were uninsured, up nearly 41% from the end of 2019…Nearly 200 banks would be at risk of failure if half of uninsured depositors pulled their money from the banking system…

To address the risk that rising interest rates will force other regional banks to sell their holdings at a loss, the Fed will offer loans at 100 cents on the dollar to banks that pledge assets such as Treasurys that have lost value. [But not commercial real estate loans which are a large part of the portfolio of medium-size banks. – W]

At the end of last year, banks held $17.5 trillion in loans and securities, while equity in the banking system was more than $2 trillion, FDIC data show. Estimated unrealized losses on total bank credit reached $1.7 trillion…

Private markets’ (so-called shadow banking) total assets under management reached $11.7 trillion last June…Private-equity firms have raised record amounts of cash in recent years and announced nearly $730 billion in investments… [end quote]

That is a LOT of money that is at risk of losing significant value. This article doesn’t address derivatives which are opaque and were the threads that unraveled the financial system in 2008.

The most striking action in the markets last week was the sudden plunge in Treasury bond yields across the entire yield curve. Since bond prices move opposite to interest rates, this immeditely boosted the value of every existing bond portfolio.

The Fear & Greed Index improved to Fear from last week’s Extreme Fear. Financial stress spiked last week and so did the VIX. But neither spiked to a crisis level. There was a tiny blip of lending to banks through the Fed’s discount window but that wasn’t significant.

Barring a crisis or rising inflation later, bond yields are likely to decline.

The stock market has been in a neutral channel since last November, moving up and down.

The Federal Open Market Committee released its meeting notes. Their median prediction of December inflation was 3.5% in Dec. 2023, 2.5% in Dec. 2024 and 2.1% in 2025. Their median prediction of December fed funds rate was 5.1% in Dec. 2023, 4.1% in Dec. 2024 and 3.1% in 2025. This indicates that the Fed projects a REAL fed funds rate of + 1% to + 2% in their intended long-term plan. That’s a far cry from the 0% fed funds rate (negative REAL fed funds rate) that the markets got used to in 2020 to 2021.

Those bubble prices are not coming back. They were juiced by zero rates that the Fed doesn’t intend to bring back. But the stock market still seems to have plenty of animal spirits. There’s no sign of revulsion.

The METAR for next week is partly sunny. The Fed and Treasury together seem to have brought the banking crisis under control, at least for the time being. The METAR is a short-term forecast. It’s possible that the strains in the system may raise their ugly head later. But I’m not seeing it short-term.



Then again, some naysayers in Europe have a gloomier outlook, despite statements last week by politicians intended to calm things down:

German Chancellor Olaf Scholz told a news conference in Brussels on Friday that Deutsche Bank had “thoroughly reorganized and modernized its business model and is a very profitable bank,” adding that there is no basis to speculate about its future.

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Someone else in another thread noted that the Fed’s QT has reversed lately, which I thought was strange. But your comments put it together for me. They’re buying up Treasuries again to support the market and improve bank balance sheets. Makes a lot is sense.



Also everyone has already ran to cash so how much further can the market drop?



This is understating what happened! The QT that took a year to accomplish had 2/3 of it reversed in just a week or two! Seems like the speed of QT is MUCH slower than the speed of QE.


Everyone has NOT run to cash. There can be quite a bit more selling.

Whether that actually happens is a different question. I suspect we will continue to see selling in weak industries and selected companies with a lot of debt that is getting more expensive to service.



I would like to see where you are getting your information.


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That is one ironic piece of humor. You meant that as humor?

The profits? Will the profits be dropping? Corporates? I’d say so into the first quarter 2024.

Ok Leap, since you can see the future, what will the earnings of the S&P be in the first quarter of 2024? Also tell me how much cash is setting on the sidelines right now?


Market cap of S&P 500 is north of 30 trillion.

And that’s just 500 stocks. My recollection is that the market cap of the Russell 3000 is over 40 trillion. That compares to the mere 5 trillion in money market funds. Not an increase of 5 trillion, a current total of 5 trillion.

Of course, sales proceeds can end up in places other than MM funds. But saying there are 5 trillion in MM funds says nothing about how much or little of the stock market has sold off.

So yeah, there’s a lot of room for selling to continue.



Right, But by that logic how big the S&P is, is also meaningless. But what is meaningful if the majority of people are sitting in cash, than the chances that their will be a bigger sell off goes down.

So with that being said, do you know how much cash is on the sidelines? I am hearing that there is a lot of cash on the sidelines but I can’t find anything that can corroborate that.


Total unknowns. I am talking the general direction overall of profits.

Depends much of that money is earmarked for retirements. Retirees generally want nothing to do with buying equities right now. By that I mean this is not a bull market. Equities will trade regardless. There is not a lot of pressure from those with cash to create much follow through for equities.

Right, The PMI is reversing and climbing up. The S&P500 isn’t dropping but consolidating. It’s weird with the banks I would have thought we would have seen a big drop. People think there is going to be a big drop but have nothing to back it up except to say unknown. :joy: Starting to sound like a religious cult instead of being built on facts.


Also Peter, another place people run to is bonds. And the bond market is twice, if not bigger , than the equity market.


@buynholdisdead please explain the difference between “dropping” and “consolidating.”


Thank you for stepping in Wendy. The way I understand it that when the market is heading up or down it will go into a consolidation mode at times, where it is trying to decide whether to keep going down or change and start going up. So with the market being range bound it is consolidating.

Do you have a chart Wendy showing how much money is out of the market, daily would be nice but weekly or monthly would do. In a linear format?

Looking at this chart it has been range bound since November.




The PMI will be generally always expanding during this period. That does not mean corporate profits wont subside from here.

The thinking in the corporate world is any project done in poorer times has an upside later when we get into better times. If you wait to build your factory till things are good then there is a downside. Ironic. The downside in how fast you get to a great market and even possibly a poorer economy the following year.

The main reason the PMI is up though is something else. Demand side recessions are very shallow. Why not forge ahead. I am not saying these are bad times. Dramatic in the markets? Sure.

Profit margins are the last dollars in. That is going to tighten.


Leap I am not arguing with you, you could very well be right, but the problem is that everyone believes what you believe. That is what is making me start to think that the herd could be wrong. Wendy did a very nice write up showing that there is a lot of money out of the market sitting on the sidelines. That money needs to go somewhere. Now maybe it will move into bonds instead of stocks because they can get a higher yield. But it could also mean that more money will come out of the market like Peter thinks. So my inclination is not to follow the herd but I am still looking for a good reason why this market has to go down when it has been fluctuating, consolidating, since November.


That depends if you are long some equities that is more like wishful thinking.

The money does need to go somewhere. There are a lot of places it can go. Business is going on as usual. You are pressing your nose too hard to the glass.

The money can go somewhere later on. And when the money goes somewhere later on the same amount of money will be on the sidelines. OHHHH!!!

Everyone was talking Coke when Buffett bought it. But it was Buffett that treated it like an elephant.