Fed Injects Over $400 Billion Into Markets As Liquidity Dries-Up (#GotBitcoin?)
The Fed Pumps Another $105 Billion Into Struggling Bank Sector. Fed Injects Over $400 Billion Into Markets As Liquidity Dries-Up (#GotBitcoin?)
* The Federal Reserve on Tuesday sold $105 billion in market repurchase agreements, or repos, in a continued effort to calm money markets and bring interest rates within its intended range.
* The bank offered $75 billion in repos expiring overnight and $30 billion in repos expiring in 14 days. Banks bid for more than was available of each repo, signaling strong demand for the government-backed asset.
* The bank began a streak of repo offerings last week, marking the first time such assets were sold since the 2008 financial crisis. The central bank said the offerings would continue through early October.
Repo And Reverse Repo Operations (Total Amount Of Money Pumped Into The Banks)
The Federal Reserve added $105 billion to the nation’s financial system on Tuesday in two transactions, seeking to calm money markets and keep interest rates in its intended range.
Banks bid for $80.2 billion in overnight repos and $62 billion in 14-day repos, signaling strong demand in the government-backed investments.
Last week marked the first time in a decade that the bank had taken such steps to relieve pressure on money markets. The bank offered a total of $278 billion in repos from Tuesday through Friday.
Also last week, the Federal Open Market Committee cut its benchmark interest rate by a quarter of a percentage point, landing in a window of 1.75% to 2%. Fed Chairman Jerome Powell called the repo offerings a temporary action.
“Funding pressures in money markets were elevated this week, and the effective federal funds rate rose above the top of its target range,” he said.
The Fed’s schedule calls for another $75 billion of overnight repos to be sold every business day until October 10, with certain days also offering at least $30 billion worth of 14-day repos.
Repo Market Meltdown Shows Bitcoin’s ‘Systemic’ Stability: Caitlin Long
Wyoming Blockchain Coalition president Caitlin Long has responded to the recent unrest in the money markets by analyzing the systemic fragility of the traditional financial sector as compared with Bitcoin (BTC).
In a Medium blog post published on Sept. 25, Long made the argument that “at a systemic level, the traditional financial system is as fragile as Bitcoin is antifragile.”
Writing in the wake of last week’s weakness in the repo markets — which prompted the Federal Reserve to temporarily inject $75 billion in cash to keep rates within its target range — Long argued that the incident represented “a modern version of a bank run.” She continued:
“And It’s Not Over Yet. Stepping Back, It Reveals Two Big Things About Financial Markets:
first, US Treasuries are not truly ‘risk-free’ assets […] and second, big banks are significantly undercapitalized. The event doesn’t mean another financial meltdown is necessarily imminent […] since the brush fire can be doused either by the Fed, or by the banks raising more equity capital.”
The liquidity squeeze — which pushed overnight repo rates to as high as 10%, well north of the Fed’s target 2-2.25% range — had been triggered by the coincidence of corporate tax payments and Treasury settlements falling on the same date.
Yet rather than being a one-off instance of exceptional, unfortunate pressure on the lending markets, Long notes that this is the fourth such episode since the 2008 meltdown.
She critiques the Fed’s assertion this June — made on the occasion of the publication of its most recent bank stress tests — that “the financial system remains resilient,” arguing that the proclamation “strains credulity.” She further notes that:
“A staggering amount of US dollar liabilities have been issued offshore in recent decades and the Fed not only doesn’t control them but can’t measure them with any degree of accuracy.”
Bitcoin: An Insurance Policy Against Systemic Instability
This inherent obfuscation — particularly glaring when it comes to highly re-hypothecated assets such as U.S. Treasuries — was importantly conceded by the Chairman of the CFTC, Chris Giancarlo during questions following a 2016 speech. He remarked that:
“At the heart of the financial crisis, perhaps the most critical element was the lack of visibility into the counter-party credit exposure of one major financial institution to another. Probably the most glaring omission that needed to be addressed was that lack of visibility, and here we are in 2016 and we still don’t have it.”
In conclusion, Long makes the case that while commentators frequently point to volatile price performance when it comes to Bitcoin, it is significantly more stable systemically:
“Bitcoin’s price is highly volatile, but as a system, it is more stable […] Bitcoin is not a debt-based system that periodically experiences bank run-like instability. In this regard, Bitcoin is an insurance policy against financial market instability. Bitcoin is no one’s IOU. It has no lender of last resort because it doesn’t need one.”
Earlier this month, crypto fund executive Travis Kling argued that that the specific properties of Bitcoin make it an exceptional hedge against monetary and fiscal irresponsibility from central banks and governments globally.
New York Fed Boosts Size of Repurchase Operations
Overnight loans rise to $100 billion from $75 billion.
The Federal Reserve Bank of New York said Wednesday it would increase the size of scheduled operations to provide short-term cash loans to financial firms.
The Fed said it would increase the size of overnight cash loans offered Thursday through the market for repurchase agreements, or repos, to $100 billion from $75 billion, while doubling the size of a two-week offering Thursday to $60 billion.
Banks asked the Fed for about $92 billion in overnight reserves Wednesday, offering collateral in the form of Treasury and mortgage securities, compared with the $75 billion provided by the central bank.
The decision to increase the size of the loans in the repo market, where borrowers offer collateral such as Treasury bonds in exchange for cash over very short periods, follows recent operations where banks have bid for more cash than the Fed had offered. This was most notable Monday after banks submitted bids for more than twice the $30 billion of two-week loans offered by the Fed.
Demand to borrow cash in the repo market is expected to increase as the end of the quarter approaches. Banks often opt to hold more cash at the end of fiscal quarters to ensure that they have enough liquid assets to protect against potential losses.
The Fed could continue to offer cash to financial firms through the repo market for the rest of the year, said Jerry Pucci, who oversees repo trading at BlackRock Inc., Tuesday at a conference held by the New York Fed.
The Fed’s decision to add reserves is intended to prevent a cash shortfall at that crucial period. The cost to borrow cash rose as high as 10% last week as cash left the financial system following quarterly corporate tax payments and the settlement of Treasury auctions. A surge in demand at the end of last year pushed repo rates to as high as 6%.
The Federal Reserve injected $75 billion into U.S. money markets as policy makers’ benchmark rate broke outside their preferred band, ratcheting up the pressure on central bank officials to find a long-term fix for the financial system’s plumbing. Fed Injects $75 Billion Into Markets As Liquidity Dries-Up
The moves underscored just how deep the structural problems in U.S. money markets have become. Namely, there is often not enough cash on hand at major Wall Street firms to meet the funding demands of a market trying to absorb record Treasury bond sales needed to cover U.S. budget deficits. The solution, according to longtime observers, would be for the Fed to continue to inject cash on a regular basis.
“The underlying problem is that there isn’t enough liquidity in the system to satisfy the demand and the job of the central bank is to provide such liquidity,” said Roberto Perli, a former Fed economist and partner at Cornerstone Macro in Washington. “What the Fed did was just a patch.”
Morgan Stanley Sees Fed Starting Permanent Open Market Ops
The Fed is likely to announce permanent open market operations in its communications today, Morgan Stanley strategist Matt Hornbach said on Bloomberg TV.
“The buffer of reserves that the Fed was hoping to have in the system clearly isn’t there any more,” Hornbach said.
Using POMOs will avoid the implication that the Fed is restarting quantitative easing, which could raise fears of a recession or a systemic problem.
“When you start losing control of the target rate, you need to increase reserves in the system, but that’s not necessarily QE as we know it in a traditional sense,” Hornbach said. “They’re going to do this via permanent open market operations.”
There is evidence things are calming down. For instance, the rate for general collateral repurchase agreements has dropped to 2.175%, down from Tuesday’s record high of 10% and about where it was last week.
‘This Is Crazy!’: Fed’s Repo Madness Sends Wall Street Reeling
Now attention turns to this afternoon’s Federal Open Market Committee decision to see what, if any, further steps are taken to remove pressure from the overnight lending business and ensure higher rates don’t harm other parts of the economy. Action is nearly certain after the New York Fed said Wednesday that the effective fed funds rate busted through policy makers’ 2.25% cap the day before, coming in at 2.30%. That’s bad because it shows the Fed is losing its grip on short-term interest rates, undermining its ability to guide the financial system.
Adjusting something called the interest rate on excess reserves, or IOER, is one likely remedy. Longer-term solutions include expanding the Fed’s balance sheet to replenish reserves in the banking system.
“These money markets are a very powerful part of the financial system and everything flows through,” said John Herrmann at MUFG Securities in New York. “What the Fed has been doing so far to address the issues is like being a fire department chasing the fire instead of sort of installing fire hydrants through facility. They need to do more.”
The New York Fed Declined Comment
The Fed’s dose of cash Wednesday follows a $53.2 billion liquidity injection Tuesday. It had been more than a decade since traders at the central bank jumped into U.S. money markets to add cash. And they seemed to get the reaction they wanted Tuesday morning, instantaneously driving down key short-term rates that had spiked, threatening to muck up everything from Treasury bond trading to lending to companies and consumers.
But The Move Didn’t Last Long
By the end of the trading session, rates were grinding back up, prompting Fed officials to fire off a second missive late in the day: They would be back Wednesday morning to offer another $75 billion of cash.
A couple of catalysts caused the liquidity squeeze in this esoteric, yet vital, corner of finance known as repurchase agreements.
There was a big swath of new Treasury debt that settled into the marketplace — adding to dealer balance sheet holdings — just as cash was sucked out by quarterly tax payments companies needed to send to the government. If left unchecked, the escalation in rates could do damage to the broader economy by hiking borrowing costs for companies and consumers.
The timing couldn’t have been worse, with Fed leaders and many key New York Fed staffers gathered in Washington for a two-day policy meeting that will end Wednesday. Fed officials are widely expected to cut their target rate by a quarter-point. But the money-market problem threatens to overshadow that, as Wall Street is ready to find out the Fed’s long-term solution is.
“The increase in repo and other short-term rates is indicative of the reduced amount of balance sheet that financial intermediaries — particularly primary dealers — are either willing or able to provide those in search of short-term financing,” said Tony Crescenzi, market strategist at Pacific Investment Management Co. and author of a 2007 edition of “Stigum’s Money Market,” a widely read textbook first published in 1978. “It serves as a reminder of the challenges that investors could face in other ways if and when they seek to transfer risk — sell their risk assets — during a risk-off mode.”
