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Money Markets are the New Suspenders
The Financial Times recently reported on the Fed’s latest exit strategy to eventually contain the inflation zombie:
During the crisis, the Fed created roughly $800bn of additional bank reserves to finance asset purchases and loans. This total is likely to rise in the coming months as the central bank completes its asset purchases and the Treasury unwinds financing it provided to the Fed. Fed officials think they could raise interest rates even with this excess supply of reserves by offering to pay banks to deposit their surplus funds with it rather than lend them out. However, they also want to use reverse repos in tandem to soak up some of the excess reserves. Policymakers call this a “belt and braces approach”. [The latter, clearly a nod to the great Gekko.]
TD touched on this last Thursday, and we will expand upon it here as it is particularly relevant to our ongoing theory that it is the proceeds from permanent open market operations (POMOs) and their close cousins that are driving equities. Though this may be received wisdom to ZH readers, the Fed has done us the favor of providing additional evidence through the FT story. A bit of background, as we are new contributors to this forum:
Money Supply: Based on our previous research on the effects of swings in M2 non-seasonally adjusted money supply (M2) on the stock market, we were a bit surprised in July 09 by the resiliency of the rally, which continued in the face of such a dramatic contraction in M2. The dismal Durable Goods report from last Friday confirms that the capital goods sector is still under significant pressure as a result of a lack of money in the general economy. With banks not lending to normal businesses and consumer credit contracting equally as violently, what is the basis for this rally and from where does the never-ending flow of equities juice flow?
Bank Non-Borrowed Excess Reserves: The Fed statistic that most closely correlates with the 2009 equities run-up appears to be bank non-borrowed excess reserves (bank NBER), which is a component of the monetary base (M0). As explained by the Fed, bank NBER is simply total bank excess reserves minus bank borrowed excess reserves (bank BER). This resulted in bank NBER going negative throughout much of 2008 because banks acquired most of their excess reserves through participation in Fed lending programs. As the Fed has wound down these programs in 2009, bank BER has steadily declined and has been a drag on M0. Concurrently, though, bank NBER has advanced since late March 09 with only one brief material pause in June, and reflects those excess reserves that need not be repaid as part of any Fed lending program. The Fed purchases of MBS, Agency and Treasury securities netted $990 billion trillion since March 09. The distinction between borrowed and non-borrowed excess reserves is critical because the latter would be ideally suited for leveraging and lending out to hedge funds and the like to “invest” in the high beta stocks that have led the rally.
The primary conclusion is simple—the stock juice flows from steadily increasing Bank NBER, which is hidden to even astute observers that focus on only M0 or M2. Though we previously found no historical correlation between M0 (or its constituent components) and the stock market, we have witnessed an historically unprecedented set of circumstances. Now that the Fed has become the world’s largest hedge fund, we are prepared to accept unorthodox conclusions.
So why not inflate both equities and the general economy simultaneously? It was most likely a race against time. The administration and Fed needed to replace the incredible evaporation of wealth that occurred in late 2008/early 2009 to quell the voting and investing masses. They could not reflate the entire economy this quickly without jeopardizing their ability to borrow cheaply and restart the housing bubble. To keep long term yields low, they reflated the stock market only, with the hope that the general economy would eventually catch up in 2010 and be able to sustain the stock market gains. The problem with rising yields has not been solved, but was postponed.
As we noted in previous research, we are toward the end of a seasonal drain on M2. Once over the October hump, it should be easier for the holiday season to carry the market into March 2010, especially with the help of another $634 834 billion in MBS and Agency POMO into next March (not to mention the possible Treasury SFP wind-down effect to the tune of $114 to 185 billion). The Fed must be perfect, however, as any new panic will quickly feed on itself and likely lead to another mass exodus from equities. This is quite simply because currently, there is absolutely nothing else to back up this rally in the general economy if the Fed funny money cannot do its trick.
Back to Money Market Funds: If bank NBER is materially tied up in equities, then the Fed cannot drain from this source to mitigate inflation, or it risks the resulting cascade of sell orders that accompany the typical panic. According to the FT article:
The obvious counterparties for reverse repo deals are the Wall Street primary dealers. However, the Fed thinks they would only have balance sheet capacity to refinance about $100bn of assets. By contrast, the money-market funds have $2,500bn in assets, which means they could plausibly refinance as much as $500bn in Fed assets. Officials think there would be appetite on the part of the funds, which are under pressure [at gunpoint] from regulators and investors to stick to low-risk liquid investments.
The Fed Helps Build Our Case: As of September 17 09, bank NBER had increased by $563 billion since the March 09 rally began. With M2 net flat during this period, the $563 billion has not made its way into the general economy by any stretch. Perhaps it is sitting idle; however, the Fed says only $100 billion would be available from primary dealers in the future? As the vast bulk of bank NBER is concentrated in primary dealers, this begs the obvious question of what will be tying up the remaining $463 billion (and we are not including the expected increases in bank NBER into next March, which could double this amount)? Given a conservative lending leverage ratio of 10 to 1, there is potentially $4.63 trillion already sloshing around. Even if we are much more conservative, given the roughly $2 trillion increase in the US stock market since March 09, it is not only easily conceivable, but probable, that a substantial portion was courtesy of the Fed ATM machine.
