The Fed won’t be rushed

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Good morning. The big market-mover yesterday, to our surprise, was not the Federal Reserve. The combination of worse than expected employment data and tech earnings plus a regional bank scare dragged stocks and yields down. More on the Fed and that shaky bank below. Email us: and

The Fed can afford to wait

Inflation is down and unemployment remains low; markets need something new to worry about. Enter the rising real rates narrative. From The Wall Street Journal earlier this week:

Federal Reserve officials start the year with a problem they would ordinarily love to have: inflation has fallen much faster than expected.

It does, nonetheless, pose a conundrum. The reason: if inflation has sustainably returned to the Fed’s 2 per cent target, then real rates — nominal rates adjusted for inflation — have risen and might be restricting economic activity too much. This means the Fed needs to cut interest rates. The question is, when and by how much.

Jay Powell isn’t buying it. In his press conference yesterday, he waved off such worries:

In theory, real rates go up as inflation comes down. But that doesn’t mean we can mechanically adjust policy [rates lower] as inflation comes down. For one thing, we look at more than just the fed funds rate; we look broadly at financial conditions. In addition, we don’t know with confidence where the neutral rate of interest is. That also doesn’t mean we wait around until we see the economy turn down. We’re in risk-management mode.

Powell’s posture was remarkably relaxed. Yes, risks remain, and are becoming more two-sided — the risk of hot inflation matching the risk of high interest rates hurting the economy. But on both counts, Powell pointed to good news. Inflation readings in the past six months have been so benign that the Fed is no longer “looking for better data, but continuation of the better data” that we’ve already received. Growth “has been expanding at a solid pace”, in contrast to Powell’s cautionary note in December that it had “slowed substantially from the outsized pace seen in the third quarter”. So far, it’s as close to an immaculate disinflation as you can really ask for.

The steady clip of good data justified the Fed nixing its bias towards further tightening. Regular language in its meeting statement was tweaked from:

In determining the extent of any additional policy firming that may be appropriate . . . 


In considering any adjustments to the target range for the federal funds rate . . . 

Yet Powell also pushed back against imminently lower rates. Though the Fed’s confidence in a soft landing is “growing”, cuts by March are “not the most likely case”. The more likely March outcome, he suggested, is waiting to gather more data and, in the meantime, talking about slowing the pace of quantitative tightening. Notably, traders still haven’t ruled out the possibility of March cuts: the market-implied probability fell only slightly yesterday, from 42 per cent to 35 per cent. Six quarter-point cuts this year remains the market’s expectation. Clearly, someone out there thinks new data could force the Fed’s hand in the near future.

But by all appearances, this is a comfortable spot for the Fed. Neither the labour market nor economic growth is throwing up warning signs, and inflation is behaving well. Unless something changes, why rush? (Ethan Wu)

New York Community Bancorp 

There is never a single cockroach, and there is never — or very rarely — a single troubled bank. So after New York Community Bancorp shares fell 38 per cent yesterday on an appalling fourth-quarter report, it is natural to wonder what else is crawling around beneath the financial system’s refrigerator.

But NYCB might just be that rare example of a troubled but non-contagious bank. American readers will remember NYCB as the bank chosen by bank regulators to take over the bulk of Signature Bank’s assets and liabilities when the latter bank hit the rocks in March of last year. This happened shortly after NYCB had bought another bank, Flagstar, in 2022. Now the much-enlarged NYCB has reported worse credit quality and lower margins. Will other banks soon feel similar pressure — or is NYCB simply struggling to digest two mergers? 

It’s not a simple question to answer. Four bad things happened in NYCB’s quarter:

  • Net interest margins fell to 2.8 per cent, from 3.3 per cent in the third quarter. This happened, the bank said, in large part because now that NYCB has more than $100bn in assets, it faces higher liquidity requirements and had to swap high-earning assets into low-earning cash “earlier than we anticipated”.

  • The company took a $552mn provision for credit loss, in contrast to a $62mn provision in the third quarter. Here, office real estate rears its ugly head, as bank bears have been saying for months that it would. “We significantly built our reserves to address office sector weakness and an expected increase in criticised [low-performing] loans due to repricing risk in the multifamily portfolio,” the bank said. Other regional banks have not reported such a big increase, but maybe NYCB is just early to the party. Management said that the large provision was aimed at bringing NYCB reserves in line with other mid-sized banks. 

  • Provisions are precautionary, but write-offs are real losses, and NYCB reported that they totalled $185mn, up from $24mn in the prior quarter. Two bad loans, one for a residential co-op with idiosyncratic problems and one for an office building that saw its valuation slashed, did most of the damage.

  • The dividend was cut to help the bank accumulate capital to satisfy the regulatory requirements for banks with more than $100bn in assets.

Making matters worse, the bank issued guidance that suggested that the tighter margins and lower levels of interest-earning assets would continue throughout 2024. One analyst on the earnings call noted irritably that the stock was crashing because “all of us are running the math on earning asset levels, applying the net interest margin guidance, and [getting] earnings that are down like 40 per cent” this year. The executives suggested that was too dire an estimate but, alarmingly, declined to give a specific target for net interest income. 

Investors are left to contemplate two unpleasant possibilities, one general, and one specific to NYCB:

  • That the higher provisions are not a matter of pushing reserves to industry standard levels, as management suggests, but instead reflect a souring loan portfolio. And if NYRB’s portfolio has problems, other banks’ will too.

  • That management simply failed to anticipate how much added capital and liquidity the mergers would require. In other words, it seems possible that the management team is just not very good. At the very least, it is fair to ask why they didn’t see more of this stuff coming.  

On the question of management’s failure of foresight, Brian Foran of Autonomous Research suggests that the regulators sprung a surprise on the bank’s leadership:

Let’s just say the quiet part out loud: it feels like the regulators jammed NYCB with more reserves, more liquidity and more capital. There is no way to know for certain but that is how it feels from the outside looking in . . . 

NYCB had historically been an outlier on a lot of basic metrics — low cash, low capital, high loan/deposit, high dividend payout . . . so [this] feels more like regulators forcing NYCB to get in-line with peers, rather than NYCB setting a new higher bar.

This is cold comfort for NYCB investors. The next year or two might be tough for profits as the bank puts money aside for losses and for liquidity. But for investors in other banks, it’s reassuring.

But those charge-offs — the actual losses on commercial and multi-family real estate loans — are not a good sign for the industry. It only makes sense that in a higher rate, higher work from home environment (where there are regional apartment gluts, too) charge-offs would creep up eventually. And eventually starts now. In the absence of a prompt and significant fall in rates, this will create a persistent drag on industry profits. 

One good read

Nicotine addiction, now in pouch form.

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