This is far from the first bout of volatility in the over $2 trillion repo market, but eye-catching moves tend to happen only at quarter- or year-end when liquidity sometimes dries up — not in the middle of the month, as it is now. Even setting aside this week’s huge spike, turmoil has been more pronounced following the 2008 crisis because reforms designed to safeguard the financial system have driven some banks out of this market. Fewer traders can lead to rapid swings by creating imbalances between supply and demand.
Fed interventions in the repo market, like the ones deployed Tuesday and Wednesday, were commonplace for decades before the crisis. Then they stopped when the central bank changed how it enacted policy by expanding its balance sheet and using a target rate band.
The tumult seen Monday and Tuesday doesn’t mean another global funding crisis, even though trouble getting funds through repo a decade ago doomed Lehman Brothers and almost snuffed out the global financial system.
But, many experts say, these wild few days show that there’s not enough reserves — or excess money that banks park at the Fed — in the banking system. That means traders are this week having to pay up to get these funds, even as bank reserves total more than $1 trillion. And it suggests the Fed may again have to grow its $3.8 trillion balance sheet through quantitative easing, or debt purchases that create fresh reserves.
There are other remedies. The Fed has considered introducing a new tool, an overnight repo facility, that could be used to reduce pressure in money markets. And some strategists predict it may make another technical tweak to IOER, something that’s already been done three times since last year in an attempt to keep markets in line.
“There were a confluence of factors that triggered the issues this week,” said Darrell Duffie, a Stanford University finance professor who’s co-authored research on repos with Fed staffers. “But the fact that it’s happening means something at the Fed should be done. For the Fed to be really confident in ending the issues, they will have to grow the balance sheet.”
The U.S. government has made matters worse over the past year by adding a record amount of new debt, and that will likely only increase as the deficit swells past $1 trillion. That has buoyed the amount of debt that dealers have on their balance sheets, and the repo market is one way they finance those positions. That said, their Treasury holdings are down from a peak in May, so that’s not necessarily behind this week’s big moves.
“Supply is a backdrop contributor to the issues, as there is just that much more collateral that needs to be financed,” said Seth Carpenter, a former adviser to the Fed Board of Governors who is now chief U.S. economist at UBS Securities LLC. “The market is still trying to deal with tight balance sheets from dealers. Overall this is all part of the market shifting through time to a new set of realities.”
Bank Reserves: What Are They And Why A Shortage Is Roiling A Key Interest Rate
Not many people realize this, but there are two basic types of money in the world.
Bank reserves are normally obscure, even to bankers and professional investors. But this week they have hit the news when a shortage of them caused a key measure of borrowing costs—known as the overnight repo rate—to spike. That’s a worry, because typically these more wonky areas of finance only become interesting when something is going wrong.
The overnight repo rate, which is what banks and other financial players charge each other to lend cash in exchange for supersafe bonds, should be close to 2%, but it shot up almost as high as 10% on Tuesday. One of the underlying causes of this is a scarcity of reserves compared with the amount of Treasury bonds in the market. That has made banks less willing to lend to each other even in exchange for safe government bonds.
To settle markets down, the Federal Reserve Bank of New York has dipped into this market, conducting three auctions this week where banks could swap Treasurys (or bonds from institutions like Fannie Mae ) for new reserves. It conducted a third auction on Thursday morning and offered $75 billion in repos.
Here’s Is A Simplified Rundown Of What Reserves Are And How They’ve Come To Matter.
What Are Reserves?
Not many people realize this, but there are two basic types of money in the world.
There is central bank money, which is known as reserves, and there is money that the rest of us use.
Central bank money can only be used by banks, governments and some government-linked institutions. They have this money in accounts at the central bank, where it is called “reserves.” The money that the rest of us use is private money that is created by ordinary banks.
There Is Also Some Special Central Bank Money That Everyone Can Use: The Notes And Coins In Our Wallets
What Are Reserves For?
The main day-to-day function of reserves is for banks to make payments to each other that reflect transactions between the rest of us. When one person transfers money to another person, it looks like private money moves from one bank account to another.
But that’s not what really happens. In fact, the first person’s bank reduces the amount in the person’s checking account, which is really just a record of money the bank owes to them. It then sends an equivalent amount of reserves to the second person’s bank. That bank now owes the second person more money and so it increases the value of their deposit with private money.
The same is true when your employer pays you your wages (assuming you don’t get them in notes and coins anyway), or when you pay for your groceries with a debit card.
Where Do Reserves Come From?
One way reserves find their way into the banking system is when a government spends money. Whether it wants to pay government workers’ wages or buy cruise missiles, it sends reserves from a government’s central-bank account to the central-bank account of the ordinary bank used by the person or company who is getting the money. That bank then increases the value of the deposit in the accounts of workers or cruise missile suppliers.
The government can get some of those reserves back by selling a Treasury bond to investors, which is done via primary dealers, banks who have a special role acting as market makers for government bonds. The bond sale is paid for, or settled, using reserves from the banks that have the deposit accounts of those investors.
Where Does QE Come In?
The whole point of QE—quantitative easing—was to ease the pain of the financial crisis by flooding the financial system with money, which would make all kinds of borrowing significantly cheaper.
Central banks did this by creating trillions of dollars (or euros or Japanese yen) worth of reserves to buy back government bonds from investors via banks. This gave banks vast amounts of reserves. In turn, the banks gave those selling the bonds equally vast amounts of new private money. That private money could then be spent in the economy or used to buy riskier corporate bonds for example. The higher demand for other forms of debt would make that debt cheaper for borrowers.
And Then The Federal Reserve Started To Reverse QE?
Yes, the Fed stopped buying Treasurys when it felt the economy was on solid footing. When the bonds that it owned matured, the government had to repay the Fed. The government did this by handing reserves back to the Fed which the Fed then destroyed, reversing the process when it bought the bonds in the first place.
Reserves also leave the banking system when the government sells new Treasurys to private investors or when it collects taxes. Tax payments are special because governments, unlike companies or private citizens, deal directly in reserves. That means a tax payment involves reserves being transferred from an ordinary bank to a government account at the central bank. An equivalent amount of private money in the taxpayer’s bank account disappears.
The Upshot: New Sales Of Treasury Bonds And Tax Payments Take Reserves Out Of The Banking System.
So Why Does This All Suddenly Matter Now?
This is the trillion-dollar question. The answer, according to some analysts, is that the Fed isn’t sure how much reserves banks need these days. New rules since the crisis and the stress tests that banks have to beat have together increased the amount of reserves they want to hold.
But reserves have been shrinking because of the reversal of QE, increased government borrowing in the Treasury market, and a recent wave of tax payments, among other things.
One key cause of the crunch in overnight lending markets is that there are more Treasurys around than banks want to own, but some banks are still being forced to buy them. These are the so-called primary dealers who buy Treasurys from the government and then sell them to investors.
If banks don’t want to spend their own reserves to buy Treasury bonds they have to borrow those reserves from elsewhere. They can do that directly in specialist bank-only markets, or they can try to borrow private money in overnight lending markets, where rates spiked this week.
That is why the short-term fix has been for the Federal Reserve Bank of New York to offer to take some of those Treasurys in exchange for new reserves. The longer-term solution could be a more permanent arrangement where the Fed conducts regular auctions. Unless that is, it turns out that the problem isn’t just with banks, but that there is a real need for funding coming from somewhere else in the system that hasn’t yet been identified.
Fed Will Weigh Resuming Balance Sheet Growth At October Meeting
Decision To Add New Treasuries Would Represent A Resumption Of Crisis-Era Quantitative Easing Stimulus
A sudden spike in overnight lending rates this week is forcing the Federal Reserve to consider growing its holdings of Treasury securities for the first time in five years, putting a decision on the agenda for its meeting next month.
Fed Chairman Jerome Powell said Wednesday the central bank would be studying whether to increase its holdings, sometimes referred to as its balance sheet, carefully before approving any action at its Oct. 29-30 meeting.
“It is certainly possible that we will need to resume the organic growth of the balance sheet earlier than we thought,” he said at a news conference. “We’ll be looking at this carefully in coming days and taking it up at the next meeting.”
A decision to resume the growth of the Fed’s balance sheet wouldn’t mark the start of a new bond-buying program to stimulate economic growth by lowering long-term interest rates, like those the Fed began in several rounds after the 2008 financial crisis.
Instead, the Fed would begin buying small amounts of Treasury securities on a regular basis to prevent the amount of money in the banking system from declining. This marks a return to the normal precrisis practice of allowing the Fed’s balance sheet to grow in line with the broader economy.
A decision to do so also wouldn’t on its own fix recent cash shortages in money markets. The New York Fed has moved to inject up to $75 billion in those markets daily since Tuesday to help pull down interest rates and announced it will do so again on Friday.
Fed officials didn’t decide the matter this week, instead preferring to study how the financial system is digesting their five-year effort to drain reservoirs of cash to reverse their crisis-era stimulus.
Analysts at Evercore ISI expect the Fed will need to buy $8 billion to $14 billion in Treasurys every month to prevent bank deposits, known as reserves, from declining; that is on top of around $35 billion in Treasurys it is buying to replace retiring bonds and mortgage-backed securities.
Central bank officials said this spring that they would stop shrinking their Treasury holdings, a decision that took effect last month. But they never said when they would allow their holdings to grow again.
The Fed’s balance sheet is composed of $3.8 trillion in assets—primarily Treasury securities and mortgage-backed securities—and liabilities, including the reserves that were created to purchase the assets.
The Fed stopped buying bonds to spur the economy in 2014 and began slowly shrinking the holdings in 2017 to reduce the stimulus, which drained reserves from the system. Reserves have fallen to less than $1.5 trillion from a high of $2.8 trillion
In the normal course of business, the Fed’s balance sheet should grow to keep up with demand for the Fed’s liabilities, which include currency in circulation and the Treasury’s general financing account.
The amount of currency in circulation has grown to $1.7 trillion from less than $800 billion in 2007. During periods when the Fed has held its balance sheet steady, reserves decline if the Fed’s other liabilities rise, removing cash from markets.
The Fed’s balance sheet doubled between 1994 and 2007—well before it started its bond-buying stimulus programs, sometimes called quantitative easing, or QE.
“By expanding its balance sheet, the Fed would simply accommodate the market demand for liquidity, not provide excess liquidity, which is a characteristic implicit in QE,” said Roberto Perli, an analyst at Cornerstone Macro, in a note to clients Tuesday.
