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The little problem that is growing and nobody is talking about UPDATE 11 16 2019 READ
The United States Federal Reserve
Is the trouble in Paradise?
269934
Since the 2008 crisis, the Federal Reserve injected somewhere in the area of 5 trillion dollars into the banking systems both here and abroad to help stabilize the financial system that was spiraling out of control due to the real estate implosion. They also guaranteed another 7 trillion or so (https://michael-hudson.com/2011/06/how-a-13-trillion-cover-story-was-written/) of debt from various institutions in addition to the injection.
It’s safe to say things have calmed down a bit since then, with the markets rising to new highs and the real estate market for all intents and purposes has taking off the to the proverbial races since 2011.
That said, last week witnessed a blast from the past in an area the average Joe Blow doesn’t really understand or even know it exists, the overnight repurchase agreements (repos) market mechanism.
The repo market is the plumbing of the financial system. The banks and market funds of all types rely on this market to finance their day to day operations. Billions of dollars flow into and out of this market daily. It’s where business and investment firms of all types draw on funds to operate, while others deposit excess funds for safekeeping and possible income. The market operates funding for as short as overnight to longer terms. From CNBC : In a repo trade, Wall Street firms and banks offer U.S. Treasuries and other high-quality securities as collateral to raise cash, often overnight, to finance their trading and lending activities. The next day, borrowers repay their loans plus what is typically a nominal rate of interest and get their bonds back.
Think of it as a huge octopus taking in and handing out thousands of loans a second to all branches of business and the markets.
If demand for funds increases, the interest rates paid for accessing these loans may rise. On the contrary, if demand falls off for this type of funding, interest rates might fall.
The interest rates on repos usually run about 2.25% and the baseline is set by the Fed. The repos typically follow the Fed set rate. Last week the repo rate (which is set by demand) rose to 4% then skyrocketed to 8%. Known as liquidity, it simply means the demand for quick cash was soaring. Higher than normal rates can cause serious turmoil as the cost to institutions rise past what is budgeted and expected. 8% is regarded as extremely high to put it mildly.
As rates climbed the Fed intervened injecting close to 53 billion dollars into the repo market by purchasing Treasuries and other debt (known as agency debt) from the various institutions known as “Primary Dealers”. This is a group of 24 big banks and trading firms that have an agreement to participate in swapping debt for cash and vice versa to provide acts like a gas pedal to the overall money supply in the system. The intervention was the first one since 2008. Ominous sounding, the recent repo rate rise was called “bordering on chaos’ by a BMO Capital Markets strategist.
The Fed sold debt back to the repo dealers (an opposite move from last week’s action) over many months last year to the tune of 700 billion in an attempt to rid itself of some of its holdings which were stockpiled during the crisis. The most recent move was a reversal of this mechanism.
This spike and subsequent move by the Fed doesn’t necessarily mean the environment resembles 2008/09 liquidity crisis but it definitely doesn’t make this analyst sleep any better. Only time will tell if the recent machinations by the Fed solved the problem and it was a simple one-off temporary occurrence or a sign of something more ominous going on in the financial gearbox of the economy.
Update: On September 18th, the New York Fed printed up another $75 billion to inject into the “repo” market — on top of $53.2 billion the day before. On September 26, the Fed added another 71 billion and I can’t keep up! It is getting more interesting by the day. Who knows how much more will be added by the time you read this?
This article expresses the opinions of Marc Cuniberti and are opinions only and should not be construed or acted upon as individual investment advice. Mr. Cuniberti is an Investment Advisor Representative through Cambridge Investment Research Advisors, Inc., a Registered Investment Advisor. Marc can be contacted at SMC Wealth Management, 164 Maple St #1, Auburn, CA 95603 (530) 559-1214. SMC and Cambridge are not affiliated. His website is www.moneymanagementradio.com. California Insurance License # OL34249
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