Inflation Conflation - Episode 17

last updated on Tuesday, April 27, 2021 in General

Hello and thank you for joining us for another episode of The Insider, a monthly podcast production of the Federal Home Loan Bank of Des Moines and your source for industry news, strategies and key information about the bank. This is your host, John Biestman, Senior Relationship Manager.

Hoping that I will soon be able to soon have some meaningful time away from my COVID cocoon, I recently swapped out my winter tires and drove to the local gas station. It was not only time to properly inflate my fair- weather tires, but it seemed that it was also time for a two-fold aggravating reality check. First, gas prices were noticeably higher.

Second, I was reminded that several quarters were required to activate the air pump needed to inflate my tires. That was an unfulfillable requirement as I have not used coin nor currency in the past 14 months. Longing for the days when air was free from the gas station, I suppose I now know why all but two states permit charging for air. I think that’s called Inflation!

No doubt, the recent conflation of short-term inflation readings has been gaining momentum. But, before we put too many quarters in the machine, year-over-year comparisons may be distorted due to the low base from 2020, right when the COVID-spurred economic slowdown abruptly appeared. That distortion is called the “base effect.”

Still, the March CPI reading was elevated, increasing 0.6% month-over-month from February and rising 2.6% from the same period one year ago. We’ll try to refrain from making the annualized calculation that multiplies 0.6% times 12! 7.2% would greatly exceed the Federal Reserve’s target of 2.0%.

It seems that producer and servicer prices are increasingly permeating the consumer level. Perhaps its that pent-up demand for dental appointments or surging lumber prices in the wake of the nation’s severe housing shortage. We know that roughly one-half of the March inflation increase was ascribed to gasoline prices, as in a 9.1% rate of increase.

We won’t even talk about some of the cost-push examples due to short-order COVID-induced lifestyle changes, save for those take-out ketchup packets whose sales have increased 300% on a year-over-year basis! Amid all the noise, we know that the Fed has telegraphed that it can tolerate periods in which inflation is allowed to exceed 2.0%.

The attitude has been described as “flexible inflation targeting.” More to the point, additional data may be needed to sort out the question of “When do elements of non-recurring inflation indicators become recurring?” Perhaps we might relax at least for now, because core CPI (which does not include food and energy cost) has increased by only 1.6% over the past year.

Still, the next few months could witness rising prices as demand rises, consumers spend their past year’s worth of extraordinary savings and the economy continues to re-open.

I hope that you were able to listen to our recent companion April 15 podcast, “On the Record,” which featured our President and CEO, Kris Williams, interviewing Esther George, President and CEO of the Federal Reserve Bank of Kansas City. 

President George shared with us her view that the trajectory of the economy will further improve into the second half of 2021, although loan growth will require further progress in demand and economic recovery.

As far as the economy’s ability to service escalating amounts of public debt and for credit losses to be held at bay, she views strong economic growth as the key. In the coming months, the spotlight will clearly be on how businesses and consumers will react once policy supports are withdrawn.

With the Fed last on record as forecasting a GDP growth of roughly 6.5% (which would be the frothiest growth rate since 1984), we’ll need that pace to service the torrent of public debt. Several months ago, the U.S. crossed the threshold of federal debt-to-GDP of 100%.

While additional debt has been justified as a necessary component of pandemic recovery and, for now, is assumed to be o.k. if economic growth exceeds inflation-adjusted interest rates; we’ll watch this relationship closely in the coming months. Remember that five-year break-even inflation rate that we talked about at the end of 2020?

Well, today it’s sitting about 2.50% and is up about one-half percent since the start of the year. If growth starts to lag growth in debt, we can’t ignore the laws of physics and would need to model the impact of such reactions as rising long-term rates or a declining dollar.

Or, we could also model a scenario based on what Jamie Dimon, CEO of JP Morgan Chase said in his recent annual letter to shareholders; in which he held out hope that infrastructure spending, vaccine growth and deployment of consumer savings could result in a “Goldilocks moment” in which strong and sustainable economic growth occurs alongside a manageable upward drift in rates and inflation.

There are quite a few balance sheet strategies to think about this month.

First, the persistence of excess liquidity in the banking system remains an understatement. As deposit flows continue in the wake of yet another round of PPP and stimulus checks continue to clear, we’re not just seeing the need to find suitable assets, we’re also seeing deposit inflows impacting capital ratios. If your institution is in the difficult position of needing to trim the funding sails, you might want to head in the direction of the least market efficiency. What do I mean by that?

