A deep dive that gets to the heart of the matter.
From Bloomberg via Yahoo Finance, July 10:
Tucked away in hours of congressional testimony by Federal Reserve Chair Jerome Powell last month was an admission that the central bank was blindsided by the impact of shrinking its balance sheet four years ago.
While Powell assured lawmakers the Fed is committed to avoiding a repeat of 2019 — when the repo market, a key part of US financial plumbing, seized up — Wall Street economists and strategists caution that quantitative tightening remains complex and hard to predict. Known as QT, it involves letting Fed bond holdings mature without replacement, draining cash from the financial system.
In the coming months, the full brunt of the Fed’s current QT program is set to be felt. How it proceeds, and how the Fed handles the process, could shape its political latitude to keep using its balance sheet as a key tool in the future, amid Republican angst that was on display in Powell’s June 21-22 hearings.
“We didn’t see it coming,” Powell acknowledged at the House Financial Services Committee June 21 when referencing the sudden problems that emerged in 2019 and forced the central bank into steps it didn’t want. The advantage now is “we have experience,” he said.
The Fed is currently shedding its bond holdings at an annual pace of roughly $1 trillion, much faster than in 2019 but from a much bigger base. Powell told lawmakers he’s “very conscious” of the importance of not just inflating the balance sheet during each easing cycle and leaving it enlarged.
So far, Powell and market participants agree, things have been going smoothly. There are still more than $3.2 trillion of bank reserves parked at the Fed, and no indication that that gauge of liquidity has shrunk to a level that would cause problems in money markets as happened in 2019. Analysts estimate — with low conviction — the banking system needs at least $2.5 trillion to function smoothly.“You don’t want to find yourself, as we did a few years back, suddenly finding that reserves were scarce,” Powell said last month. This time, the goal is to slow QT down at some point, ending the bond-portfolio runoff when reserves are still “abundant,” with an added buffer “so we don’t accidentally run into reserve scarcity.”
One reason things are going well so far is that there’s another big element of liquidity on the Fed’s balance sheet — the reverse repo facility. Known as RRP, money-market funds have used it to park cash. And that account stands at more than $1.8 trillion.
Full Impact
Another reason is that the overall Fed balance sheet has only shrunk by a fraction of the amount it surged during the pandemic. The Fed’s liquidity injections during the spring — to help address regional bank troubles — expanded the balance sheet. The Treasury was also limiting sales of bills — which remove liquidity — while it was constrained by the debt-limit standoff.Those two dynamics have largely ended now, however.
“Things will start tightening on the liquidity side,” predicted Raghuram Rajan, the former International Monetary Fund chief economist and Indian central bank governor. “Then we will see the full consequences” of QT, the University of Chicago economist said last week on Bloomberg Television.
Even then, a number of observers see things going relatively smoothly. That’s because QT could end up mainly draining RRP. Indeed, it’s already receded to the lowest level since May 2022.
Powell’s Preference
The RRP can shrink “dramatically” without “particularly important macroeconomic effects,” Powell explained last month. And he told a Senate panel that “that’s what we would have hoped to see, rather than taking reserves out of the system.”....
....MUCH MORE
We've been babbling about the events of the Autumn of 2019 for so long that I'm sure weary reader has wondered if yours truly was obsessed. Nah, it's more like an idée fixe.
Turning to the nearest dictionary we see:
Idée fixe Definition & Meaning - Merriam-WebsterHmmmm, not the denotation I was looking for. Anyhoo...
The term idée fixe is a 19th-century French coinage. French writer Honoré de Balzac used it in his 1830 novella Gobseck to describe an obsessive idea. By 1836, Balzac's more generalized use of the term had carried over into English, where idée fixe was embraced as a clinical and literary term for a persistent preoccupation or delusional idea that dominates a person's mind. Although it is still used in both psychology and music, nowadays idée fixe is also applied to milder and more pedestrian obsessions....
