Strategies for Navigating Liquidity Risks in an Unpredictable Economy & the Importance of the Discount Window for All Banks

Here is what we will be getting into today:

1. Preparing for Change: Managing Liquidity Risk in an Uncertain Economic Climate.

2. Leveraging the Discount Window for Small Banks and Large Banks Alike.

3. Insights from China's Two Sessions on Economic Growth and Policy Direction.

Let's Dive In!

Newsletter: Prometheus Research

Title: The Observatory. Link: https://prometheusresearch.substack.com/p/the-observatory-e21

Here are the key highlights:

• Liquidity plays a crucial role in facilitating economic activity in both the real economy and financial markets. Policymakers use liquidity to achieve societal objectives such as speeding or tempering the economy. The Federal Reserve has been actively engaged in quantitative easing (QE) and quantitative tightening (QT) programs to control interest rates across the economy. These programs are achieved by purchasing Treasury securities and giving the financial system liquid reserve assets. The government also borrows to offer a store of wealth while redistributing excess private income in the economy to achieve some measure of societal good.

• It is important to keep in mind that liquidity conditions are far from good and may not continue at their current rate of expansion. Economic activity is slowing down and profit compression is continuing, meaning that borrowing and investment activity will likely weaken. This will be compounded by Treasury bill issuance remaining modest, leading to reduced policy liquidity. All things considered, the current situation in corporate borrowing markets is fragile and could change quickly if economic conditions deteriorate further.

• Despite improvements in policy liquidity over the last quarter, private sector entities have increased their credit exposure to the real economy, but this has been offset by declines in reserve balances/cash and Treasury, Agency, and MBS reductions. These reductions have resulted in a contraction of checking and savings account balances.

• Companies should take steps now to ensure they are well prepared for any potential changes in liquidity conditions so they can maximize their chances of success going forward. Proper management of policy liquidity through QE & QT programs as well as government borrowing to redistribute excess private income can ensure that the economy remains healthy for years to come. Policymakers should continue to take liquidity seriously and use it to achieve societal objectives.

YouTube Channel: Eurodollar University

Title: Who is still knocking at the Discount Window?Link: https://www.youtube.com/watch?v=OcIsPoKLkh0

Here are the key highlights:

• The Federal Reserve's primary credit program, formerly known as the discount window, is a liquidity program designed to provide funding for banks during times of financial difficulty. Any bank can apply for primary credit, and the Federal Reserve is committed to providing funding to support the stability of the financial system.

• During the 2008 global monetary disruption, there were noticeable spikes in primary credit usage that warranted attention. Moody's analysts suggested potential systemic funding weaknesses in certain corners of the banking sector. The recent rise in discount window borrowing triggered a response from the Federal Reserve, specifically their Liberty Street economics blog.

• One corner of concern may be small banks that finance mortgages, especially for smaller communities, but have experienced significant cash strain, leading them to access credit lines with Federal Home Loan Banks (FHLB). The FHLB advances are critical to their mortgage businesses and ensure they can provide access to mortgage credit. However, during the pandemic, larger banks experienced a significant windfall while draining the book entry cash that smaller banks use to fund their mortgage activities.

• Therefore, it is important to support smaller banks and ensure they have access to funding mechanisms like FHLB advances to continue serving their communities.The discount window has become more accessible and provides an opportunity for smaller banks to supplement their cash flow, while also benefiting larger banks with competitive interest rates. Utilizing the discount window can help alleviate the cash drain on banks and improve their overall financial position. The discount window is a valuable tool for securing primary credit, and collateralization with GSE mortgage bonds or other assets can prove valuable.

• There is a strong correlation between primary credit usage and fluctuations in the SOFR rate, and collateral problems linked to primary credit usage must be monitored closely. Repo failures and other collateral indications consistently point to elevated levels. It is crucial to remain observant of primary credit usage and collateral trends to make critical decisions effectively.

Website: ZeroHedge

Title: What To Know Ahead Of China's Two SessionsLink: https://www.zerohedge.com/economics/what-know-ahead-chinas-two-sessions

Here are the key highlights:

• China's Two Sessions event is a significant event where the National People's Congress will discuss and approve the Government Work Report and the 2023 fiscal budget proposals. This year's event is crucial as it coincides with a once-in-a-decade personnel reshuffling at the State Council and other ministries. The Congress is expected to concentrate economic and financial power under the Chinese Communist Party (CCP).

• Three things to watch during the Two Sessions are the growth target, fiscal budget, and personnel changes. The GDP growth target is expected to be around 5%, and the fiscal budget proposal may provide clues on policymakers' expectations for nominal GDP growth, transfer from central to local governments, and government-managed fund revenue.

• Changes to Party and state organizations and reshuffling of State Council and ministerial personnel are planned, indicating more party control over the financial regulatory system.

• Statements on sector-specific policies, such as property market characterization, consumption boosting measures, and internet regulations, are worth monitoring. Statements in the Government Work Report regarding Taiwan may also gather market attention. To gauge policy stance to be unveiled at or after the Two Sessions, one must first assess where China is in its post-COVID economic recovery.

• China's post-COVID recovery has just started with some encouraging signs, setting the stage for a forecasted 5.5% full-year GDP growth, which is above consensus. Policymakers are likely to be patient in withdrawing support due to the potential downside risks from weaker external demand and fragile confidence. Business and consumer confidence remain the main risk to growth domestically, as without confidence, the post-COVID recovery may not be sustainable.

• The most significant downside risk to China's 2023 economic growth is exports, and if exports turn out to be weaker than expected, policymakers may need to boost monetary/fiscal easing and infrastructure building. However, risks of policy overtightening appear low, and the government is likely to manage financial risks from small & rural banks and local government financing vehicles.

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