Well, we’ve seen some members negotiating “below market” prepayments via pricing inefficiencies associated with retails CD’s. That is, some institutions are putting together marketing programs that are encouraging particularly non-core depositors to redeem their time deposits at favorably negotiated rates.

To get more information on this strategy, as part of our Series of Solutions, FHLB Des Moines has partnered with The CorePoint and recorded an hour-long webinar. You can access the webinar that was recorded on April 20 in the Education Resources section of our website.

On to another strategy for this period of tepid loan growth and sizzling deposit growth. I’ll give you some statistics from the April 9 edition of the Federal Reserve H8 report: Over 2020, insured deposits in the nation’s bank industry increased by 20.0% annualized, while during the same period, loans increased by only 3.7%. During the first quarter of 2021, the numbers were even more telling. Loans decreased at an annualized rate of 1.4%, while deposit increased by 11.9%.

It’s a no-brainer that there’s an urgency to expeditiously deploy excess cash into safe and profitable loans. While it’s difficult to deploy funding all at one time, it would at least be worthwhile to generate a positive spread. How? Compare the cost of those excess deposits you are parking at the Fed at 10 basis points with a one-week advance priced within shouting distance of zero-percent. How? Did I say zero-percent?

While posted levels are already low on one-week advances, you can’t forget the 22-basis point-or-so impact of the cash dividend on activity stock. Soon, you may also factor in a rate promotion that we’ll be running for three weeks on one-week fixed-rate advances, starting April 26. The special program will continue through May 14. For execution, members must call into the Money Desk to take advantage of the program.

If we are indeed living under ZIRP or zero-interest policy, we should at the very least be entitled to fund at zero-percent or close to zero, and positively arbitrage at the Fed or other sources!

Finally, here is yet another strategy we see members executing of late. As part of an institution’s liquidity stress testing program, we know that it’s prudent to regularly conduct meaningful FHLB Des Moines line testing. Still, an ideal stress test goes beyond merely proving that you can tap into the line for a short period of time. An ideal stress test is mapped to advance line draws that take place under different liquidity stress scenarios. We’ve seen some members have different stress scenarios on the shelf that involve contingent deployment of FHLB Des Moines funding.

Rather than simply having plans for those scenarios stored on the shelf, on a disk or in the cloud, best practices call for performing test runs on each of them and showing that your contingent plans can be executed in the real world, and not simply in theory. Don’t simply test your advance lines, but test your ability to use advances for each of your stress scenarios.

We hope that you and your team can join us on Wednesday, May 26, 2021 from 1:00 - 5:00 PM CST for our first-ever Member Value Meeting. This all-virtual event will be an exciting chance for our members across our 13-state district to connect and learn from industry experts and gain more knowledge around how to maximize your partnership with FHLB Des Moines.

Please note that this meeting is being held in lieu of Regional Member Meetings this year. We have a first-class speakers line-up: Chris Low, Chief Economist at FHN Financial; members of the Darling Consulting Group who will be discussing the New Abnormal in Balance Sheet Management and the Hidden Risks & Opportunities to Consider in 2021; then finally a well-known business leader as our keynote speaker that we’ll be announcing shortly.

Feel free to register on the Events section of the FHLB Des Moines website. Continuing Professional Education (CPE) credit will be available for members who participate in the event's livestream. This event is provided at no cost to attendees.

Some parting thoughts on inflation. When you think of John Maynard Keynes and Milton Friedman, you generally think of diametrically opposing views. Not so with inflation. Here are some respective quotations: “By a continuing process of inflation, government can confiscate, secretly and unobserved, an important part of the wealth of their citizens,” said the Keynesian; and “Inflation is the one form of taxation that can be imposed without legislation” said the monetarist. In any event, many also agree that inflation is a bit like fire, it’s a productive tool, unless it gets out-of-hand.

A small amount of inflation encourages businesses and consumers to invest and spend today, rather than hoard and see values of goods and services decline. Either way, here at FHLB Des Moines, we’re here to provide the tools and strategies to support your balance sheet for multiple scenarios. Stay well and we’ll see you next time on the FHLB Des Moines Insider Podcast. Thanks for tuning in.

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