Recap 2-10-14


Another interesting post from the NYFRB:

We find that since early 2008 banks have increasingly extended loans to corporations with interest rate spreads tied to the borrower’s CDS spread (or to a CDX index) over the life of the loan, a practice referred to as market-based pricing…Market-based pricing has the potential to lower the cost of bank credit because it saves on monitoring costs, that is, the costs banks incur to screen borrowers for credit quality and the costs banks incur to follow borrowers during the realization of their investment. Market-based pricing also has the potential to lower the cost of bank credit because it protects banks against increases in borrowers’ default risk… In my paper with Ivanov and Vo, we find that banks charge lower interest rates at origination when they tie loan spreads to borrowers’ CDS spreads… It appears that banks are able to lower the cost of credit because of the savings they realize by replacing costly screening and monitoring with borrower-specific information from CDS markets. We draw this conclusion because we find that loans with market-based pricing have fewer covenants than otherwise similar contracts with fixed interest rate spreads… market-based pricing has the potential for creating spirals in the cost of bank credit. Adverse shocks to the CDS market could lead to an increase in the cost of bank credit, putting pressure on the financial condition of borrowers. This outcome could, in turn, lead to further increases in borrowers’ CDS spreads and another wave of increases in the cost of bank credit.

Separately, a Fed paper notes:
Under our preferred specifications, we estimate that a 1 percentage point increase in the rate on a 30-year fixed-rate mortgage reduces first mortgage demand by between 2 and 3 percent. We also present evidence that about one third of the response is driven by borrowers who take out second mortgages while leaving their total mortgage balance unchanged. Accounting for these borrowers suggests a reduction in total mortgage debt of between 1.5 and 2 percent per percentage point increase in the interest rate.

Now, those numbers seem much too low to me, given that a change in 30y yields from 3.5% to 4.5% increases the monthly payments by almost 13%, but given the importance of the housing sector in the economy as well as a transmission mechanism for the Fed, this paper is worth noting.


  • Japan Current Account Balance declined to -639bn vs -685bn exp and -592bn prev
  • Japan Eco Watchers Outlook Survey dropped to 49 vs 54.7 prev.
  • Canada Housing Starts dropped to 180.2k vs 185k exp and 189.7k prev
  • Portugal plans to launch a 10yr bond this week in a step towards regaining regular debt market access.
  • Italy – the country’s banks may face capital shortfalls totaling ~$20B or more; that said, the firms are expected to pass the upcoming stress tests and AQR. “We are confident that the Italian banks will pass the stress test exercise without major problems” – Bloomberg
  • Spain – the government is planning a sweeping reform of its tax system in an effort to provide further support to its recovering economy; marginal rates on personal and corporate income will be lowered as part of the reform – FT
  • GOOG’s market cap briefly surpassed that of XOM on Friday, making the internet search giant the second-most valuable US corporation; AAPL remains #1 and MSFT is #4 – Bloomberg
  • USDA Ag report: Corn end

Upcoming Data:

  • Mon: USDA Ag report, Australia Home Loans, NAB Business Confidence
  • Tue: Yellen Testifies, Japan Money Supply,
  • Wed: Australia Inflation Exp, Employment, UK RICS House Price Balance
  • Thu: US Retail Sales, Jobless Claims,
  • Fri: EU GDP, UMichigan Confidence