The decision to resume growth of the balance sheet isn’t a big surprise. Several Fed officials said earlier this year they didn’t want to reduce reserves to levels that might fuel volatility in short-term money markets. A seasonal cash crunch on Monday, however, did just that.
Corporate tax payments and settlements of government bond sales resulted in a large transfer of cash from the banking system to the Treasury, fueling a spike in overnight lending rates, including the Fed’s benchmark federal-funds rate.
The fed-funds rate traded at 2.3% on Tuesday, according to the New York Fed, rising above the central bank’s target range between 2% and 2.25%.
Separately, the Fed lowered the range by a quarter percentage point on Wednesday to cushion the economy against risks from trade policy uncertainty and slowing global growth.
Tuesday’s rate jumps raise the possibility the Fed misjudged the appropriate level of reserves or that broader plumbing issues are interfering with the ability of banks and other broker-dealers to move cash, which could require a larger volume of reserves to keep markets running smoothly.
Determining when to stop the decline in reserves is “is probably more art than science,” said Boston Fed President Eric Rosengren in an interview earlier this year.
When it comes to determining the right point to stabilize reserves, “we’ve always said that the level is uncertain,” Mr. Powell said Wednesday. “I think we’ll learn quite a lot in the next six weeks.”
Fed officials face other thorny questions after that, including whether to change the mix of the Treasury securities they are purchasing and whether to become more involved in money markets by creating a new standing facility that would reduce volatility in participants’ demand for cash.
Powell’s Subtle Messaging To Trump On Trade Fight
Fed chairman mentioned trade 20 times at his news conference on Wednesday.
Fed Chairman Jerome Powell ’s press conference this week carried a subtle message for President Trump: If you’re worried about an economic slowdown, find a way to cool down the trade war.
Mr. Powell, of course, didn’t spell this out so explicitly.
As has been his custom, he pointedly declined to respond to Mr. Trump’s latest insults on Twitter Wednesday, when he said Mr. Powell had “no ‘guts,’ no sense.” Mr. Trump has tweeted disapprovingly about the Fed more than 30 times since the Fed cut rates in July.
Still, in his past three public appearances, Mr. Powell has more strongly signaled his concern that recent market turmoil, including a swift decline in long-term bond yields last month, reflected worries that the U.S.-China trade war was hurting business confidence and investment.
Trade disputes ratcheted up in May when Mr. Trump declared an escalation of trade tariffs on China when negotiations over a trade agreement broke down. Later, he threatened to impose tariffs on Mexico to address concerns over border security.
Trade developments have been “up and down and then up, I guess—or back up, perhaps—over the course of this intermeeting period,” Mr. Powell said Wednesday. “In any case, they’ve been quite volatile.”
Mr. Powell mentioned trade 20 times at his news conference on Wednesday. Other geopolitical risks figured less prominently or not at all. Mr. Powell mentioned Brexit once, and tensions in Hong Kong and Saudi Arabia didn’t come up.
“The thing we can’t address, really, is what businesses would like, which is a settled road map for international trade. We can’t do that. We don’t have that tool,” Mr. Powell said. “But we do have a very powerful tool which can counteract weakness to some extent by supporting demand through sound monetary policy.”
Mr. Powell said business contacts across the country have reported being discouraged from making new investments because of trade-related uncertainty.
Business executives have sent Mr. Trump and his advisers a similar message, particularly after he escalated trade tariffs and threatened to bar U.S. firms from doing business in China last month.
Fed officials voted to cut rates Wednesday by a quarter-percentage point for the second time in as many months, though the vote on the 10-person rate-setting committee wasn’t unanimous. Two dissenters favored holding rates steady, while one preferred a larger, half-point cut.
The Fed’s benchmark rate is now in a range between 1.75% and 2%.
In an interview Thursday on the Fox Business Network, White House economic adviser Lawrence Kudlow said the Fed’s recent move was a “step in the right direction.” He added, “They probably have more work to do…and I reckon they’ll probably get there.”
Mr. Kudlow brushed aside a question over whether trade-related uncertainty was harming business investment. Recent data on manufacturing activity showed improvement, he said, and he predicted a pickup in spending on business equipment.
For his part, Mr. Powell said he didn’t mean to suggest the Fed’s tools haven’t had any effect. The Fed’s pivot away from raising interest rates at the start of the year to holding them steady during the spring to cutting them this summer helped keep the economic outlook favorable, he said.
“We do have a very powerful tool which can counteract weakness to some extent,” Mr. Powell said. He added: “I was pointing out that there is a piece of this that we really can’t address.”
Fed Says It Will Extend Repo Operations Through At Least Oct. 10
Fed Adds $75 Billion In Fourth Repo Transaction This Week
The Federal Reserve Bank of New York will offer to add at least $75 billion daily to the financial system through Oct. 10, prolonging its efforts to relieve funding pressure in money markets.
In addition to at least $75 billion in overnight loans, the New York Fed said in a news release it will also offer three separate 14-day repo contracts of at least $30 billion each next week. The Fed will conduct further operations as needed after Oct. 10.
On Friday banks asked for $75.55 billion in reserves, $550 million more than the amount offered by the Fed, offering collateral in the form of Treasury and mortgage securities.
The Fed’s operation was the fourth time this week it has intervened to calm roiled money markets. Rates on short-term repos briefly spiked to nearly 10% earlier this week as financial firms looked for overnight funding. The actions marked the first time since the financial crisis that the Fed had taken such measures.
What Billions In Fed Repo Injections Reveal About The Promise Of Bitcoin
Last week, the Federal Reserve injected $278 billion into the securities repurchase, or “repo,” market over four days, all so that banks could meet their liquidity needs. It was the first time the Fed had intervened in this vital interbank market, where banks’ pawn financial assets to fund overnight cash needs, since the financial crisis of 2008.
Fed officials and bankers dismissed the rare liquidity breakdown as a hiccup stemming from a series of coincidental factors in bond markets and corporate tax payments. It wasn’t a very comforting explanation, not when other economic warning signs are flashing, too: $17 trillion in bonds worldwide showing negative yields; a worsening U.S.-China trade war; and manufacturing indicators signaling an impending global recession.
Predictably, certain crypto types have viewed this alarming scenario with glee. More than a few HODLing tweeters responded to the repo story with two words of advice: “buy bitcoin.”
But it’s actually hard to predict what all this means for crypto markets, at least in the short- to medium-term.
If and when a 2008-like financial panic takes hold, will bitcoin rally as a new kind of uncorrelated “safe haven” or will it decline in a broad-based “risk-off” dumping of all things speculative? (Notwithstanding a sharp dip and rebound midway through last week, bitcoin has proven quite stable of late, at least by its own volatile standards.)
Other questions: do these vulnerabilities in traditional credit markets highlight the promise of new blockchain-based ideas? For example, would wider use of security tokens allow speedier settlement and, by extension, reduced counterparty risks and greater market confidence? Or, far more radically, would MakerDAO’s on-chain #DeFi lending markets enable a more reliable clearing mechanism, with collateral calls locked in by a decentralized protocol? Or might these underdeveloped ideas simply be recipes for systemic risk, a single hack or software glitch away from setting off a vicious spiral of collateral calls and bankruptcies?
The Jury Is Out On All This Untested Stuff.
Still, if nothing else, the many signs of stress in the traditional financial system offer a valuable framework for thinking about how the world could be different and the role blockchain technology might play in enabling that new world.
Let’s Look At Some Of Them:
The rare phenomenon, where creditors are essentially paying issuers for the privilege of lending them money – head scratcher, right? – reflects excessive demand for “safe” assets, especially for government-issued bonds. It has historically been a strong indicator of impending recession, since it reflects an overwhelming reluctance among investors to take on risk.
Now, another way of thinking about that reluctance is to express it as a perceived shortage of good investment opportunities. That perception can be fueled by a worsening economic outlook, but it’s also dictated by the barriers to entry that make it difficult for otherwise investable businesses of offer new opportunities.
Here, certain blockchain-based credit ideas offer hope. There’s the prospect for distributed-ledger asset registries that better track collateral and enable new emerging-market lending in developing-country land, commodities and energy markets. Or there are ideas such as having exporters tokenize their receivables to tackle a major structural limit on global trade finance, where a majority of small-and-medium enterprise are denied letters of credit because bankers don’t trust their documentation.
Effective use of blockchain technology could boost trust in assets and lien registries and help bring to life the $20 trillion in “dead capital” that economist Hernando de Soto says the world’s poor are sitting on.
Just as importantly, it would open a world of new alternative assets to draw in investors’ capital, giving them less of a reason to park it in low-yielding bonds.
Global Economic Slowdown
An alarming, synchronized downturn in manufacturing indicators, most notably in purchasing manager indexes, which measure current and future business spending on inventory and equipment, flows directly from the U.S.-China trade war. In cutting off Chinese goods exporters from U.S. consumer markets and driving up costs for their U.S. importers – and vice versa for U.S. farmers selling to food distributors in China – the conflict has added a massive new burden on global economic activity.
But let’s look at the starting point for this trade battle. It lies in American companies’ mostly legitimate complaints about China’s mercantilist, centrally planned approach to supporting Chinese companies at their expense, all enabled by a system of surveillance and control over people and businesses. This where there’s a crypto angle.
Cryptocurrency and other decentralizing technologies could work against the Chinese government’s capacity to control its economy in this interventionist manner. If Chinese businesses and hundreds of millions of Chinese citizens used bitcoin to circumvent capital controls, for example, the ever-present risk of monetary flight would act as a pressure valve, compelling Beijing to pursue a more open economic model to maintain competitiveness. That would give anti-free-traders like President Trump less of an excuse to ratchet up protectionist attacks against it.
The Repo Intervention
Some innovators have sought to apply blockchain technology to the back-office structural problems that periodically roil money markets, such as those now manifest in repo. They see a distributed ledger as a superior mechanism for tracking the IOUs of money and pawned securities upon which inter-institutional credit markets are based.
One was former J.P. Morgan credit market maven Blythe Masters, who founded Digital Asset Holdings in 2014 on the idea that on-chain settlement and a universally auditable ledger could improve transparency in global finance’s opaque, complex matrix of interconnected credit relationships. This way, she argued, it could mitigate the mistrust and counterparty risks that fueled the financial crisis.
The DAH model and those of others working on back-office blockchain solutions for capital markets have not come to fruition. This is at least partly due to the reluctance of incumbent financial institutions and their regulators to kill off existing functions that a blockchain would make redundant; they instead designed cumbersome hybrid distributed-ledger models that sustained vested interests but were expensive and difficult to collectively implement.
