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How the Federal Reserve Could Suffer Capital Losses; Midterm Economic Headaches; ECB Signals End to Negative Interest Rates
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Good day. For the past decade, because of relatively low short-term rates, the Federal Reserve earned more money on its securities than it paid to banks as interest on reserves. Now, if the Fed has to raise rates a lot to fight inflation, it faces the prospect of losses. When exactly that happens depends on the level of rates and the size of the Fed’s balance sheet—specifically, the point where it pays more in interest on its reserves than it earns on its securities. Meanwhile, as the U.S. heads into midterm-election season, much of the political discussion has centered around solid economic growth and robust employment versus the damaging impact of rising prices. That could create a headache for the Biden administration, as the Fed oversees the strongest economic levers. The central bank is mounting an aggressive effort to tame inflation
without substantially slowing the jobs market and the broader economy, a feat some economists doubt is possible. Elsewhere, European Central Bank President Christine Lagarde said the ECB is likely to increase its key interest rate to zero or above by September, drawing a line under an eight-year experiment with negative interest rates amid record-high inflation and mounting concerns over the weakness of the euro.
Now on to today’s news and analysis.
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Higher Rates Raise Risk of Future Fed Losses
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The break-even level of the Federal Reserve’s benchmark rate is around 3.5%, according to economists’ projections. PHOTO: JOSHUA ROBERTS/REUTERS
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The Federal Reserve’s plans to raise interest rates aggressively to combat high inflation could have an overlooked and uncomfortable side effect for the central bank: capital losses.
The potential for losses hinges on obscure monetary plumbing. The Fed’s $9 trillion portfolio, sometimes called a balance sheet, is full of mostly interest-bearing assets—Treasury and mortgage-backed securities—with an average yield of 2.3%. On the other side of the ledger—the liability side of the Fed’s balance sheet—are bank deposits held at the Fed known as reserves, which are also interest bearing, as well as currency in circulation.
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Rising Risk of Recession Creates New Headache for Biden
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The Federal Reserve’s efforts to slow inflation are raising the possibility of higher unemployment, a slower-growing economy and a recession, prospects that could create new headaches for the Biden administration.
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ECB Signals End to Negative Interest Rates by September
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The European Central Bank said it could raise its key interest rate in July for the first time in 11 years, raising it to zero from minus 0.5% and echoing robust moves by the Federal Reserve and other major central banks.
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Surging Dollar Raises Possibility of Parity With Euro
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A roughly 7% slide in the euro against the dollar this year is breathing new life into a two-decade old question on Wall Street: Will this be the year the currencies finally reach parity? The last time they reached parity was late 2002, though Europe’s common currency has had brushes with the threshold in the more recent past. In 2016, the euro careened toward parity after Donald Trump won the U.S. presidential election and as traders anticipated a series of interest-rate increases by the Federal Reserve.
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Small Businesses Lose Confidence in U.S. Economy
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Fifty-seven percent of small-business owners expect economic conditions in the U.S. to worsen in the next year, up from 42% in April and equal to the all-time low in April 2020, according to a survey of more than 600 small businesses.
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Retailers May Offer Clues on Strength of Consumer Spending
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This week, Macy’s Inc., Dollar General Corp., Costco Wholesale Corp. and other retailers are slated to release quarterly reports showing sales without the lift from government stimulus that helped consumer spending last year.
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Companies Cut Orders, Build Inventory as Supply Trouble Continues
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Ongoing supply-chain issues are forcing finance teams to rethink how they are managing customer demand, from increasing inventory to cutting the number of orders taken, or—as a last resort—canceling those that cannot be filled.
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In Battle for Workers, Companies Build Houses
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Soon after Lizbeth Martinez set out to buy a house near her hometown of Cactus, Texas, she was in a situation familiar to millions of Zillow-browsing Americans: few decent options. Then she found an unlikely partner—her employer.
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Key Developments Around the World
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Biden Kicks Off Economic Group Linking U.S., Asia
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President Biden and leaders from a dozen countries in the Indo-Pacific region endorsed a new economic platform meant to counter China’s influence through cooperation on global issues such as supply chains and clean energy.
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China Spends Far More Than Others to Help Favored Industries
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A study, to be published by the Center for Strategic and International Studies on Monday, finds China’s backing of its companies amounted to at least 1.73% of its gross domestic product in 2019 and the trend is continuing.
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Russian Inflation Makes U.S. Price Rises Look Tame
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Sanctions are hitting Russians at the grocery store as food prices rise amid surging inflation, which is already running at double the rate of the West, and consumers are falling further behind as wages stagnate in a slowing economy.
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Germany Warns Falling Euro Could Push Inflation Even Higher
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Germany’s finance minister warned a weak euro might be driving up inflation in Europe and urged the ECB to raise interest rates, an unusual step that underlines concerns in Europe’s largest economy about the rapid pace of price increases.