Previously in totally not obsessed postings:
"Anatomy of the Repo Rate Spikes in September 2019"
A topic of ongoing interest in light of recent events. HT up front to one of the authors, the Fed's R. Jay Kahn.
From The Office Of Financial Research, April 25, 2023:
Repurchase agreement (repo) markets represent one of the largest sources of funding and risk transformation in the U.S. financial system. Despite the large volume, repo rates can be quite volatile, and in the extreme, they have exhibited intraday spikes that are 5-10 times the rate on a typical day. This paper uses a unique combination of intraday timing data from the repo market to examine the potential causes of the dramatic spike in repo rates in mid-September 2019 (Working Paper no. 23-04).
Abstract
Repurchase agreement (repo) markets represent one of the largest sources of funding and risk transformation in the U.S. financial system. Despite the large volume, repo rates can be quite volatile, and in the extreme, they have exhibited intraday spikes that are 5-10 times the rate on a typical day. This paper uses a unique combination of intraday timing data from the repo market to examine the potential causes of the dramatic spike in repo rates in mid-September 2019. We conclude that the spike resulted from a confluence of factors that, when taken individually, would not have been nearly as disruptive. Our work highlights how a lack of information transmission across repo segments and internal frictions within banks most likely exacerbated the spike. These findings are instructive in the context of repo market liquidity, demonstrating how the segmented structure of the market can contribute to its fragility....
....MUCH MORE , (24 page PDF)
Also from Kahn et al via the OFR: "Why Is So Much Repo Not Centrally Cleared?" and via the Social Science Research Network: "Hedge Funds and the Treasury Cash-Futures Disconnect"
Previously on the 2019 repo spike:
"Economist Michael Hudson Says the Fed 'Broke the Law' with its Repo Loans to Wall Street Trading Houses"
At
the time I remember thinking "Oh look, the Fed has a new lending
facility" and moving on to something shiny, not realizing it was a very
big deal. As the old-timers used to say: "Pay attention or pay the
offer."....
"ANALYSIS-U.S. banks face trillion-dollar reverse repo headache"
A Nomura Document May Shed Light on the Repo Blowup and Fed Bailout of the Gang of Six in 2019
"A Closer Look at the U.S. Bacon Situation"
"The Federal Reserve's Explanation Of What Happened In The Money Markets In September 2019
What seems to have happened was that somebody's derivative book got upside down to the tune of a few trillion dollars (notional, always say notional) and in addition the contagion through the counterparty daisy chain was also in the trillions and well, here's the Fed with their version.
From the Board of Governors of the Federal Reserve System....
....And more to come. We've been picking at this scab for quite a while and the picture puzzle is only now coming together so dribs and drabs.
And how does this ancient history tie into what's going on in 2022?
I have a feeling that lands somewhere in "the nebulous region between mere suspicion and probable cause"(LaFave & Israel on U.S. v. Ramsey, 431 U.S. 606 [1977])that there is some sort of misdirection going on that I'm not understanding.If so, any attempt at analysis of Fed policy and market moves by traditional means, global macro, central bank policy and practice, market internals such as options gamma etc., etc. is just so much blather.And I keep coming back to the 3rd and 4th quarters of 2019 as the period when things were getting very weird.More to come (maybe)
Trouble In Repo Land—The QE Endgame: A Big Problem Is Emerging For The Fed
"The Fed Is About to Ramp Up Balance-Sheet Shrinkage. It May Get Dicey".
"Red Pill or Blue Pill? Variants, Inflation, and the Controlled Demolition of Society"
Money, Money, Money: "A Self-Fulfilling Prophecy: Systemic Collapse and Pandemic Simulation"
June 2019: In its Annual Economic Report,
the Swiss-based Bank of International Settlements (BIS), the ‘Central
Bank of all central banks’, sets the international alarm bells ringing.