Either way, a blockchain back-office fix for traditional finance isn’t coming any time soon – whether because of internal politics or the limitation of the technology.
Shining A Light
A more important question is why we even tolerate a system that’s so vulnerable to those back-end markets’ problems at all. The only reason central banks ever intervene to support interbank credit markets is because society’s means of payment depends on avoiding cash shortfalls and maintaining confidence in fractional-reserve banking.
If banks don’t have enough cash to meet short-term creditor calls, they would suffer runs on their deposits, companies wouldn’t make payroll, tenants would have to skip rent, ATMs would run out of banknotes, etc. The economy would seize up. The worst of it is that, because of this ever-present threat, banks hold our political system to ransom, knowing that they can always rely bailouts: the too-big-to-fail problem.
But what if banks just stuck to longer-term lending? What if there were no checking accounts or debit/credit cards, and we simply exchanged value with each other via cash or digital currencies that we hold ourselves?
If people used bitcoin, or fiat-backed stablecoins or central bank digital currencies to exchange value instead of the IOUs of an inherently fragile fractional reserve banking system, institutional cash shortages simply wouldn’t matter as much. Banks’ biggest creditors might take a hit against their risk-adjusted positions and their stock prices would fall, but the rest of us, including the Fed, could ignore the problem.
As the journalist and commentator Heidi Moore astutely observed in a tweetstorm last week, the reason the repo market tumult is so worrying is because it speaks directly to the core problem of trust in the banking system.
If nothing else, this is where blockchain technology provides a valuable lens with which to assess the current stress in the financial system. It helps us think about how the trust problem creates vulnerabilities, power imbalances and systemic risks and how we might design a system that’s better able to resolve it.
BTC And Quantitative Easing: What’s The Correlation To Crypto?
In 2018, the executive on the board for the European Central Bank (ECB) declared Bitcoin, “the evil spawn of the financial crisis” — referring, of course, to the economic disaster 10 years prior. Interestingly, also born from the ashes of the mortgage crisis was the United States government’s adoption and unabated use of quantitative easing (QE).
However, according to some, there’s more of a connection between Bitcoin (BTC) and the government’s use of QE than just their origins. A recent tweet from BitMEX CEO Arthur Hayes highlighted this supposed correlation:
“QE4eva is coming. Once the Fed gets religion again, get ready for #bitcoin $20,000.”
Nodding to the Federal Reserve’s latest decision to pump the economy with billions of dollars, Hayes brazenly suggests a relationship between a growth in Bitcoin’s price and an increase in QE. But is this idea entirely out of the realms of possibility?
A Bailout For Banks
At the start of last week, banks all over the U.S. ran out of cash, as interest rates in the overnight market — a platform reserved for interbank lending — shot up to 10%. forcing the Fed to act. On Tuesday, $53 billion was mainlined into the financial sector in order to quell short-term interest rates. Known as an “overnight repo operation,” the Fed spent $40.8 billion on treasuries, $11.7 billion on mortgage-back securities and a further $600 million on agency bonds, all in an attempt to lessen borrowing costs from the proverbial line in the sand.
This line was drawn back in July, when the Fed set a renewed target range for interest rates of 2% to 2.5%. Come Wednesday, and with overnight lending rates still sky-high, this target was redrawn to a range of 1.75% to 2%, resulting in another $75 billion siphoned from the Fed’s coffers.
However, it didn’t stop there. On Thursday, with rates citing a spike of approximately five times the acceptable benchmark, the Fed released a statement bracing the market for an additional $75 billion. Friday marked yet another $75 billion in capital injections.
In total, $278 billion funneled into the markets. Finally, the Fed did away with the daily charade and announced that further operations would continue regularly through to mid-October. Previously, sky-high repo rates declined following the injection of $278 billion.
Fed Chairman Jay Powell mostly brushed the repo operations off, suggesting that while they were integral to the smooth running of the market, they had no “implications for the economy or the stance of monetary policy.”
These repurchasing agreements, or repos, typically involve the overnight lending of government securities on the open market, with distributors selling to investors with the expectation of repurchasing the following day. While these generally take place between financial institutions, once in a while, the Fed will get involved — entering into agreements to regulate the monetary supply. This latest flurry of investment marks the first time in over a decade that the Fed has intervened with a repo agreement, with the last being the 2008 global financial crisis.
The Goldilocks Paradigm
It’s perhaps important to make a distinction between the Fed’s recent repo agreements and QE. Broadly speaking, while open-market operations are an inevitable step toward quantitative easing, these two policies differ significantly. To use a reasonably reductive explanation, within repo operations, the Fed uses reserves to buy government assets such as treasuries on the overnight lending market to influence interest rates.
Whereas under QE, the Fed “prints” money — or rather, generates it electronically — and uses it to purchase securities with the direct intent and consequence of expanding the monetary supply.
QE is typically used as a last resort. For the Fed, this last resort comes when it fails in its mandate to keep interest rates in their designated sweet spot — thus, we have the principle of a goldilocks economy. If interest rates climb too high, pricing people out, a recession can occur; too low, and there’s a risk of excessive economic growth, inflation and subsequent currency devaluation.
Currently, the pressure from rising lending rates is forcing the Fed into a corner by which it needs to reduce its target to maintain an equilibrium. However, with four consecutive days of repo transactions last week, and a new pledge to continue buying government assets, it looks like quantitative easing could be next on the agenda.
Can Quantitative Easing Act As Momentum For Bitcoin?
While the objective of QE is to revitalize the economy via low rates, providing a new incentive for borrowing and investing, it can also drive investors to diversify more risk into their portfolios, as they look to maintain the same yield. Speaking to Cointelegraph, Alex Krüger, a cryptocurrency trader and economist, explained what this expanding desire for risk may entail for Bitcoin:
“QE would push longer interest rates lower and thus push some investors out the risk curve, i.e., seeking riskier investments to achieve desired returns. One can theorize some of that money would end in Bitcoin, adding upward pressure to prices.”
Additionally, this notion of excessive risk-taking during quantitative easing was highlighted in a report by the International Monetary Fund (IMF), which said that “prolonged monetary ease may also encourage excessive financial risk-taking, in the form of increased portfolio allocations to riskier assets.” Thanks to its widespread stigma as a “risk-on” asset, Bitcoin could, in theory, reap some of the benefits afforded by increased demand for more perilous investments.
A modest supplement of the previous theory is established from the increase in monetary supply. Simply put, the more fiat funneled into the financial system, the more disposable capital there is for investments. Mati Greenspan, eToro’s senior market analyst, noted this while talking to Cointelgraph, suggesting that, “Some of that money will likely be channeled into Bitcoin.”
So, Why Bitcoin? The Nascent Protocol Is Known As The Antithesis Of The Financial System.
It was born literally to oppose and subvert traditional banking. With such an option at their disposal, and with growing concerns of a systemic collapse, it’s not inconceivable that people are turning to Bitcoin for capital refuge.
Furthermore, a somewhat darker theory relates to the relationship between QE and currency devaluation. As interest rates decrease and the monetary supply rises, domestic currency inflates and loses value. Interestingly, for some — especially during a trade war — a weaker currency is a welcome byproduct of QE due to exports becoming cheaper and more competitive on a global scale. For Bitcoin believers, it is just another sign of the imminent collapse of the financial system.
With the defacto world reserve currency on its last legs, Bitcoin’s purported role as a macro hedge is becoming more of a reality. Broadcaster, Bitcoin bull and fiat doomsayer Max Keiser is one such propagator of this theory. In a conversation with Cointelgraph, Kieser suggested that much of Bitcoin’s value is based on the denigration of the financial industry:
“QE (debt-monetization) is designed to keep zombie banks alive. Bitcoin was introduced to battle zombie banks and QE and the price has exploded higher in response to the increase in global reliance on the accounting fraud and chicanery of QE. There is no end to QE.
There is no scenario other than all fiat everywhere crashes to zero (as all fiat has done over 300 years). And there is no top to the Bitcoin price. $1 million and above is virtually a certainty at this point.”
Bitcoin: A Hedge Against Economic Uncertainty?
If a genuine connection between QE and Bitcoin’s price is to be seen, then a clear definition of BTC’s asset status needs to be made. Seemingly in accord with Kieser, economist and CEO of Global Macro Investor Raoul Pal has been especially vocal on this topic as of late.
In August, Pal delivered a tweetstorm, declaring a worldwide currency crisis and advocating for investment in Bitcoin, as it “trades like a call option on a new system.”
Speaking to Cointelegraph, Pal communicated that while Bitcoin may not be the best bet against macro risk, it will likely play a significant role in the event of a financial collapse:
“I view BTC as an option on the End Game to the current monetary system. No, it is not a good day to day macro hedge. It is a macro systemic risk hedge, however. That is very different. It does play a decent role in capital flight too in emerging markets.”
Wall Street veteran and Wyoming Blockchain Coalition President Caitlin Long similarly believes in Bitcoin’s budding utility as a hedge against economic instability. Within a recent article, Long lambasted the fragile nature of the financial system, referring to last week’s repo events as “a modern version of a bank run.” Nevertheless, Long maintains that it provided further confidence in Bitcoin:
“Bitcoin is not a debt-based system that periodically experiences bank run-like instability. In this regard, Bitcoin is an insurance policy against financial market instability. Bitcoin is no one’s IOU. It has no lender of last resort because it doesn’t need one.”
Krüger appeared to agree that Bitcoin is only a hedge against the additional, tail risk of central bankers and/or governments losing control. However, Krüger added the caveat that the Fed’s execution of QE “would not represent losing control.”
This is an important distinction to make when weighing up any correlation between QE and Bitcoin’s price action. On this point, Krüger remarked that there had been no precedent that shows any such relationship, yet:
“There is no evidence BTC has benefited from prior QE rounds. However, the more engrained with traditional markets Bitcoin becomes, the higher the impact one should expect. The QE impact should be significant if by then BTC is already behaving from a macro standpoint as digital gold, which is not yet the case.”
Krüger’s assertion seems to hold some merit. During Bitcoin’s short history, QE has had very little impact. However, it could be argued that price discovery during these periods was still underway. As Krüger notes, this correlation could strengthen as Bitcoin matures.
The Fed’s balance sheet tends to increase in conjunction with various QE rounds, as it did from 2008 to 2014, but it also seems to share very little correlation to any increases in Bitcoin’s price.
How Likely Is QE, Anyway?
