The SLR exemption is ending! The SLR exemption is ending!

Doesn’t exactly roll off the tongue, does it? There has been rampant speculation the last few weeks about the fate of the exemption the Fed provided banks a year ago with regard to the Supplemental Leverage Ratio that allowed them to ignore Treasuries and reserves. The banks themselves warned that allowing the exemption to expire might unleash all manner of nasty economic side effects. Why, how in the world could they lend with all these Treasuries and reserves eating up capital? Elizabeth Warren warned that we shouldn’t let the banks sidestep this oh-so-important improvement of bank regulation that had sprung from the ashes of the 2008 financial crisis. The usual stock market bears were sure it would finally vindicate them and push stocks down if Jerome Powell somehow found the courage to defy the banking lobby.

And so, last week Jerome Powell, announced that the Fed would allow the exemption to lapse on schedule. And…nothing much happened. Well, I suppose that isn’t exactly true or may not be. Treasuries did sell off again last week, the 10-year nominal Treasury and the 10-year TIPS yields hitting new highs (which are still pretty darn low) for the post-virus crisis period. I mean, my goodness, the nominal 10-year yield shot up 10 basis points in one week! Dear Lord, will the carnage never end??? And TIPS?? Well, ok, TIPS barely moved but they could have!

At Alhambra we noted the debate over the SLR a few weeks ago but mostly because clients and readers asked us to comment. The fact is that the banks have plenty of capital and they aren’t exactly slugging it out to lend to Joe Public anyway. Even if the SLR is fully enforced it won’t mean much for the market or the economy. Yes, there had been some selling in the Treasury market ahead of the decision but that is not exactly news. The downtrend in bonds is now 8 months old so if you’re still in long-term Treasuries and taking weekly losses, don’t blame Jerome Powell. I do not expect banks to change anything in response to the expiration of the SLR exemption.

The Treasury market sell-off last week was just an extension of the selling that began in earnest last summer. The trend is pretty obvious and it will persist until it changes. I cannot tell you when that will be or at what interest rate but yields will eventually peak. Or not I suppose. At some point, the bull market that has persisted my entire career must come to an end. But I sure can’t make that call based on this little bond bear market. As I said last week – perspective. Get some.

The post virus boom narrative did take a bit of a hit last week from several sources. Europe appears determined to find a way to get another virus surge, consistently taking aim at their own feet rather than their citizens arms. Well, to be fair to the incredibly inept vaccination effort over there, it is as much about citizens keeping their arms in their sleeves as it is governments missing the mark. Whatever the cause, various parts of Europe appear to be shutting down again and with it hopes for a rapid rebound in energy demand. The boom will apparently not be global. Crude oil got smacked around last week on that news but also because everybody and his cousin was already long. The pullback did not, however, break the trend which is still up, at least for now.

We also had a couple of pretty negative economic reports, starting with housing where starts and permits both fell over 10% from last month. Some of that may be due to the cold weather shutdown in Texas and some of it may be due to some pretty outrageous lumber prices. I’m sure both of those conditions will be relieved, the weather probably sooner and lumber probably later. We’ll find out this week whether either of those conditions affected sales.

The other negative surprise last week was Industrial Production but that one probably was mostly weather-related. In any case, one month does not make a trend and the business inventory report for January, also released last week, points to a recovery in production. Inventories did rise about 0.5% but business sales were up nearly 5% (7% year over year) knocking the inventory to sales ratio down to 1.26 from 1.32. That’s the lowest reading since 2012 and means production will need to ramp up in coming months unless sales just fall off a cliff. If weather held February down, March may be a big catch-up month. It needs to be since IP is still down by over 4% year-over-year.

 

We’ll get some more clues – maybe – about future production next week with the durable goods report. We’ll also get a look at corporate profits for the 4th quarter which I suspect will not be that great but of course, the market doesn’t care about what already happened. We also get the Chicago Fed National Activity index next week, a broad view of the current state of the economy.

 

The environment is unchanged again this week as the dollar barely budged. The dollar may have more upside in the near term but market positioning may have gotten too bullish too soon for a big move. Large speculators flipped to net long the dollar index last week. The positioning isn’t extreme by any measure (and really wasn’t when they were short either) but the rapid shift caught my attention. There seems to be quite a bit of urgency in that move.

Stocks were mostly down last week, Japan a notable exception and up 2.77% on the week. Small caps saw a fair bit of profit-taking as did commodities on the back of the crude oil move late in the week. Value slightly outperformed except in small-cap. In general, foreign markets did a bit better than the US with even EM stocks outperforming the S&P 500.

As might be expected, defensive sectors led last week. Energy was the big loser but, again, there was no change in trend and the stocks were overdue for a correction.

The post-virus boom narrative remains intact but after seeing the crowds in Miami Beach and other areas last week, I must admit I am a tad nervous about another virus surge. I have no idea whether we are close to or can even achieve herd immunity. Maybe we are really close to putting the virus in our rearview mirror. I have my doubts as to whether the populace would countenance another severe shutdown in any case. But anything that disrupts the narrative will have an impact on the markets. The most important economic statistic right now is “new cases”.

Joe Calhoun