Operation Twist Extension: Latest Round of Monetary Easing

The Federal Reserve on June 20th it announced its seventh installment of unconventional monetary policy since running out of orthodox ammunition in late 2008, when short-term interest rates fell, in effect, to zero. It would purchase $267 billion of long-term bonds by the end of the year, paid for from the proceeds of sales of short-term bonds already in its portfolio.

The move extends a program, called Operation Twist (because it "twists" the slope of the yield curve on bonds) . To lower long-term interest rates down in the hope of stimulating demand, the Fed announced Operation Twist program last autumn and due to expire this month, under which the Fed has swapped $400 billion of short-term bonds for long-term ones. Previous initiatives have included purchasing bonds with newly created money (“quantitative easing”, or QE), reinvesting the proceeds of maturing bonds, and verbally committing to keeping rates near zero for ever longer periods.

This latest round of monetary easing, like its predecessors,  was motivated by the economy’s failure to grow as quickly as the Fed had forecast. Members of the Federal Open Market Committee (FOMC), the Fed’s main policymaking body, now expect growth of between 1.9% and 2.4% this year, down sharply from their April forecast of growth between 2.4% and 2.9%.

Moody’s Slashed Credit Ratings of Big Banks

Moody’s Investors Service on Thursday slashed the credit ratings of 15 large financial firms. Citigroup and Bank of America, two United States banks that were hit hard in the financial crisis, are now rated only two notches above junk. While Morgan Stanley avoided a worst-case scenario of a three-notch downgrade, its rating slipped by two levels.

The downgrades are a serious blow for the banking industry, which is already dealing with the European sovereign debt crisis, a weak American economy and new regulations.

Moody’s downgrades are part of a broad effort to make its analysis more rigorous. The financial crisis stained the reputation of credit rating agencies. Both companies attached high ratings to mortgage-backed bonds that later suffered big losses in the housing bust.

Before the announcement on Thursday, bank shares continued to fall. Goldman Sachs, Citigroup, Bank of America and Morgan Stanley were all down for the day.

JPMorgan's $2 Billion Loss

JPMorgan Chase CEO Jamie Dimon on Thursday revealed that the banking giant lost a $2 billion due to a massive trade that went sour, and that the losses could climb by another $1 billion in the coming days. Mr. Dimon said on Thursday that JPMorgan’s “synthetic credit portfolio,” an amalgam of derivatives and hedging bets that blew up in recent weeks, was part of “a strategy to hedge the firm’s overall credit exposure.”

Several days after announcing a $2 billion loss in its chief investment office, JPMorgan Chase is clearing house. Matthew E. Zames, the JPMorgan executive, was tapped Monday to replace the outgoing chief investment officer, Ina Drew.

The bank most likely structured the trade in a way that magnified losses (see the image). Read more “JPMorgan's Appalling $2 Billion Loss”

 

(The illustration is a courtesy off The New York Times)

S&P & Fitch lowered J.P. Morgan rating due to $2B loss

S&P cuts outlook on J.P. Morgan to negative

Standard & Poor's said late Friday it lowered its ratings outlook on J.P. Morgan Chase to negative from stable because of the bank's unexpected $2 billion loss on derivatives. S&P kept its A/A-1 issuer credit ratings on the bank and its A+/A-1 ratings on its subsidiaries.

S&P said it could lower its ratings by a notch if its determines that risk management mistakes were not limited to the specific credit portfolio mentioned late Thursday, or if it believes management is pursuing a more aggressive investment strategy than originally believed.

Fitch downgrades J.P. Morgan after trading loss

Fitch Ratings said on Friday it downgraded J.P. Morgan Chase & Co.'s long-term credit rating to A-plus from AA-minus, saying that while the $2 billion trading loss disclosed by the bank on Thursday is "manageable," the potential reputational risk and risk-governance issues raised are no longer consistent with an AA-minus rating. "The magnitude of the loss and ongoing nature of these positions implies a lack of liquidity," Fitch said in a statement after the stock market closed. "It also raises questions regarding J.P. Morgan's risk appetite, risk management framework, practices and oversight; all key credit factors."

Stock market reaction

Shares of J.P. Morgan closed down 9.3% on Friday and slipped further in after-hours trading.

U.S. stocks mostly slid Friday to a second weekly decline after a rise in consumer sentiment failed to outweigh J.P. Morgan Chase & Co.'s $2 billion trading loss, disclosed by the bank late Thursday.

The Dow Jones Industrial Average fell 34.44 points, or 0.3%, to 12,820.60, off 1.7% from the week-ago close. The S&P 500 retreated 4.6 points, or 0.3%, to 1,353.39, down 1.2% for the week. The Nasdaq Composite managed a fractional gain to close at 2,933.82, down 0.8% from last Friday's finish

First U.S. budget surplus in the past four years

The U.S. government posted its first monthly budget surplus of $59 billion in April since September 2008, thanks to increase in tax receipts and decrease in spending on education, Medicare and certain defense programs.

The government spent $260 billion in April, $70 billion less than in the same month in 2011. Receipts in April were $319 billion, up $29 billion from a year ago.

For the fiscal year to date, the deficit is $720 billion. For the full fiscal year, Treasury is projecting another deficit of more than $1 trillion.

The previous surplus of $46 billion was posted in September 2008, the month Lehman Brothers filed for bankruptcy.

Global Economy Prospects Improving

The global economy prospects are slowly improving, according to the IMF, which released new forecasts this week.

World GDP is set to rise by 3.5% this year, and by 4.1% in 2013. Emerging markets will sparkle, and America will grow by an improved 2.1%.

The IMF sees several risks ahead: the euro crisis and fiscal austerity in the rich world, upheaval in the Middle East and the possibility of a hard landing in countries, such as China, which have seen exceptional credit growth.

The IMF also warned that growth could be hurt by the deleveraging that is under way at European banks. Balance-sheets could be reduced by up to $2.6 trillion over two years, as the banks boost capital and get rid of unprofitable businesses. Credit will be harder to come by.

Inflation surpassed earnings

Consumer prices increased 0.3 percent last month, the department said on Friday. Gasoline prices rose 1.7 percent, a slowing from February when costs at the pump rose more than three times as quickly.

The inflation outstripped wage gains remains. Workers’ earnings fell 0.4 percent in March after adjusting for the increase in prices.

Core inflation, which strips out food and energy prices, climbed 0.2 percent, pushed higher by rising rents, medical care costs and used car prices.

In the 12 months to March, core consumer prices increased 2.3 percent after rising 2.2 percent in February. The persistence of core inflation could affect the Federal Reserve’s maneuvering room for stimulus.

Overall consumer prices rose 2.7 percent compared with a year ago, down from a reading of 2.9 percent in February.