While the ongoing repo agreements hint to some further measures to avoid inflation, it isn’t exactly concrete proof that QE will be initiated in its traditional sense. However, if the Fed continues to follow the global monetary policy of other sluggish economies, it will perhaps be an inevitability.
In September 2019, the ECB announced a fresh bout of economic stimulus, reintroducing an aggressive phase of quantitative easing to the tune of 20 billion euros per month, starting in November.
The ECB also slashed interest rates further into the negative, from -0.4% to -0.5%, much to the anguish of President Donald Trump, whose competitive nature came out in full swing. In a trademark Twitter tirade, he remarked.
“European Central Bank, acting quickly, Cuts Rates 10 Basis Points. They are trying, and succeeding, in depreciating the Euro against the VERY strong Dollar, hurting U.S. exports… And the Fed sits, and sits, and sits. They get paid to borrow money, while we are paying interest!”
Trump’s pressure on the Fed to cut interest rates to the negative gives a fair bit of credence to the possibility of the U.S. entering its own QE phase. On this point, Greenspan remained unperturbed, suggesting that the ongoing repo operations were enough to sustain the economy for now:
“The ECB has rekindled their QE program. For the moment, the Fed in the United States is content to ease policy through interest rate manipulation.”
Similarly, Krüger noted that U.S. interest rates still had room to breathe before Federal Reserve Chairman Powell considered implementing QE:
“Powell has explicitly said the Fed would consider using QE again if ‘we were to find ourselves at some future date again at the effective lower bound — again, not something we are expecting.’ Rates are at the moment far from the effective lower bound (i.e. 0%).”
Nevertheless, Kruger included the caveat that QE might be adopted “during Trump’s 2nd term.” Indeed, with the ongoing trade war between China and the U.S., it isn’t likely that Trump will give up exerting his dovish will on the Fed. In recent months, a quasi-currency war has threatened to develop between the two nations. In June, the first rate cut in Bitcoin’s nascent history was imposed by the Fed, with Powell alluding to the escalating U.S.–China trade war.
Come early August, China combatted a fresh batch of U.S. tariffs by devaluing its own currency. To counter the move, Trump pressured the Fed to lower interest rates once again, to which it eventually acquiesced last week. Ruminating on this to Cointelgraph, Naeem Aslam, market analyst for a trading platform ThinkMarkets, suggested that QE may advance if the trade war lingers:
“I think if the trade war continues, then the Fed will be left with no other option but to continue the path of rate cuts. What matters the most is the pace and the aggressiveness of the Fed through which they cut the interest rates.”
Thanks to the possibility of a looming currency war and the subsequent economic depression that may bring, a Reuters poll relays that the median probability of a U.S. recession in the next two years stands at 45%. With such high estimations of a rising recession, it seems almost undoubtedly that QE will continue and proliferate.
As for a consensus on Bitcoin’s potential reaction to quantitative easing, it’s perhaps too early to tell. While numerous outcomes such as a systemic breakdown, an escalation between China and the U.S., or even something as simple as an increased risk appetite could all lead Bitcoin higher, there has been no real precedent to allude that it will.
Nonetheless, a predilection toward using Bitcoin as a safe haven is seemingly on the rise. And if sentimentality is anything to go by, the market dictates at least some movement from Bitcoin following economic strain in the future.
Big Banks Loom Over Fed Repo Efforts
Concentration of market activity there can drive borrowing costs higher for smaller firms.
The dominance of big firms trading in the overnight market for cash loans is hampering Federal Reserve efforts to calm short-term funding markets.
Activity in the market for repurchase agreements, or repos, where banks and investors seek more than a trillion dollars in cash loans every day, has increasingly concentrated at large banks. When those banks hoard reserves, it can drive borrowing costs higher for smaller firms, according to a study by Fed economists published last year. The five largest banks hold more than 90% of the supply of total reserves and a more even distribution would help cushion against such shocks, the study found.
That is one challenge confronting Fed officials as they try to get funds flowing through the financial system following last week’s surge in overnight interest rates, which climbed as high as 10%. As the Fed has increased lending in the repo market, it is reliant on a small group of bond dealers to recirculate that money through the financial system, increasing opportunities for channels to get clogged.
Under the current market structure, “concentration levels among the biggest banks are only going to get more concentrated,” said James Tabacchi, president of South Street Securities, a brokerage specializing in repos.
The Fed works with a group of 24 banks or securities dealers known as primary dealers, such as JPMorgan Chase & Co., Citigroup Inc. and Bank of America Corp. They are exclusively responsible for trading with the central bank when it wants to engage in market activities, ranging from buying or selling bonds to adding cash to the financial system. Those dealers then work as intermediaries between the Fed and other investors and financial institutions.
When the Fed lends money through the repo market, officials are acting in the expectation that what they lend will be recirculated by the primary dealers. However, the Fed faces the risk that those dealers may hold on to funds to meet their own needs, analysts said.
One risk is that the larger banks could opt to lend less cash than usual at the end of the quarter to smaller dealers. At the end of last year, those larger banks cut back on lending, sending repo rates soaring above 6%. The large banks may have held on to cash then because regulators typically examine their balance sheets at the ends of fiscal quarters to ensure they are following rules that safeguard the banking system.
Such decisions can make borrowing in the repo market difficult for smaller dealers, said Seth Carpenter, chief U.S. economist at UBS Group AG and a former official at the Fed and the Treasury Department.
“This question about segmentation in the market and what happens at quarter-end is important,” Mr. Carpenter said.
The Fed has twice announced increases to its cash loans in the repo market after demand from banks repeatedly exceeded the funds made available. Demand has been strongest for recent offerings of two-week loans that are intended to ensure that banks have cash available heading into the end of the quarter, which is a time when they frequently try to hold on to reserves.
On Thursday, banks asked for $72.75 billion in 14-day cash loans, $12.75 billion more than the amount offered by the Fed. In a second separate operation, banks asked for $50.1 billion in overnight reserves, all of which the Fed accepted.
“There’s still a very big demand for cash that may not be satisfied by the current operations,” said Gennadiy Goldberg, a fixed-income strategist at TD Securities.
At the same time, the repo desks at some smaller primary dealers have languished in recent years as those lenders invested resources in more lucrative businesses, such as corporate bonds. Others kept idle money at the Fed, collecting the risk-free rate paid by the central bank for such funds, known as interest on excess reserves.
Another issue is a decline in the number of smaller firms that borrow from the larger dealers through the repo market, distributing the money more widely. That includes CRT Group LLC, which closed in 2017; KGS-Alpha Capital Markets L.P., which was acquired last year by BMO Capital Markets; and the repo operations of Rosenthal Collins Group LLC, which were shuttered in February after the company was bought by Marex Spectron, a commodities brokerage.
Smaller firms also tend to have less cash on hand and fewer ways to quickly raise it than their bigger peers, which puts them at greater risk to the extent they have used cash borrowed in the repo market to pay for the securities on their books, repo market participants said.
Concentration in the repo market is likely to persist, some analysts said. Big primary dealers have structural advantages, including more lines of credit connecting them with large regional banks, and trading relationships with money market mutual funds, such as Vanguard Group and T. Rowe Price which roll billions of dollars each day into the repo market. That gives bigger banks more sources to tap when they seek funding, according to current and former repo traders and industry observers.
Last week the financial system ran out of cash. It was a modern version of a bank run, and it’s not over yet. The Real Story Of The Repo Market Meltdown, And What It Means For Bitcoin
Stepping back, it reveals two big things about financial markets: first, US Treasuries are not truly “risk-free” assets, as most consider them to be, and second, big banks are significantly undercapitalized. The event doesn’t mean another financial meltdown is necessarily imminent—just that the risk of one is heightened—since the brush fire can be doused either by the Fed, or by the banks raising more equity capital. However, it provides a “teachable moment” regarding systemic fragility and anti-fragility.
What’s Happening, In Plain English?
Somebody—probably a big bank—needs cash so badly that it has been willing to pay a shockingly high cost to obtain it. That’s the layman’s explanation of what’s happening. Interest rates have betrayed common sense—interest rates in the repo market should be lower than rates in unsecured markets, for example, because repos are secured by assets and thus supposedly lower-risk. But repo rates spiked way above unsecured lending rates last week, even for “risk-free” collateral such as US Treasuries.
But US Treasuries are not risk-free. Far from it. (By this, I’m not referring to the US potentially defaulting on its debt obligations. Rather, I’m referring to the practice in the repo market that allows more people to believe they own US Treasuries than actually do. It’s called “rehypothecation.”)
Why was someone willing to borrow cash at a 10% interest rate last Tuesday, in exchange for pledging US Treasury collateral that yields only 2% or less? That trade lost someone a whopping 8% (annualized) overnight, but presumably the trade allowed the bank to stay in business for another day. As risk premiums go, 8% is shockingly high—for a supposedly risk-free asset!
On the flip side, the better question is why banks weren’t willing to lend against “risk-free” collateral for an 8% “risk-free” gain? Banks are supposedly healthy and flush with cash, right? So why aren’t banks falling over themselves to rake in such easy, “risk-free” profits?
hockingly, the Fed admitted to asking itself this same question, as revealed in an extraordinary interview on Friday with New York Fed President John Williams in the Financial Times. The Fed has a theory about why. Many analysts do too. But almost no one is talking about the elephant in the room.
The Elephant In The Room
For every US Treasury security outstanding, roughly three parties believe they own it. That’s right. Multiple parties report that they own the very same asset, when only one of them truly does. To wit, the IMF has estimated that the same collateral was reused 2.2 times in 2018, which means both the original owner plus 2.2 subsequent re-users believe they own the same collateral (often a US Treasury security).
This is why US Treasuries aren’t risk-free—they’re the most rehypothecated asset in financial markets, and the big banks know this. Auditors can’t catch this because GAAP accounting standards obfuscate it, as I’ll explain later.
What it all means is that, while each bank’s financial statements show the bank is solvent, the financial system as a whole isn’t. And no one really knows how much double-, triple-, quadruple-, etc. counting of US Treasuries takes place. US Treasuries are the core asset used by every financial institution to satisfy its capital and liquidity requirements—which means that no one really knows how big the hole is at a system-wide level.
This is the real reason why the repo market periodically seizes up. It’s akin to musical chairs—no one knows how many players will be without a chair until the music stops. Every player knows there aren’t enough chairs. Everyone knows someone will eventually lose.
Financial regulators can’t publicly admit to this, but big banks know it’s true—and that’s why they hunker down (and stop lending) when they sense one of their kin is in trouble. They recognize that what appears to be an 8% risk-free arbitrage is anything but risk-free.
