Saturday , June 6 2020
Home / Acting Man / The Impulses of Lunar Fed Policy Under Repo Madness

The Impulses of Lunar Fed Policy Under Repo Madness

Summary:
Trepidation Nation This week, while you were busy working, Jamie Dimon, CEO of JP Morgan Chase, took time out from rubbing elbows with fellow movers and shakers at the World Economic Forum in Davos, Switzerland, to share his trepidations: “The only thing I have trepidation about is negative interest rates, QE, and the diversion between stock prices and bond prices and yield and stuff like that…  I think it’s very hard for central banks to forever make up for bad policy elsewhere, that puts them in a trap.  We’re a little bit in that trap today with rates so low around the world.” Jamie Dimon having nightmares in his money bunker [PT] Fair enough.  Though Dimon, in what we presume was an inadvertent omission, failed to share that his

Topics:
MN Gordon considers the following as important: , ,

This could be interesting, too:

Alicia García-Herrero and Elina Ribakova writes COVID-19’s reality shock for external-funding dependent emerging economies

P. T. writes Investing in the Post-Corona World

P. T. writes Rate Cutters Unanimous

P. T. writes The Corona Virus Epidemic – Going Global

 

Trepidation Nation

This week, while you were busy working, Jamie Dimon, CEO of JP Morgan Chase, took time out from rubbing elbows with fellow movers and shakers at the World Economic Forum in Davos, Switzerland, to share his trepidations:

“The only thing I have trepidation about is negative interest rates, QE, and the diversion between stock prices and bond prices and yield and stuff like that…  I think it’s very hard for central banks to forever make up for bad policy elsewhere, that puts them in a trap.  We’re a little bit in that trap today with rates so low around the world.”

Jamie Dimon having nightmares in his money bunker [PT]

Fair enough.  Though Dimon, in what we presume was an inadvertent omission, failed to share that his firm may have recently walked the Federal Reserve into an elaborate policy trap. Now the Fed is stuck. JP Morgan has thrown away the keys. And Dimon has reaped a significant windfall.

If you recall, between Monday night and Tuesday morning September 16/17 the overnight repurchase agreement (repo) rate hit 10 percent.  Short-term liquidity markets essentially broke.  The Fed had to intervene in the repo market, via overnight repo operations, to push the repo rate back below 2 percent.

Since then, overnight repo operations by the Fed have become a near daily occurrence.  What is more, these daily operations have ballooned to the order of up to $120 billion and are being maintained indefinitely.

Outstanding Fed repos – from a peak of $255 billion at the turn of the year they have now decreased to $189 billion – which still dwarfs anything seen during the 2008 crisis. [PT]

On Tuesday, for example, the Fed created $90.8 billion out of thin air.  Of this, $58.6 billion was added to the overnight repo. The remaining $32.2 billion was added to the 14-day repo.  Then, on Thursday, the Fed created another $74.2 billion out of thin air.  Of this, $44.15 billion was added to the overnight repo, and the remaining $30 billion was added to the 14-day repo.

Mere Coincidence?

What exactly triggered the September 16/17 repo rate spike is unclear.  Did a large bank or hedge fund not have sufficient high quality collateral, which then froze them out of the repo market?

One theory is that JP Morgan had a hand in it. Here CCN shares the abstract thinking of DataDash founder Nicholas Merten:

“According to Merten, JP Morgan ‘predominantly caused’ the repo market surge in September. The financial giant pulled out $130 billion from the overnight lending market. The sudden drop in reserves drove the overnight lending rate to soar to 10 percent.

“At this point, the Fed had a choice.  They could have stay away from the repo market and watch interest rates skyrocket while stocks crash.  Or they could step in, supply liquidity and keep things humming.  We know how it panned out.

“JP Morgan wins twice in this situation.  First, they have the liquidity to initiate a large buyback scheme.  While pumping shares, they could dole out handsome dividends to attract more investors.  The result is a surge in stock price.

“Second, the bank [JP Morgan] forced the central bank [the Fed] to fund hedge funds and keep their over-leveraged positions open.  As long as these hedge funds have access to liquidity, the extended bull market will likely continue.  In other words, the Fed (through hedge funds) is helping drive up the price of JP Morgan (NYSE:JPM) shares.

