Repo has been the talk of the town lately, and the Federal Reserve has so far downplayed the issue at hand.
Fed chair Jerome Powell did mention this problem in his last FOMC press conference, but again told journalists and viewers that this is not quantitative easing (QE).
Repo and QE both inject money into the system. he difference is really new money vs old money.
In QE, the central bank purchases bonds as a way to inject money into the system as this purchase sends money to the primary dealers (banks). This is done to keep interest rates low. Bonds and yield have an inverse relationship: when bonds go up, the yield drops and vice versa.
With QE you can get to a very crazy environment (one that economic students in post secondary for the last 10 years know nothing about as it was not part of the curriculum) which is negative interest rates. This is what we see in Japan, Europe and Switzerland. Basically the central banks in those countries have killed their debt markets. The central bank is the only one buying bonds at the auctions because no one in the right mind would buy an investment knowing they will collect less money than they invested when the bond matures. Now a days bonds are being traded because you can find a bigger fool who will buy them.
I have outlined this as the problem with real estate and stock markets around the world rising as there is nowhere to go for yield now. Central banks have forced money away from bonds to chase yield to those aforementioned markets.
The second way to inject money into the system is through repo.
Banks have to keep reserves with the central bank. Generally when transactions are done, the reserves held in the central bank changes.
For example Bob banks with Bank A and buys a coffee from Jen who banks with Bank B. When the transaction is through what really happens is that Bank A’s reserves with the central bank is credited (reduced) and Bank B’s reserves are debited (increased). This happens on a daily basis at a time when all balance of payments are settled. Of course if both bank with the same bank, then nothing changes, the mechanism still works the same way.
When banks need to borrow money for the short term, they can borrow from the reserves of other banks at the Fed Funds rate (for the US). When other banks do not have much reserves left over, repo is needed to inject more money to keep the interest rates low.
Interest rates are really the price of money. If there is a lot of money and banks can lend due to the environment, then interest rates can be low.
If you get into a period of time when nobody wants to lend money because of big risks, uncertainty etc and there is not much cash being floated into the system (people want to hoard money) then the price of money (interest rate) has to go up in order to entice people and banks to part with the money.
So when interest rates spiked up to 10% in the US, it was because there was no money left in the reserves. A really scary situation.
When the Federal Reserve injects money through repo, they take collateral from the banks. The Fed says this collateral is US treasuries from the banks. However, I would not be surprised if toxic assets are being passed to the Fed so the banks do not have to take a loss on something they know will lose.
In this way the difference between QE and repo is new bonds (bought up at auction) vs old bonds (collateral that the banks already have and is exchanged).
Both operations inject money into the system. If you follow my work, I have outlined why this operation will not be named QE because it would illicit a confidence crisis.
QE was supposed to be a one time desperate policy initiated by the central banks to prevent another 1920-30’s type depression. There was so much bad debt in the system that it could not be allowed to fail.
Forward to today and there is more debt now. The real economy has not really improved. Financial engineering by keeping interest rates low, have made people go into debt to buy things they really can’t afford. Economic growth is not based on real fundamentals.
If QE is brought up again, then people will realize that QE actually did now work. Central banks were wrong, their monetary policy did not work. Once people understand this, the realization will be that we are stuck in a QE and 0% interest rate environment forever.
Central banks had no plans to raise interest rates and get off of QE. We are now in a managed economy and central banks will morph into the BUYERS of last resort as they cannot allow things to fall. Not only will they have to buy bonds to keep interest rates low, they may need to buy other assets just to keep the system propped.
We are already seeing the Bank of Japan and Swiss National Bank buying stocks and ETF’s.
In other words, central bank balance sheets are expanding.
New York Fed Senior Vice President Lorie Logan posted an article titled “Money Market Developments: Views From the Desk”. It was quite something.
So when repo began, the Fed said they were promising an average about 45 billion dollars a day to provide liquidity to the banks.
They said it was only temporary, but then this number turned to 120 billion a day, with the program being extended from October 24th, until next year.
This article indicated that the average repo daily is now 190 BILLION per day. Take a look at the chart (figure 3) at the top of this post and you can see it is pretty close to this average. This is possible because the US Dollar is the reserve currency so there is an artificial demand for it meaning the US can print as much as they want and do not have to care about deficits…this is why China and Russia are attacking US Dollar demand. Both Europe and Japan can do this type of monetary policy too because they export a lot of goods meaning other nations buy Euro’s and Yen for trade…creating demand for those currencies which warrants printing.
To put this number into perspective, the stock market cap for Goldman Sachs is 79 billion, for JP Morgan it is 407.7 billion and for Wells Fargo it is 228.3 billion.
Once again, I have mentioned how this will be indefinite. It seems like something has broken and the Fed may be losing control of the system. They will throw as much money as they have to in order to keep this propped up. Balance sheets are expanding. They have pretty much erased all the progress from Quantitative Tightening for 3-4 years in less than 3 months with this repo madness.
Central banks are stuck, and it is all about maintaining confidence in the system. They have to appear as if they know what they are doing and everything is okay.
At this blog, I have been warning about this confidence crisis. I believe we are very close.
Right now the market believes the Fed. The Fed is making it appear as if they are pausing on their interest rate cuts. However, I believe they will cut in December/January.
Once this cut happens, people will begin to realize the game. Also, the Fed is running out of excuses. They have to maintain this cutting rates in a strong economy narrative by using geopolitical factors. In the end they are cutting rates mainly for three reasons 1) they know a recession is coming, 2) as a way for government and the public to service their debt loads which are increasing, and 3) perhaps the most important, to attempt to weaken the US Dollar (although I have outlined through my work why the Dollar will likely go higher and how this is what will cause problems for the Fed…perhaps lead to another Plaza accord type deal). The problems in the world get worse as the US Dollar gets stronger.
So again everyone, not a dull time to be alive. Repo madness continues and it shows no sign of stopping.