Choking on Liquidity
The New York Fed Market Data Dashboard shows $1.283 trillion in reverse repos.
At Wednesday’s FOMC meeting the the Fed announced that a “moderation in the pace of asset purchases may soon be warranted“.
Soon be warranted? How about many months ago?
Better yet, why is there a Fed?
As Fed continues its monetary QE (asset purchases) to the tune of $120 billion a month, it has conducted Reverse Repos (asset sales) to the tune of $1.28 trillion.
It get even more amusing as the New York Fed just doubled the amount of cash eligible parties can send back to the Fed.
The Federal Open Market Committee directed the Open Market Trading Desk at the Federal Reserve Bank of New York to conduct overnight reverse repurchase agreement (ON RRP) operations with a per-counterparty limit of $160 billion per day, effective September 23, 2021. The increase in the per-counterparty limit from the current level of $80 billion per day helps ensure that the ON RRP facility continues to support effective policy implementation.
Not only that but Wolf Street noted the number of eligible counterparties increased as well.
- At the end of June, the Fed had already approved 74 counterparties. Now there are 128 approved counterparties.
- Fidelity has 11 money market funds on the list of approved RRP counterparties.
The amount of reverse repos is guaranteed to soar.
The Fed does not list daily participation but here are the reverse repo numbers as of the end of August.
- Fidelity: $267 billion
- Vanguard: $102 billion
- Blackrock: $92 billion
- Morgan Stanley: $86 billion
- Federated: $85 billion
Were it not for Reverse Repos, overnight rates would be negative. Simply put, the system is choking on liquidity that the money market funds don’t want and cannot use.
Balance Sheet Reduction In Progress With a Twist
The Fed has mopped up $1.283 trillion in reverse repos. That not just tapering but an effective balance sheet reduction.
$1.283 Trillion / $120 Billion in QE Per Month = 10.69 Months.
The Fed has effectively undid nearly 11 months of QE! And that pace of unwinding will accelerate because the Fed doubled the eligible amount and increased the number of eligible parties.
However, reverse repos are not precisely the same as balance sheet reduction. The Fed accumulated longer term securities, suppressing rates on mortgages, while ridding itself of shorter term securities.
Rate Hikes? When?
Fade This Consensus
The FOMC meeting on Wednesday provided some real humor. The meeting participants believe the Fed will hike in 2022 then accelerate the rate of hikes through 2024.
For discussion, please see Fed Anticipates Rate Hikes in 2022 and 2023 – Fade This Consensus
Hells bells, the Fed cannot even taper properly and participants believe the Fed is going to get in all those hikes.
Heck, I bet there is another recession before 2024.
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One firm sells securities to a second institution and agrees to purchase back those assets for a higher price by a certain date, typically overnight. The contract those two parties draw up is known as a repo. Essentially, it’s a short-term collateralized loan. And just as most loans come with an interest payment, you can think of the difference between the original price and the second, higher price, as the “interest” paid on that loan. It’s also known as “the repo rate.”
A second complication is that the Fed does not mark its assets to market. Every increase in market interest rates drives down the market value of its Treasury and MBS holdings and will require the Fed to sell more and more of the book value of its portfolio to lower the monetary base by a given amount. Selling assets at their lower market value would deplete both the value of the Feds asset holdings and its earnings. The Fed carries its holdings of MBSs on its books as being worth $1.68 trillion, the price at which they were purchased. But since mortgage rates have risen by an average of 40 basis points since the MBSs were purchased, those same MBSs would now sell for only some $1.52 trillion. The same principle applies to Treasury bonds and notes that were bought for $2.3 trillion but would today sell for only some $2.15 trillion. Their market devaluation will increase in proportion to rising interest rates.
To avoid these losses, the Fed can hold its Treasuries and MBSs to maturity. But the long maturity of the Fed’s portfolio means that as interest rates rise and the Fed is forced to pay banks higher interest rates on reserves to prevent them from expanding lending and the money supply, its earnings on the bonds it holds will not grow. As a result, Fed profits will fall as interest rates rise.
In both 2014 and 2015, the Fed earned large profits on its portfolio and transferred earnings of almost $100 billion each year to the Treasury. In both years those earnings covered an astonishing 40 percent of the total cost of servicing the entire federal debt. The transfer of earnings from the Fed to the Treasury in 2017 fell to $80 billion, which funded only 30 percent of the Treasury’s debt servicing costs. In 2018 Fed earnings were sharply lower at $65.4 billion. Fed earnings continue to drop sharply. The decline in the payment of Fed earnings to the Treasury will drive up the federal budget deficit and Treasury borrowing and in turn put upward pressure on interest rates. Once the public understands that the Fed is paying banks not to lend during a time of rising interest rates, a political blowback seems inevitable.”
Oops! I know they can’t.
That sounds like Operation Twist to me. Is there a difference between that and Reverse Repos?
banks (table 2). Net interest income decreased slightly for credit card banks from 2018 to 2019 because of both lower interest income and higher interest expense. At the same time, credit card banks slightly decreased their provisions for loan losses. Delinquency rates and charge-off rates for credit card loans across all banks increased modestly in 2019 but remained below their historical averages.