Most financial regulators baffle us with jargon when they discuss this issue, making it barely intelligible to regular folks (cloaking it in such terms as “clogged transmission mechanisms,” “length of collateral chains”). The closest I’ve heard a financial regulator speak publicly of this is former CFTC Chairman Chris Giancarlo, to his credit, when he answered a question after a 2016 speech:
“At the heart of the financial crisis, perhaps the most critical element was the lack of visibility into the counterparty credit exposure of one major financial institution to another. Probably the most glaring omission that needed to be addressed was that lack of visibility, and here we are in 2016 and we still don’t have it.”
This is why the FT’s interview with Williams was so extraordinary. It’s as close as a regulator will come to admitting the reality that the system doesn’t work the way most of us think it does and that the Fed may not even understand critical things about it. Specifically, the Fed’s focus on the fed funds market is misplaced because the real action is in the much bigger, much more global repo market; the Fed shouldn’t have allowed America’s big banks to pay dividends or buy back stock when they’re so capital-constrained that they can’t even pick up an 8% “risk-free” arbitrage; the Fed’s proclamation that “the financial system remains resilient,” when it released the results of the most recent bank stress tests in June 2019, strains credulity; a staggering amount of US dollar liabilities have been issued offshore in recent decades and the Fed not only doesn’t control them but can’t measure them with any degree of accuracy; and banks’ financial statements don’t accurately reflect their financial health.
No one really knows how solvent (insolvent?) the financial system is.
Auditors can’t help here, and the accounting profession bears some of the blame for this problem. In June 2014, FASB updated the US GAAP accounting rules for repos. Here’s what the books of three parties show when a transferee (Party A) sells pledged collateral to a third party (Party C):
* Party A Owns A Particular Us Treasury Bond, Showing An Asset Of $100.
* Party B Borrows It, Showing A Liability Of $100 ($100 Of Securities Sold, Not Yet Purchased).
* Party C Shows An Asset Of $100.
If you add up the positions of all parties, economically there’s no problem because the net of the two longs and one short position add up to $100. The problem arises when you aggregate the three US GAAP financial statements. Both Party A and Party C report that they own the same asset (!) The balance sheets balance because Party B records a liability, so auditors don’t catch the problem. When that same bond is reused again and again and again in similar transactions, the magnitude of double counting within the financial system builds in a manner that no one can accurately measure.
Singh has been recommending for years that regulators’ financial stability assessments of big banks be adjusted to back out “pledged collateral, or the associated reuse of such assets.” Financial regulators should have followed his advice years ago!
What does this mean for markets in the short-term? No one knows, but I doubt this is “the big one.” Sure, the repo market is flashing red sirens. But the run on repo can be stalled in one of two ways: (1) banks raise new equity capital, or (2) the Fed injects more dollars into the system.
Yes, it’s true that a run in the repo market is serious, since the big banks are still overly reliant on it and one dropped ball by the Fed could quickly turn the brush fire into an inferno. But, as usual, the Fed will almost certainly do what it always does—stem the run by injecting cash into the system in various ways, thereby socializing losses among all US dollar holders.
A Teachable Moment
If this topic makes you uncomfortable, it should. It made me uncomfortable when I first realized all of this, which for me happened during the financial crisis while I was working on Wall Street and took a deep dive into why the crisis was happening. The financial system is fragile. It’s unstable. It always has been. What started in the repo market last week isn’t new—it’s actually the fourth such episode since 2008.
Here I distinguish between price volatility and systemic volatility.
Bitcoin’s price is highly volatile, but as a system it is more stable. In stark contrast to the traditional financial system, Bitcoin is not a debt-based system that periodically experiences bank run-like instability.
In this regard, Bitcoin is an insurance policy against financial market instability. Bitcoin is no one’s IOU. It has no lender of last resort because it doesn’t need one.
For me, Bitcoin is empowering because it provides a choice to opt out of the traditional financial system. In light of the traditional financial system’s instability, despite all of Bitcoin’s drawbacks, I find that a powerful concept.
Fed Confronts Balance-Sheet Decisions To Curb Money-Market Volatility
Central bank will need to clarify that its moves are aimed at smoothing market operations, not providing new stimulus.
The Federal Reserve fixed the recent dysfunction in an obscure but critical lending market. Now it has to decide how to prevent these problems from recurring.
Shortages of funds that banks were willing to lend on Sept. 16 and 17 led interest rates in very short-term lending markets to rise sharply. In response, the Fed injected billions of dollars of cash to pull rates down to their target range.
Fed officials discussed the issue at their policy meeting on Sept. 17 and 18, and minutes of that gathering—to be released Wednesday—will provide some details on their thinking.
Among the decisions they face: when and how to resume increasing the size of their asset portfolio—often referred to as the balance sheet—and whether to create new tools to reduce money market volatility.
The Fed also will have to clarify that such moves are aimed at smoothing out market operations, not providing new economic stimulus.
Fed policy makers set their benchmark federal-funds rate to influence a suite of short-term rates at which banks lend to each other overnight, including in the “repo” market for collateralized short-term loans. A sudden shortage of cash in this market cause repo rates to surge on Sept. 16 and 17, prompting the Fed intervention.
The repo market is an arcane but important part of the financial system. With $1 trillion in funding flowing through it every day, any disruptions—if allowed to fester—could influence the rates businesses and consumers pay and also drag on economic growth.
The Fed’s intervention in repo markets, which will continue at least through early November, were standard operating procedure before the 2008 crisis. But today they amount to a temporary Band-Aid, which is why officials must now settle on a permanent fix.
Some analysts say last month’s rupture shows how the Fed’s delays in finalizing nuts-and-bolts decisions that could have been made months or years ago—either because officials couldn’t reach agreement or didn’t feel urgency to do so—has now forced the central bank to play catch up.
At issue is some complex monetary plumbing. To boost growth after the 2008 financial crisis, the Fed bought bonds to push down long-term interest rates and drive up asset prices. These purchases flooded the banking sector with deposits held at the central bank, known as reserves.
Before the 2008 crisis, the Fed kept its balance sheet at less than $1 trillion. The size was dictated primarily by demand for the Fed’s liabilities, which include currency, reserves and the Treasury’s financing account. The Fed shifted the supply of reserves up and down in incremental amounts to adjust short-term rates.
The crisis changed everything. With the banking system awash with reserves, the Fed devised new tools to control interest rates. It started paying interest on these reserves directly to banks, raising or lowering the interest rate on reserves to change the interest rates banks charged each other.
Later, the Fed wanted to demonstrate that its crisis-era stimulus could be withdrawn and began shrinking the balance sheet two years ago. Officials stopped the process this past summer and are now holding its portfolio steady at $3.9 trillion, but that means any increases in nonreserve liabilities lead to a one-for-one decline in reserves.
The Fed now has to decide when to allow the balance sheet to start growing again to keep up with demand for the central bank’s liabilities. Officials knew that eventually, reserves would reach a level low enough that banks would charge more to lend to each other in overnight markets, but didn’t think they would hit that point this soon.
The Fed will study whether postcrisis financial rules or informal guidance from regulators changed banks’ behavior in a way that amplified recent market stress.
“Essentially, the Fed underestimated the system’s demand for liquidity and allowed its balance sheet to shrink too much,” said Roberto Perli, an analyst at Cornerstone Macro.
Fed Chairman Jerome Powell said last month that officials would consider resuming balance sheet growth at their Oct. 29 and 30 meeting, but many market participants “are now hoping for something more audacious,” said Lou Crandall, chief economist at financial-research firm Wrightson ICAP.
Some current and former Fed officials think the easiest fix would be to build a “buffer” of reserves $150 billion or $250 billion above mid-September’s low watermark by buying Treasury securities.
“The way to address [reserve scarcity] is to start growing our reserves…and maybe increase [them] enough that we don’t have to do as many high-frequency interventions,” Boston Fed President Eric Rosengren said in an interview.
If Fed officials choose this option, they must also decide how fast to build up reserves and what mix of Treasury securities to buy. One way to limit the perception that such purchases represent new stimulus would be to buy shorter-term Treasury bills instead of the longer-dated notes and bonds the Fed bought after the 2008 crisis.
Officials believe holding long-term securities boosts the economy and financial markets by lowering long-term rates and driving investors into stocks and bonds. They think a portfolio weighted toward shorter-term securities provides less stimulus.
The Fed also could add new tools. Officials in June debated creating a so-called standing repo facility that would allow banks to exchange Treasurys for reserves without the stigma of emergency borrowing at the Fed’s discount window.
Officials would have to determine certain details, including which financial institutions would have access and what interest rates to charge. They don’t appear to be close to making any decisions.
The discussions about this tool “are in their infancy, and there is more work to be done,” said Philadelphia Fed President Patrick Harker in a speech last month.
Federal Reserve To Announce Measures To Increase Supply of Bank Reserves
The central bank is contemplating purchases of Treasurys to rebuild reserve buffer after recent funding market volatility.
The Federal Reserve will soon increase its purchases of short-term Treasury securities in order to avoid any recurrence of the unexpected strains experienced in money markets last month, Fed Chairman Jerome Powell said on Tuesday.
Fed officials stopped shrinking the assets on its balance sheet in August but never said when they would allow the balance sheet to grow again. As a result, a crucial liability on the balance sheet—bank deposits held at the Fed, called reserves—have continued declining, and in recent weeks, stresses in very-short term funding markets suggested banks have grown reluctant to lend out of those reserves.
For months, officials have said they would someday allow reserves to grow again, which would require the Fed to increase its purchases of Treasury securities. But they hadn’t said when exactly they would take that step until Tuesday.
“That time is now upon us,” Mr. Powell said in a speech to the National Association for Business Economics in Denver.
Mr. Powell didn’t delve into specifics. “My colleagues and I will soon announce measures to add to the supply of reserves over time,” he said.
Reserves dropped to less than $1.4 trillion last month, from $2.8 trillion in 2014, when the Fed stopped buying assets, with most of the decline occurring over the last two years after the Fed pared its asset holdings by allowing some bonds to mature without replacing them.
Mr. Powell emphasized that the coming moves are aimed at maintaining a firm grip on very short-term lending rates—and not to provide new economic stimulus, as the Fed did between 2008 and 2014 by purchasing longer-dated Treasury and mortgage securities.
Rather than purchase longer-dated securities, Mr. Powell said officials are now contemplating buying shorter-dated Treasury bills in order to rebuild the level of reserves in the system.