The document highlights “overheating […] in the leveraged loan market”,
where “credit standards have been deteriorating” and “collateralized
loan obligations (CLOs) have surged – reminiscent of the steep rise in
collateralized debt obligations [CDOs] that amplified the subprime
crisis [in 2008].” Simply stated, the belly of the financial industry is
once again full of junk.
9 August 2019: The BIS issues a working paper
calling for “unconventional monetary policy measures” to “insulate the
real economy from further deterioration in financial conditions”. The
paper indicates that, by offering “direct credit to the economy” during a
crisis, central bank lending “can replace commercial banks in providing
loans to firms.”
15 August 2019: Blackrock Inc., the world’s most powerful investment fund (managing around $7 trillion in stock and bond funds), issues a white paper
titled Dealing with the next downturn. Essentially, the paper instructs
the US Federal Reserve to inject liquidity directly into the financial
system to prevent “a dramatic downturn.” Again, the message is
unequivocal: “An unprecedented response is needed when monetary policy
is exhausted and fiscal policy alone is not enough. That response will
likely involve ‘going direct’”: “finding ways to get central bank
money directly in the hands of public and private sector spenders” while
avoiding “hyperinflation. Examples include the Weimar Republic in the
1920s as well as Argentina and Zimbabwe more recently.”
22-24 August 2019:
G7 central bankers meet in Jackson Hole, Wyoming, to discuss
BlackRock’s paper along with urgent measures to prevent the looming
meltdown. In the prescient words of James Bullard, President of the St Louis Federal Reserve: “We just have to stop thinking that next year things are going to be normal.”
15-16 September 2019:
The downturn is officially inaugurated by a sudden spike in the repo
rates (from 2% to 10.5%). ‘Repo’ is shorthand for ‘repurchase
agreement’, a contract where investment funds lend money against
collateral assets (normally Treasury securities). At the time of the
exchange, financial operators (banks) undertake to buy back the assets
at a higher price, typically overnight. In brief, repos are short-term
collateralized loans. They are the main source of funding for traders in
most markets, especially the derivatives galaxy. A lack of liquidity in
the repo market can have a devastating domino effect on all major
financial sectors.
17 September 2019: The Fed begins the
emergency monetary programme, pumping hundreds of billions of dollars
per week into Wall Street, effectively executing BlackRock’s “going
direct” plan. (Unsurprisingly, in March 2020 the Fed will hire BlackRock to manage the bailout package in response to the ‘COVID-19 crisis’).
19 September 2019: Donald Trump signs Executive Order 13887,
establishing a National Influenza Vaccine Task Force whose aim is to
develop a “5-year national plan (Plan) to promote the use of more agile
and scalable vaccine manufacturing technologies and to accelerate
development of vaccines that protect against many or all influenza
viruses.” This is to counteract “an influenza pandemic”, which, “unlike
seasonal influenza […] has the potential to spread rapidly around the
globe, infect higher numbers of people, and cause high rates of illness
and death in populations that lack prior immunity”. As someone guessed, the pandemic was imminent, while in Europe too preparations were underway (see here and here).
In the carefree days of yore I probably wouldn't have taken much notice of this beyond thinking "ah, big money manager has thoughts."
TradingView, DJIA daily, December 2019 - June 2020
Some highlights from the Fed Chair's calendar:
February 19, Wednesday
3:00 PM – 4:00 PM Meeting with Jamie Dimon, CEO and Jenn Peipszack, CFO, JPMorgan Chase
Location: AnteroomMarch 19, Thursday
4:30 PM – 5:00 PM Phone call with Larry Fink, CEO BlackRock
April 3, Friday
3:30 PM – 3:45 PM Phone call with Larry Fink, CEO, BlackRockApril 9, Thursday
5:15 PM – 5:30 PM Phone call with Larry Fink, CEO, BlackRock
May 13, Wednesday
1:30 PM – 2:00 PM Phone call with Larry Fink, CEO, BlackRock
Of course there is much much more but discerning reader gets the point: Powell forgot to call me!
It appears I may have become a bit obsessed with the events of September 2019 - March 2020.
