The following is an excerpt from a recent Market Comment featured on The Felder Report PREMIUM.
Repo Man – this may be the title Jerome Powell is labeled with after what has gone on over the past month or so. Every Fed Chair is remembered for something. Volcker is remembered for breaking the back of inflation. Greenspan is remembered as a champion of deregulation and for his indecipherable speeches. Bernanke and Yellen are remembered as the Lords of QE.
The Fed recently started buying treasuries again and in massive scale all the while insisting it’s not a return to quantitative easing. I agree that this is not QE which was implemented in an attempt to lower long-term borrowing costs to spur debt creation. Because these new programs are focused at the short-end it’s hard to consider them stimulative in the same sense.
What the Fed has been doing over the past month is really what it was created to do: act as the lender of last resort. When banks are unwilling to lend to each other, the Fed should step in and unclog the pipes of the financial system.
'A sudden shortage of cash caused interest rates to spike sharply in the “repo” market, where participants such as banks, hedge funds and money-market mutual funds borrow and lend money against the collateral of securities.' https://t.co/cFgbGfCSDv
— Jesse Felder (@jessefelder) October 24, 2019
And this is really what they are doing in the repo market.
'The New York Fed had said Wednesday it was raising its minimum offerings for overnight repos to $120 billion from a minimum of $75 billion, with the next two-term repo operation increased to $45 billion from a minimum of $35 billion.' https://t.co/OV5peQlGmu
— Jesse Felder (@jessefelder) October 24, 2019
However, it’s important to point out that the trouble that the money markets now find themselves in is a direct byproduct of QE. Buying up risk-free debt has created two things. First, it created the “shadow banking” phenomenon. Investors, like pension funds and insurers and all sorts of other non-bank entities, who could no longer get decent risk-free returns were forced to get more aggressive and lend to riskier credits.
'Total lending to non-bank financial institutions (shadow banks) rose by $172bn in the past year, and now stands at $7tn.' https://t.co/yb50hCHCQz pic.twitter.com/z1H2J3LTNR
— Jesse Felder (@jessefelder) October 24, 2019
Pushing long rates lower also encouraged these riskier credits to borrow like never before.
'The record amounts of debt and unusually high leverage ratios imply that eventually there will be a bunch of defaults and a bunch of bankruptcies, as there always have been in the three debt crises that I’ve lived through in the last 30 years.' https://t.co/7MoRivvXAy
— Jesse Felder (@jessefelder) October 23, 2019
It’s certainly possible that what is bothering the money markets today is a disturbance in the “shadow banking” sector of the finance economy.
'Brian Porter, CEO of Scotiabank, is worried about the health of the so-called shadow banking sector — firms that are not banks but lend money to consumers for things like auto loans or home mortgages and aren't subject to the same regulations.' https://t.co/fL7niB57eW
— Jesse Felder (@jessefelder) October 21, 2019
We are certainly starting to see some signs of distress in the lower-rates segments of the credit markets.
The rolling 3-month ratio of leveraged loan credit rating downgrades to upgrades has just spiked to the highest level since the GFC. RM #DriehausAlts pic.twitter.com/Uos4YZBF3s
— Driehaus (@DriehausCapital) October 24, 2019
But the second byproduct of QE is a general disdain for fiscal austerity. By keeping interest rates lower for longer across the entire yield curve, the Fed has encouraged lawmakers to conclude that there is no such thing as a problematic level of debt. The bond vigilantes are dead and so the government feels free to grow the debt ad infinitum. As a result the money markets are now “starting to choke” on the supply of new treasuries.
'Plenty of factors helped cause liquidity to dry up, but one that’s getting more attention is concern that dealers are starting to choke on Treasuries as the U.S. government goes deeper into the red.' https://t.co/SgciDIcRdb
— Jesse Felder (@jessefelder) October 8, 2019
Stepping in as lender of last resort to the banking system is what the Fed was intended for. Stepping in as the lender of last resort to the Federal Government is now what the Fed is being used for.
To be sure, this is outright monetization of the debt, without any other intended purpose. This may be why the dollar has taken a dive this month. Keep a close eye on it and the long-end of the bond market. If the dollar and long bonds both begin to fall together it may mean the markets have figured this out.
