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Down the Rabbit Hole in Reverse Repos, What is the Fed Doing?

The Fed just unwound over 8 months of QE. What's going on?
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Reverse Repos Approach $1 Trillion 2021-06-30

Repo Q&A

Repos are a cash injection by the Fed to banks. The Fed gives cash to banks in return for collateral, typically short-term treasuries. The Fed's QE program is accomplished by outright purchases (but that is effectively the same a short term repos continually applied).

Reverse repos are the opposite. It's a cash drain from banks. Thus, the Fed has unwound nearly $1 trillion of its QE program.

June 16, FOMC Meeting

Recall that the Fed met on June 15-16, holding interest rates at 0-0.25 and reiterated its QE program would continue. 

See Fed Will Continue QE Purchases in Search of Higher Inflation for more details including these three points.

  • With inflation having run persistently below this longer-run goal, the Committee will aim to achieve inflation moderately above 2 percent for some time so that inflation averages 2 percent over time and longer‑term inflation expectations remain well anchored at 2 percent
  • In addition, the Federal Reserve will continue to increase its holdings of Treasury securities by at least $80 billion per month and of agency mortgage‑backed securities by at least $40 billion per month until substantial further progress has been made toward the Committee's maximum employment and price stability goals.
  • These asset purchases help foster smooth market functioning and accommodative financial conditions, thereby supporting the flow of credit to households and businesses.

Smooth Functioning!?

The Fed has been pumping $120 billion a month into banks and has now taken back 8.27 months of QE.

Nonetheless, New York Fed President John Williams said that the reverse repo system “was working really well,” and that there were “really, no concerns about that. We expected that to happen. It’s working exactly as designed."

Banks are So Stuffed With Cash They Tell Companies: No More Deposits

On June 10, I commented Banks are So Stuffed With Cash They Tell Companies: No More Deposits

Some banks, awash in deposits, are encouraging corporate clients to spend the cash on their businesses or move it elsewhere. It's a strange case of "No More Cash Please".

“Raising capital against deposits and/or turning away deposits are unnatural actions for banks and cannot be good for the system in the long run,” Jennifer Piepszak, then-CFO of JPMorgan Chase & Co., said on a call with analysts in April.

In recent months, banks including BNY Mellon have focused on moving clients from deposits into money-market funds. The money-market funds, in turn, need new places to park all that new cash and earn some interest. But rock-bottom interest rates have pushed them into storing it back at the Federal Reserve overnight, in a facility that pays them zero return and had been largely ignored for the past three years

Synopsis 

No one wants the cash but the Fed keeps cramming it down their throats. And despite a red hot housing market, $40 billion of the monthly $120 billion cram is agency (housing) related. 

To top it off, at the June FOMC meeting the Fed increased the amount it pays banks on reverse repos from 0.0% to 0.05%. It also hikes the amount it pays on excess reserves to 0.15% from 0.10%.

Those actions were all but guaranteed to increase demand for Reverse Repos. 

Working Really Well?!

Allegedly, this seemingly ridiculous process is allegedly:

  1. working really well
  2. as expected with no concerns
  3. exactly as designed 
  4. thereby supporting the flow of credit to households and businesses

Down the Rabbit Hole

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Can you come up with any rational thesis to support those statements? 

I can, by tossing a single point, and that would be point #4, a blatant lie.

Jim Dandy to the Rescue

Recall that after the meeting various Fed governors discussed tapering, that is reducing its QE asset purchases. 

In response to taper talk, the market started to tank and Fed Chair Jerome Powell and NY Fed President John Williams came to the rescue. They both reiterated support for asset purchases and the market did a sudden reversal overnight.

It was a case of Jim Dandy (Fed Presidents) Halt a Taper Tantrum and Coordinate a Stock Market Rescue. Click on the link for an excellent musical video.

Working Marvelously!

The Fed's trial taper talk balloon fell flat but reverse repos are working marvelously!

Without getting the market upset with taper talk, the Fed just took back the last 8.27 months of QE!

If that was the Fed's goal, Reverse Repos are indeed "working really well", "as designed", and "as expected". 

Lies, Hopeful Bluff, or a Plan?

Other than Powell's statement, it all fits the picture even if Williams was making it up. Was it a big set of lies or a confidence game bluff by Williams with a lucky result, or was this the fallback taper plan all along? 

I am fond of asking the question: Are these people really that stupid or is something else going on? Fans of "something else" have a possible explanation. Occam's Razor believers may vote for door number one with a lucky twist. 

Regardless, given that the Fed wants and needs asset bubbles to continue, it's a marvelous result for the Fed, huge tapering with no consequences (yet anyway).

That only leaves Powell's statement "thereby supporting the flow of credit to households and businesses" to deal with. And that's a clear, purposeful lie.

For further discussion of bank lending, please see Charts That Should Scare the Pants Off the Fed (And Probably Do)

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