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Rates Low for a While is Good for NIMo


Rick Rieder, Black Rock,There’s a good reason to assume that interest rates will stay low for a long time, here. This is more bullish news for NIMo. If rates stay low for an extended period, Bank Net Interest Margin is going to stay near its 30-year lows in US, EUR, and UK. the only securities we do not have good cashflow models for are deposits. Deposits are not going to be the rate limiting factor in funding cashflow prediction error control. I can fund for 6 months at 40 bps with USDLibor ( I can fund for -5 bps for 10 years in EURIbor). The place where the NIM optimization can make a difference is in timing of getting into cards, mortgages, and loans. At least in cards and mortgages there are mature two-way markets in collateralized instruments so the cash flow models have to control error to some extent otherwise the market spreads would be very wide. Moreover, I suspect we can attribute both credit and rates in the cashflow models to the underlying optimization is not trivial.

So, the model error will be controlled and the demand for NIM returns will be historically high. PBC can model all USD Assets and Liabilities using the information given by the Fed. We back out what the various banks capital allocation plan was for the previous quarter then resimulate to see what the optimal allocation was starting with those inferred capital plans. We can determine where any slippage might have occurred and determine how close to optimal each bank performed. We can run P&L explanatories on the aggregate USD portfolio and then attribute back to the banks to fit the slippage model.  PBC can simulate forward using the optimal capital allocation to set targets for the next quarter. It should be a useful tool for Bank Analysts. PBC will probably miss on trading revenues as opposed to banking book revenue. Trading revenues in two sided markets are much more expensive to simulate and optimize.

Slowing labor market growth combined with the other factors mentioned above will make normalization this year difficult for the Fed. However, we still believe the Fed will try to raise rates later this year, but it very likely won’t get a chance to do so in the near term, as we do not foresee much pressure on the central bank to resume rate normalization. In the end, investors will have to contend with rates that are much lower for longer and the fact that generating return in fixed income markets will continue to be challenging, requiring a different toolkit than the traditional one previously used.


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