“Since September, JPM’s stock price has gone from $107.32 to 136.84, a gain of over 27 percent.  That number is nearly twice of what the S&P 500 gained in the same time period.”

Indeed, JPM has outperformed the SPX handily since last September – we suspect that this trend was driven to some extent by the steepening yield curve in recent months. [PT]

Was this mere coincidence?  Was this an elaborate trap?  We’ll let you decide. Regardless, the Fed’s now trapped… and there is no safe way out.  Here is why…

The Impulses of Lunar Fed Policy Under Repo Madness

The Fed, through its repo madness program, has supplied financial markets – including big banks like JP Morgan – with mass liquidity.  But that is not all.  The Fed has also supplied financial markets with a highly tenuous assumption:

The Fed will never allow the lack of liquidity of a major debtor to become an insolvency crisis that contracts the money supply. This assumption, without question, will be proven false at the worst possible time.

The repo market, as we understand it, is where big banks and hedge funds conduct countless interlocking transactions, totaling as much as $3 trillion in debt being financed each and every day.  However, the repo market’s massive size and complex web of lending agreements makes it inherently fragile.  Everything works just great… until suddenly something breaks.

All it takes is the failure of a big bank or hedge fund to meet its commitments and the whole complex web of agreements comes undone.  In short, a liquidity crisis could quickly contract credit with far-reaching implications.  Namely, rapid deflation.

Thus, to counteract the prospect of a liquidity crisis and deflationary credit crisis the Fed must inflate the money supply.  But it cannot inflate too fast.  And it cannot inflate too slow. Like piloting a lunar module, the Fed must throttle and thrust the money supply just right.

The expansion of the US money supply has certainly accelerated rather noticeably since last September… [PT]

For example, as noted above, on Thursday the Fed spread $74.2 billion between the overnight repo and the 14-day repo.  But get this… net liquidity declined.  Because of past operations expiring, outstanding short-term Fed liquidity injections fell by $10 billion.

The lunar policy module in mid-flight [PT]

How long will it take before the Fed makes a mistake, and repo rates shoot to the moon followed by a deflationary credit crisis? More than likely, the Fed will err on the side of supplying excess liquidity.  But if the Fed overcompensates, consumer prices could quickly hyperinflate out of orbit.

Such are the impulses of lunar Fed policy under repo madness.

Charts by stockcharts, St. Louis Fed

Chart annotations and image captions by PT

MN Gordon is President and Founder of Direct Expressions LLC, an independent publishing company. He is the Editorial Director and Publisher of the Economic Prism – an E-Newsletter that tries to bring clarity to the muddy waters of economic policy and discusses interesting investment opportunities.

 

 

Emigrate While You Can... Learn More

 


 

The Impulses of Lunar Fed Policy Under Repo Madness 
 

Dear Readers!

You may have noticed that our so-called “semiannual” funding drive, which started sometime in the summer if memory serves, has seamlessly segued into the winter. In fact, the year is almost over! We assure you this is not merely evidence of our chutzpa; rather, it is indicative of the fact that ad income still needs to be supplemented in order to support upkeep of the site. Naturally, the traditional benefits that can be spontaneously triggered by donations to this site remain operative regardless of the season - ranging from a boost to general well-being/happiness (inter alia featuring improved sleep & appetite), children including you in their songs, up to the likely allotment of privileges in the afterlife, etc., etc., but the Christmas season is probably an especially propitious time to cross our palms with silver. A special thank you to all readers who have already chipped in, your generosity is greatly appreciated. Regardless of that, we are honored by everybody's readership and hope we have managed to add a little value to your life.

   

Bitcoin address: 12vB2LeWQNjWh59tyfWw23ySqJ9kTfJifA

     
About MN Gordon
MN Gordon
MN Gordon is President and Founder of Direct Expressions LLC, an independent publishing company. He’s the Editorial Director and Publisher of the Economic Prism – an E-Newsletter that brings clarity to the muddy waters of economic policy and targets investment opportunities for acquiring considerable wealth. The Economic Prism is written peering through a prism of free market principles, limited government, and individual liberty.

Leave a Reply

Your email address will not be published. Required fields are marked *