Sunday, May 23, 2021

"Fed Prepares to Go Direct with Liquidity"

 From The Institutional Risk Analyst, May 21 (also on blogroll at right):

May 21, 2021 | Back in 2019, we published a post in The Institutional Risk Analyst called “Nationalizing the Federal Funds Market,” that talked about the increasingly overt actions of the Federal Open Market Committee in the market for short-term funding. Then as now, we view the actions of the FOMC as slowly destroying the private money markets in the US and preparing to very visibly push the big banks out of the transmission chain of monetary policy.

One reader of The IRA asked yesterday:

“Brother maybe you can help me understand: reverse repo 351BN 5th largest ever. What is going on? Any thoughts? No rush but I haven't heard anyone talking about this. I don’t get with all the excess why banks need to be doing this. Haven’t seen it since march 2020.”

Now that is the right question. As we told Keith McCullough at Hedgeye recently, the Fed’s primary concern is not employment or inflation, but rather keeping the market for Treasury securities functioning. In this we agree entirely with our friend Ralph Delguidice, who has believed for several years now that the Fed is preparing to take direct control over the market for Treasury securities. He wrote in a recent missive for Pavilion Global Markets:

“Before the Fed can even think about thinking about raising rates or tapering the pace of QE, they have a suite of urgent repairs to make to the wholesale financial infrastructure supporting the US capital markets. In the year-end 2020 report to Congress, the Financial Services Oversight Council (FSOC) highlighted several specific areas of ongoing systemic concern. The first—and by far most pressing— is the problem in the Repo markets, AKA ‘The Usual Suspects,’ which failed disastrously in the fall of 2019.”

Ralph and many other colleagues who trade the short-term money markets in the US have long identified a basic structural problem that has existed since the passage of Dodd-Frank in 2010 and also the many changes to the Basle bank capital framework. What problem? That the big banks sometimes step back from the money markets and deny liquidity to nonbank clients. For the Fed the worry is not the small nonbanks, but the resulting market volatility as they scramble for liquidity....