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IN THIS WEEK’S NEWSLETTER:

📈 Biggest Weekly Jump In Treasury Yields Since 2001
📊 Best Week for S&P 500 Since Nov 2023
🥇 Gold Records Best Week In Five Years
🧊 Lowest CPI Reading Since March 2021
🏦 Earning Season Kickoff: Market Volatility Boosts Banks
⚖️ Supplemental Leverage Ratio In Focus Amid Treasury Market Turmoil
📝 Key Points: Jamie Dimon’s Letter to Shareholders

QUOTE OF THE WEEK:

“We think the supplementary leverage ratio is an ill-advised ratio. Maybe it was born out of the financial crisis at a time when there was a lot of anti-bank sentiment, which was understandable at the time. But the people who pay the price today are market participants. The Treasury market is less well supported because of the existence of that ratio, in our opinion.” - Robin Vince, Bank of New York Mellon CEO

KEY US ECONOMIC EVENTS NEXT WEEK:

MARKET CLOSE:

CURATED INSIGHTS & ANALYSIS:

• Key Points - The FOMC Minutes:

  • The core indicators to assess maximum employment are: unemployment rate, job vacancies, the employment-to-population (EPOP) ratio, and the labor force participation rate (LFPR).

  • Over the intermeeting period, Treasury yields declined, equity prices fell, credit spreads widened, and the dollar depreciated.

  • Some indicators suggested that conditions in money markets continue to tighten.

  • The ON RRP facility is nearly depleted, and repo market conditions have tightened. Portfolio runoff (Fed balance sheet reduction) will likely result in lower bank reserves. Slowing portfolio runoff will be effective.

  • The majority of foreign central banks eased policy during the intermediate period. They were increasingly noting the elevated uncertainty about trade policy.

  • Short-term funding markets stayed orderly. Secured rates initially rose, reversing December’s ON RRP dip, then eased later.

  • The labor market is not seen as a major inflation source, and there are concerns that core inflation may be more persistent. Participants emphasized keeping longer-run inflation expectations anchored.

  • Most participants see the policy well-positioned to wait for clarity amid elevated uncertainty.
    

• Supplemental Leverage Ratio (SLR):
  From JP Morgan to BNY Mellon, multiple bank CEOs openly criticized the SLR this week, so I thought of covering this at a high level. Criticism of SLR is not new, and Jay Powell, in multiple interactions, has mentioned that the FRB is working on revising these rules. Below are the high-level details:
  
  The Supplementary Leverage Ratio (SLR) measures a bank’s Tier 1 capital against total leverage exposure, which includes all on-balance-sheet assets (like Treasuries and reserves) and some off-balance-sheet exposures:
  

  SLR = Tier 1 Capital / Total Leverage Exposure
  

  The SLR treats Treasuries and reserves the same as risky assets, penalizing balance sheet expansion and discouraging banks from holding Treasuries or providing repo financing, especially in volatile markets. The Fed temporarily exempted treasuries and reserves from the SLR scope after March 2020, post-COVID stress. That relief ended in March 2021.
  

  With issuance surging and no exemption, the SLR is blamed as a binding constraint for some banks. It reduces their balance sheet capacity, thereby restricting market participation and the ability to provide liquidity when needed the most.
  

• Key Points - Jamie Dimon Letter to Shareholders:
  The letter is full of philosophy and wisdom, but I list only the key points and my take in some cases (in italic). Some of his comments on the trade deficit are spot on in the context of events in the last two weeks:

  • Despite the unsettling landscape, the US economy remains resilient, with consumers still spending and businesses still healthy.

  • There are many ways to fix unfair trade, but this needs to be done correctly or not at all. The trade deficits, by their nature, are not good or bad. The US trade deficit over the last 20 years is $12T, which is probably large, but this has led to foreign investments in the US.

  • The other side of the trade deficit is an investment surplus, which has resulted in foreign investors owning $30T of US securities. In contrast, the US investors own only $ 16T of foreign securities.

  • The US needs to be broadly trusted and reliable to protect its status as the world's reserve currency. This week's dollar depreciation highlights the importance of this point.

  • The CCAR stress tests are flawed, and the numbers are inaccurate. They unfairly misled the public about the bank's true strength.

  • The Supplemental Leverage Ratio and G-SIB surcharge treats US Treasury securities and repurchase agreements as far riskier than they are. This is covered above in detail.

  • The Liquidity Coverage Ratio treats all other securities and loans as riskier than they are. I don't wholly agree with Jaime Dimon on this point. The LCR is a standard rule for all banks; hence, it has standard haircuts, inflows, and outflows rates. Maybe Jamie finds them more stringent (especially for loans) for JP Morgan as it's a well-run bank with sophisticated risk management infrastructure. However, considering the broader applicability of the rule, some conservatism makes sense. Data from the recent few stress periods shows that all other securities (outside US Treasuries), especially off-the-run bonds, can see sharp haircut widening.

  • Before the Great Financial Crisis, banks used to have 15% of their assets held as liquid assets, and they now hold 30%. As per Jamie, this additional capital and liquidity, sitting idle, could be put to better use. I am not sure how Jamie can say this confidently that excess liquidity can be deployed without increasing the risk. It’s a very high-level generic statement. The liquid assets in banks have gone up mainly due to the Liquidity Coverage Ratio requirements. The banking stress of March 2023 proved that the smaller institutions subjected to the lenient US LCR standard due to the tailoring rules suffered. It's a highly complex topic, and I am not sure this statement makes sense without specifics.

  • The biggest risk for JP Morgan is Geopolitical Risk, e.g., Cyber attack, energy disturbance, etc.

  • The US deficit remains large, at 6.6% of GDP, and it’s not sustainable. We can’t say whether it will create a real problem in six months or six years - the sooner we deal with it, the better.

  • It costs $225 to maintain a consumer checking account. Out of which, $150 is fixed. If we add litigation costs and cost of capital, we will have to add another $25, i.e., the total cost to maintain a checking account is $250. Consumers pay for these accounts by the bank retaining net interest, around 2.25% or ~$275 per account. However, for the lower balance accounts, which are the majority, this is $25. Banks also receive certain fees on these accounts, which are ~$100. For the lower balance accounts, our cost to maintain and operate them is far more than what we make from them.

  • Complacency, arrogance, bureaucracy, and BS kill companies.

FRONT PAGES:

EARNINGS UPDATE:

EARNINGS PREVIEW:

VIDEOs OF THE WEEK:

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