“Neither the recent technical issues nor the purchases of Treasury bills we are contemplating to resolve them should materially affect the stance of monetary policy,” he said.
The Fed’s goal “is to provide an ample supply of reserves to ensure that control of the federal-funds rate and other short-term interest rates” doesn’t require regular market intervention by the central bank, Mr. Powell said.
Fed policy makers set their benchmark federal-funds rate to influence a suite of short-term rates at which banks lend to each other overnight, including in the “repo” market for collateralized short-term loans. A sudden shortage of cash in this market caused repo rates to surge on Sept. 16 and 17, prompting the Fed intervention.
The repo market is an arcane but important part of the financial system. With more than $1 trillion in funding flowing through it every day, any disruptions—if allowed to fester—could influence the rates businesses and consumers pay and also drag on economic growth.
The Fed’s daily interventions in repo markets, which will continue at least through early November, was standard operating procedure before the 2008 crisis. But today they amount to a temporary Band-Aid, which is why officials must now settle on a permanent fix.
Some current and former Fed officials think the easiest fix to recent funding market pressures would be to build a “buffer” of reserves $150 billion or $250 billion above mid-September’s low watermark by buying Treasury securities.
Market analysts applauded Mr. Powell’s announcement, which they said helped clarify ambiguity around the Fed’s mid- and long-range plans. “This was a helpful announcement today, allowing investors to focus on the actual rate decision/guidance provided in three weeks rather than mechanics,” said Jim Vogel, an interest-rate strategist at FTN Financial.
Mr. Powell provided fewer clues Tuesday about the central bank’s plans to provide additional interest rate cuts after lowering its benchmark federal-funds rate for a second time in September, to its current range between 1.75% and 2%.
He didn’t explicitly ratify or rebut recent market expectations of another quarter-percentage-point cut at its Oct. 29-30 meeting. The Fed’s next policy meeting is several weeks away “and we will be carefully monitoring incoming information,” Mr. Powell said. “We will be data dependent, assessing the outlook and risks to the outlook on a meeting-by-meeting basis.”
Economic data last week pointed to signs of a continued slowdown in the pace of job growth, but not a sharp downturn. The September jobs report showed a gain of 136,000 positions and unemployment falling to 3.5%. Mr. Powell said recent labor market data has been solid, with the slower pace of job gains still strong enough accommodate new workers who want jobs.
A recent spate of weak factory data and other signs of a slowdown have helped to fuel market expectations of another cut in October.
While the jobs and inflation picture for the U.S. economy has been favorable, Mr. Powell said global developments pose risks to this outlook, including from trade policy uncertainty and Britain’s impending departure from the European Union.
Mr. Powell said he believed the Fed’s recent rate cuts had provided support to the outlook, and he said the Fed would “act as appropriate” to sustain the current expansion.
New York Fed Adds $82.7 Billion To Financial System in Latest Repo Transaction
The Fed began offering repo loans last month after a shortage of available cash in the financial system led rates to climb.
The Federal Reserve Bank of New York added $82.7 billion to the financial system Friday, using the market for repurchase agreements, or repo, to relieve funding pressure in money markets.
Banks asked for $21.15 billion in 6-day loans, all of which was accepted by the Fed, offering collateral in the form of Treasury and mortgage securities.
In a second separate operation, banks asked for $61.55 billion in overnight reserves, all of which the Fed accepted, also offering collateral in the form of Treasury and mortgage securities.
In the repo market, borrowers seeking cash offer lenders collateral in the form of safe securities—frequently Treasury bonds—in exchange for a short-term loan. The term of these loans can be as short as overnight.
When the Fed adds money to the financial system through the repo market, it is acting as a lender. In typical repo market transactions, lenders can include money-market mutual funds, banks or hedge funds that are seeking to earn a slightly higher rate of interest than what is available from holding very short-term government securities. The borrowers are often banks, securities firms or hedge funds that use the cash to finance positions in the market.
Banks and hedge funds borrow or lend depending on their needs and investment goals.
The Fed began offering repo loans last month after a shortage of available cash in the financial system led repo rates to climb as financial companies scrambled for overnight funding. The actions marked the first time since the financial crisis that the Fed had taken such actions.
Last week, the Fed said it would extend its scheduled repo lending through Nov. 4. It said it would continue to offer overnight repos, which are meant to relieve funding pressure in money markets, for an aggregate amount of at least $75 billion each night through Nov. 4.
The Fed said it would extend its two-week repo loans as well. It plans to offer at least $45 billion between Oct. 8 and Oct. 11. After that, the amount available will drop to $35 billion through Oct. 29.
Fed Will Purchase Treasury Bills At Least Into Second Quarter of 2020
Central bank seeks to avoid a recurrence of the unexpected strains experienced in money markets last month.
The Federal Reserve will begin buying Treasury bills on Tuesday to boost its balance sheet and avoid a recurrence of the unexpected strains experienced in money markets last month, the central bank said.
The Fed will begin initial purchases of $60 billion in Treasurys over the month beginning next Tuesday. The central bank said it would continue purchases of Treasury bills of unspecified amounts into the second quarter of 2020.
The Fed’s rate-setting committee met by videoconference last Friday, Oct. 4, to discuss recent developments in money markets. It voted unanimously on the plans to purchase Treasury bills to grow its balance sheet.
The central bank said the actions announced Friday were “purely technical measures to support the effective implementation” of the committee’s policy setting “and do not represent a change in the stance of monetary policy.”
The Federal Open Market Committee last agreed on a policy decision in between its eight regularly scheduled annual meetings in May 2010, when it reopened a lending program with foreign central banks to alleviate funding pressures growing out of Europe’s fiscal crisis.
Fed officials stopped shrinking the assets on their balance sheet in August but never said when they would allow them to grow again. As a result, a crucial liability on the balance sheet—bank deposits held at the Fed, called reserves—has continued declining.
Stresses in very-short-term funding markets last month suggested banks have grown reluctant to lend those reserves. Officials hadn’t said until Tuesday when they would allow reserves to grow again to avoid further scarcity issues from roiling funding markets.
“That time is now upon us,” Fed Chairman Jerome Powell said in a speech Tuesday in Denver.
The Fed has been purchasing up to $20 billion of a range of Treasury securities since August to replace maturing mortgage securities. The $60 billion of monthly bill purchases announced Friday will be added to those existing purchases.
Reserves dropped to less than $1.4 trillion last month, from $2.8 trillion in 2014, when the Fed stopped buying assets. Most of the decline occurred over the past two years after the Fed pared its asset holdings by allowing some bonds to mature without replacing them.
The goal will be to rebuild the level of reserves in the system to levels that prevailed in early September, the central bank said. Reserves stood at $1.5 trillion at that time.
The Fed said Friday it will adjust the timing and amounts of Treasury purchases and other temporary funding operations “as necessary to maintain an ample supply of reserve balances over time and based on money market conditions.”
Mr. Powell emphasized that the moves are aimed at maintaining a firm grip on very-short-term lending rates—and not to provide economic stimulus, as the Fed did between 2008 and 2014 by purchasing longer-dated Treasury and mortgage securities in successive campaigns sometimes referred to as quantitative easing, or QE.
“This is not QE,” Mr. Powell said Tuesday. “In no sense is this QE.”
Rather than purchase longer-dated securities, officials will instead buy shorter-dated Treasury bills. Officials believe holding long-term securities boosts the economy and financial markets by lowering long-term rates and driving investors into stocks and bonds. They think a portfolio weighted toward shorter-term securities provides less or no stimulus.
The Fed’s balance sheet has swelled to nearly $4 trillion from $3.8 trillion over the past month because the New York Fed has been conducting temporary overnight and short-term lending operations to restore liquidity to a key very-short-term funding market.
The Fed also said Friday it will continue to conduct those short-term and overnight repurchase agreement operations, known as repos, at least through January of next year. It will initially offer at least $35 billion of term repo operations, generally twice a week. Overnight repo operations will take place daily, initially in an offering amount of at least $75 billion per operation, the Fed said.
The Fed Is Buying Treasurys Again. Just Don’t Call It Quantitative Easing
Central bank is buying assets for sole purpose of fine-tuning liability side of its balance sheet.
The Federal Reserve began buying short-term Treasury debt Tuesday at an initial pace of $60 billion a month, but officials say these purchases are nothing like the bond-buying stimulus campaigns unleashed by the central bank between 2008 and 2014 to support the economy.
Here are answers to six commonly asked questions about what is happening:
Q: What is the Fed doing?
The Fed began buying Treasury bills on Oct. 15 at an initial pace of $60 billion a month because officials concluded that last month’s dysfunction in very-short-term lending markets may have resulted from allowing its $4 trillion portfolio to shrink too much.
Q: What happened in money markets last month?
Large payments of corporate taxes and Treasury auction settlements on Sept. 16 resulted in a large transfer of cash from banks to the government. A mismatch in the demand and supply for cash put pressure on a critical funding market in which banks lend to each other overnight through repurchase agreements, or “repo.”
This year, repo rates usually have been no more than a 10th of a percentage point above the midpoint of the benchmark federal-funds rate, or around 2.2% in August and early September. Repo rates rose to 5% on Sept. 16.
Pressure intensified when Wall Street firms’ repo desks began rolling over loans early Sept. 17, with the repo rate rising as high as 10%. Even then banks refused to lend, passing up big profits to hold on to their cash.
The dysfunction led the Fed’s benchmark federal-funds rate to rise to 2.3%—above its then-target range of between 2% and 2.25%. This hadn’t happened since the central bank began setting a range during the 2008 crisis.
The Fed began injecting cash into money markets on Sept. 17 to pull down interest rates, and it has conducted overnight lending operations every business day since then to keep markets functioning smoothly.
Q: Even if the Fed restored order, did the central bank play any role in contributing to this volatility?
Yes, according to some Fed officials and outside observers. To understand how, it helps to review changes in the central bank’s asset portfolio, sometimes called a balance sheet, over the past two years.
Between 2008 and 2014, the Fed dramatically expanded its portfolio to stimulate the economy. In 2017, central bank officials began shrinking their holdings by allowing some Treasury and mortgage securities to mature without replacing them.
When private investors buy bonds, they use cash, borrow funds or sell assets to raise money to fund those purchases. The Fed is different. It doesn’t have to do any of that because it can electronically credit money to the bank accounts of bond dealers that sell mortgage and Treasury securities. The Fed gets the bonds, and the sellers’ bank account increases by the same amount as the bonds’ value. Banks keep deposits at the Fed, known as reserves, and when the Fed buys bonds from banks, their reserves rise by an equal amount.