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At Davos This Year, It’s Goodbye Snow, Hello Peep-Toe Shoes
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As CEOs, world leaders and billionaires converge in the Swiss Alps for the first World Economic Forum annual gathering to be held in the spring, the hills are alive with pollen, pricey white sneakers and peep-toe shoes.
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Financial Regulation Roundup
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Crypto Might Have an Insider Trading Problem
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As regulators raise questions about the crypto market’s fairness for retail users, public data suggests that several anonymous crypto investors profited from inside knowledge of when tokens would be listed on exchanges.
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SEC Probe Looms Over Auditors’ Fastest-Growing Businesses
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When top executives of a hot electric-vehicle startup made share purchases that later drew scrutiny, they were helped by accounting firm BDO USA, according to the auto company. BDO was also the auditor of the company they ran.
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Time N/A: ECB’s Lagarde and Panetta at Eurogroup meeting in Brussels
2 a.m.: World Economic Forum annual meetings
12 p.m.: Atlanta Fed’s Bostic speaks on economic outlook at Loudermilk Conference Center in Atlanta
7:30 p.m.: Kansas City Fed’s George speaks at bank’s Agricultural Symposium Reservation Economic Summit
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Time N/A: ECB’s de Guindos at ECOFIN meeting in Brussels
2 a.m.: World Economic Forum annual meetings
6 a.m.: Bank of England’s Woods speech on bank’s exercise on financial risks from climate change
10 a.m.: U.S. new home sales for April
12:20 p.m.: Fed’s Powell speaks at National Center for American Indian Enterprise Development Reservation Economic Summit
2 p.m.: ECB’s Lagarde gives opening remarks at ‘Europe’s Global Role’ dinner at World Economic Forum
10 p.m.: Reserve Bank of New Zealand interest rate decision
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For U.S. Inflation, China’s Slowdown Is a Double-Edged Sword
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China’s impact on the U.S. inflation picture works through two different channels, and which one ends up predominating will be a significant factor for how aggressively the Fed has to move to contain inflation, Jacky Wong writes.
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Housing Boom Is on Borrowed Time
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In a hint of what might be to come, the National Association of Home Builders earlier this week said its measure of prospective buyer traffic, is now somewhat below levels that prevailed right before the pandemic, Justin Lahart writes.
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A closely watched Canadian confidence index in May recorded its largest month-over-month drop since the onset of the pandemic, as multidecade-high inflation took a toll on consumers and spending plans. The Conference Board of Canada’s Index of Consumer Confidence fell 11.7 points to 88.1. (Dow Jones Newswires)
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The Bank of Korea is likely to raise its base rate at Thursday's policy meeting with a back-to-back rate increase to fight stronger-than-expected inflation, a WSJ poll shows. Of the 26 analysts surveyed in the poll, 23 expect the BOK to deliver the same 25bp rate increase this month, as done in April, to take the policy rate to 1.75%. (DJN)
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Indonesia's central bank is expected to keep its benchmark seven-day reverse repo rate unchanged at 3.50% in May, although a few economists polled said a 25bp rate increase may be possible. Seven of 11 economists polled by The Wall Street Journal think the central bank is likely to stand pat in May and raise rates later in the year. (DJN)
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Consumer confidence in the eurozone edged up in May, despite concerns over the war in Ukraine and the increasing cost of living. The European Commission said its measure of consumer confidence rose to minus 21.1 this month from a revised minus 22.0 in April. (DJN)
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Producer prices in Germany rose strongly in April, driven by higher energy prices, posting the biggest increase ever recorded, statistics office Destatis said. Producer prices rose 33.5% on year, with energy prices up 87.3% from a year earlier. The producer price index excluding energy rose 16.3% on year. (DJN)
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U.K. retail sales rebounded in April as spending on alcohol, fuel and at online stores rose, the Office for National Statistics said. Sales volumes rose 1.4% from March, compared with a forecast by economists polled by the Wall Street Journal that sales would weaken by 0.3%. Compared with April 2021, retail sales weakened by 4.9%. (DJN)
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Gabon's economy is forecast to grow by 2.8% this year after a contraction of 1.5% last year largely due to the efforts undertaken to limit the impact of the Covid-19 pandemic and the rise in oil prices, the International Monetary Fund said. (DJN)
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This newsletter is compiled by James Christie in San Francisco.
Send us your tips, suggestions and feedback. Write to:
James Christie, Jon Hilsenrath, Michael S. Derby, Nell Henderson, Nick Timiraos, Paul Hannon, Kim Mackrael, Tom Fairless, Megumi Fujikawa, Perry Cleveland-Peck, Michael Maloney, Paul Kiernan, James Glynn
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