When the Fed started shrinking its balance sheet in 2017, it put the process in reverse. As the Fed’s holdings of Treasury bonds matured, balances in the Treasury’s general account at the Fed declined by the same amount; when the Treasury issued a new security to private investors to replace the maturing one, banks fund those purchases by reducing their reserves. Reserves peaked at $2.8 trillion in 2014 and had fallen to less than $1.4 trillion by mid-September.
Everyone knew there would come a time when reserves would grow scarce enough that banks might charge more to lend in overnight money markets, but experts inside and outside the Fed weren’t quite sure where that level was. Since the 2008 financial crisis, banks’ demand for reserves is much higher than it used to be because of changes in financial regulation and market structure.
Some Fed officials thought reserves wouldn’t grow scarce until they fell to less than $1.2 trillion based on surveys they had been conducting over the past year. But the repo market volatility from Sept. 16 to 17 suggested the Fed may have misjudged demand for reserves and allowed them to fall too low.
Q: How does the Fed’s purchases of Treasury securities help fix the problem?
If Fed officials concluded that they drained too many reserves from the system, a permanent fix would be to add reserves to the system. Buying Treasury bonds will create the reserves the Fed now thinks are needed to implement its policy decisions.
Q: How many securities will the Fed need to buy?
It depends on how big a “buffer” of extra reserves the Fed wants to maintain. The Fed has said its purchases of short-term Treasury bills will continue into the second quarter of next year, though it hasn’t committed to buying at a $60-billion-a-month pace beyond the first month of purchases.
Fed officials have said they want to return reserves to at least a level that prevailed in early September, when they were at nearly $1.5 trillion. If not for the Fed’s current repo market intervention, reserves would be at around $1.35 trillion.
Without the new purchases, reserves would decline even lower because other liabilities on the Fed’s balance sheet are growing. These liabilities include currency in circulation, the Treasury’s general account and certain services the Fed offers to foreign central banks.
For example, the Treasury is replenishing its general account after drawing it down this summer when it was using emergency measures to remain below the debt limit. Growth in currency and the Treasury’s general account could reduce reserves by another $150 billion this year.
Even though the Fed is likely to taper its purchases of Treasury bills in 2020, it will need to continue buying smaller amounts of Treasurys—likely no more than $15 billion a month—simply to keep up with currency growth.
Q: The Fed bought bonds to stimulate the economy between 2008 and 2014. Isn’t this the same thing?
Not according to the Fed. The central bank has taken pains to emphasize that these purchases don’t represent a return to what is known as quantitative easing, or QE.
Make no mistake: the Fed is buying a lot of securities—more than most analysts who closely monitor bond markets anticipated. In addition to $60 billion in Treasury bills, the Fed is buying up to $20 billion every month in a wider range of Treasury securities to replace maturing mortgage securities. By way of comparison, the Fed bought $85 billion a month in Treasury and mortgage securities between December 2012 and October 2014 in its largest and final round of quantitative easing.
There are three ways in which these purchases are different from QE.
First, QE was designed to inject more liquidity into the banking system than was needed to spur more risk-taking and boost growth. The Fed isn’t doing that this time. Instead, it is buying assets for the sole purpose of fine-tuning the liability side of its balance sheet.
Second, Fed officials believed QE was effective because the central bank bought long-term securities, lowering long-term rates and driving investors into stocks and bonds. The Fed’s latest purchases are concentrated in short-term bills that officials believe provide much less stimulus.
Third, QE had potentially powerful effects by telling investors about the Fed’s broader intentions to stimulate the economy, including by keeping rates lower for longer than might otherwise have been the case. The Fed isn’t doing that this time and instead has gone out of its way to say the opposite—that its latest purchases are technical measures designed to have “no material implications for the stance of monetary policy,” according to a primer the Fed published on Friday.
“This is not QE,” said Fed Chairman Jerome Powell last week. “In no sense is this QE.”
The Fed Just Printed More Money Than Bitcoin’s Entire Market Cap
Bitcoin (BTC) proponents are voicing fresh alarm after the United States Federal Reserve printed more than its entire market cap in new money this month.
Fed Balance Sheet Approaches $4T
As noted by cryptocurrency social media pundit Dennis Parker on Oct. 21, since mid-September, the Fed has injected $210 billion into the economy.
Part of its newly-revitalized quantitative easing (QE) strategy, the move dwarfs the total market cap of Bitcoin, which stands at $148 billion.
QE refers to the buying up of government bonds in order to provide economic stimulus. The Fed’s balance sheet, Parker notes, jumped from $3.77 trillion last month to $3.97 trillion. It had previously been higher, while the Fed’s own projections call for a balance sheet worth $4.7 trillion by 2025.
World “Sleepwalking” Into The Next Financial Crisis
For holders of assets that cannot have their supply inflated, such as gold and Bitcoin, money printing has regularly sparked calls to decrease reliance on fiat currency.
Parker’s suggestion that investors should buy BTC now came amid warnings from even the fiat establishment itself about the ailing health of the banking system.
In a speech at the International Monetary Fund’s general meeting last week, former Bank of England governor Mervyn King told attendees the world was “sleepwalking” into a financial crisis even worse than that of 2008.
“By sticking to the new orthodoxy of monetary policy and pretending that we have made the banking system safe, we are sleepwalking towards that crisis,” he summarized.
The concept that interventionist economic practices on the part of governments and central banks leads to financial destruction forms one of the central tenets of Saifedean Ammous’ “The Bitcoin Standard.”
Released in March 2018, the book focuses on Bitcoin as it compares to fiat currency and commodities such as gold.
As Cointelegraph noted, at ten years old, Bitcoin has now lasted 40% of the average fiat currency’s lifespan.
Fed Boosts Amount of Liquidity Offered to Financial System
Strong demand for the offerings is seen from eligible banks.
The Fed’s expanded offerings of liquidity to the financial system saw strong demand Thursday from eligible banks.
The Federal Reserve Bank of New York intervened twice Thursday morning with what is called an overnight repurchase-agreement operation and via a 14-day repo operation. The New York Fed had said Wednesday it was raising its minimum offerings for overnight repos to $120 billion from a minimum of $75 billion, with the next two-term repo operation increased to $45 billion from a minimum of $35 billion.
The Thursday term repo saw dealers submit $62.15 billion in securities and the Fed take in $45 billion in Treasurys, agency and mortgage securities. The overnight operation was also well bid, with dealers offering and the Fed taking $89.154 billion in securities. The Thursday overnight repo operation was much bigger than the one-day operation Wednesday, where the Fed added $49.845 billion in one-day liquidity.
Fed repo interventions take in Treasury and mortgage securities from eligible banks in what is effectively a loan of central bank cash, collateralized by dealer-owned bonds. The bill purchases permanently add reserves to the financial system and are seen as a more-enduring fix for potential market volatility.
The expansion of temporary liquidity comes as the Fed is about to meet in a policy gathering next week that is likely to result in a cut in short-term rates. It is also month’s end, when short-term rates often face pressure as banks and companies sort out their financial liquidity needs.
Some Investors Resolve To Ring In the New Year By Lending Cash
Demand for overnight cash loans isn’t subsiding nearly two months after the repo market disruption.
Some investors expect a new surge of volatility in short-term money markets at year-end and are preparing to take advantage, gathering cash to lend overnight in the market for repurchase agreements, or repos.
While periods of volatility are often difficult to forecast, these investors are making an educated guess. The cost of borrowing overnight using repo has spiked at the end of recent quarters and at the end of 2018, when a scarcity of available cash drove rates as high as 6%. Some analysts blamed the move on banks’ reluctance to add to their year-end repo positions by lending cash on Dec. 31.
Though the Federal Reserve has been lending billions of dollars each day in the repo market, some analysts and bankers are concerned that the central bank’s method for providing funds limits the benefits of those loans, opening the door to volatility. The Fed works through a group of 24 big banks, known as primary dealers, that function as the central bank’s exclusive counterparties when trading in financial markets. That network could limit the effectiveness of the Fed’s repo programs if the primary dealers hold the cash rather than lend it out to other banks.
For those who lend in the repo market, such as money-market funds and other investors with available cash, that scenario could present an opportunity.
Jeffery Elswick, director of fixed income at Frost Investment Advisors, said he benefited from having an unusually large amount of cash in September available to lend in the market. That experience drove him to plan for another year-end event, even though he acknowledges that the Fed could ramp up its lending programs enough to minimize any spikes.
Mr. Elswick typically invests the firm’s cash in assets commonly found in money-market accounts such as Treasury bills and repo contracts. In September he had about $150 million in cash, which he was able to lend in the repo market. He said he plans to have as much as $200 million available at year-end.
“When rates were spiking out we were going, ‘Oh cool, we get to invest in repo at 6% today,’” he said.
One factor blamed for 2018 volatility around the new year: Banks’ regulatory capital requirements are determined by a snapshot of their holdings at the end of December. That recurring dynamic gives them an incentive to hold cash instead of lending because small changes in their books could tip them into a higher or lower capital-requirement tier for the next year.
Since the September spike in repo rates, the Fed has taken steps to ease conditions in cash markets. Officials began by injecting cash into money markets for the first time since the financial crisis, offering billions of overnight loans in the repo market. Then they added two-week repo loans, increased the amount of the offerings and committed to continue them well into next year. Fed officials also said they would buy $60 billion a month in Treasury bills.
Those steps, and the potential for others, could reduce the risk of another year-end spike, analysts and investors said.
Yet, almost two months after the September repo market disruption—and almost two months of measures to provide liquidity from the Fed—demand for cash isn’t subsiding. This month, banks and other borrowers are bidding for an average of about $74 billion in overnight cash loans from the Fed a day—about a 25% increase from last month. Central bank officials have said they plan to continue offering the loans into the second quarter.
“We are prepping for a pretty big spike in volatility and repo rates in the fourth quarter,” said Nick Maroutsos, co-head of global bonds at Janus Henderson. That means making sure the firm has cash available to lend if the supply becomes scarce again and rates climb.
Mr. Maroutsos said he plans to sell short-term assets to build up a larger cash position, which he intends to lend in the repo market and possibly use to purchase short-term company loans known as commercial paper.
Mr. Maroutsos is skeptical that the Fed’s overnight loans will calm markets at year-end. “The likelihood of a dollar squeeze is ultimately high,” he said.
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