As Gekko closed his famous speech in Wall Street, “Greed - you mark my words - will save Teldar, and that other malfunctioning corporation, the U.S.A.” While we have focused here only on coercive greed, it will be interesting nonetheless to see how this works out.
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Update Sep 29 09 1:39 pm EDT: Corrected "trillion" to "billion" and "834" to "634". Both marked.
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I believe Fed has said that the excess deposits are levered to fund all of its rescue programs, such as QE and MBS purchases.
In that case the excess reserves would indeed be another proxy for those bailout programs but at the same time, but it could also be a subpar indicator since the Fed can change its leverage at will.
So the excess deposits measure the capacity for the liquidity injections, while the tracking of those injections would tell you how much money is actually going into the "market". But in the end I would have to think that capacity is the main factor here. As long as everyone realizes that the Fed can keep doing what theyre doing they wil lmost likely stay out of the way.
Andrew Jackson is spinning in his freaking grave right about now....
I think he has been ever since he was featured on the $20 bill issued by our latest central bank.
10 to 1 is an old figure. The real truth is these are already loaned out and owed by the system. There hasn't been a real reserve requirement for over 10 years and the real bank problem is capital.
+1
Don't get me wrong, I agree the Fed has hired Primaries to gun the SPY at opportune times, but I doubt the money stayed in the market. Then where has $700 billion gone if it can't be called back to reduce liquidity? My guess is they are using it over at Fannie, Freddie and the Home Loan Banks to keep the lights on. And if it isn't already LOST, they will use it when the official quant easing concludes. That liquidity is never coming back, it's lost home equity. As for the money markets, they want that all on the banks balance sheet so it's easier to "use". All they have to do is a pass a law making it unprofitable to operate a money market fund. Easy.
Has anyone noticed the proliferation of anti precious metals articles and commentary rolling out across all the previously pro precious metals sites these days? It reminds me of the Crameresque nature of stock, markets and financial media articles and the mean-spirited turn in bobble-head rhetoric in mainstream media outlets after 9/11.
All or mostly nonsensical, uneducated and/or ad hominen attacks or commentary. The only thing wrong with the dollar is that it is missing an 'L' somewhere in the ubiquitous "In God We Trust" ... that is all and Nixon took it out for war.
10 to 1 try 30+ to 1, blew-up last year will blow-up again.
As for greed "just one more hit and I will be fine."
I can see Gecko now jogging on his treadmill while chain smoking and drinking Scotch-believe I will be draining my MM's today :)
So, SPY's going to stay elevated when oil, commodities and
China get flattened? I don't think so:)
Excellent analysis. Now we know why both Treasuries and Stocks are going up - banks are directly channeling the Fed money-out-of-thin-air into both markets - and which is why as I said earlier - BOTH are WRONG.
Agreed. Ben has pumped both stocks and
bonds but now realizes what little
recovery he has engendered looks unsustainable.
Hope he doesn't kick his dog.
Given that the Market Capitalization of Spy is a mere $90 billion, it's easy to see how a handful of primary lenders and vampire squids have the means to influence, if not downright control the equities market.
Wonderful. Thank you. It helps to answer the question of how the Fed can conjure up $800b for the PD’s and 6 mos. later they can’t come back with >$100b. Do I have this right? NBER is in shares, BER is on deposit at the Fed and MM’s are in Corporates & muni’s? Is that the new normal asset allocation?
No matter how Fed would like to exit they must drain the juice from somebody. Ergo, street Fight: PD’s vs. MM’s. I think a betting man would back the PD’s. They’ve had their way with the Fed to now. And the alternative is …?
Bravo, +1
WhatdidIread - MMF 2.2 trillion in assets - ripe for the pickens !!
the fed is the world's new biggest UNhedgeDfund
yes. UFB
in order to transfer Treasury dollars to Wall Street
I can't believe the pitchforks aren't flying yet
Well, it's a good thing you didn't say that the Money Markets were the new jock strap, whew, boy what a picture that woulda been!
Long John Silver away!
Not that a double D bra strap would have been any more appropriate!
Eh, RoboT?
Woo, woo, donuts, woo, woo!
lol...the Fed doesn't provide that kind of fodder.
Time to buy SPY calls with reckless abandon.
.
This works until everything that's meaningful exists only locally. Contraction in nominal terms, and contraction in trust/supply chain terms are two very very different things.
.
I don't mean to be negaitve so late at night, but housing is the killer here. It is not part of this puzzle and is leaking like an untarred kayak. Without addressing this the Federal Leviathan is going to choke on its own spit regardless of the 'liquidity' of NBER to HF and then to the SPY at 5AM.
Good work for tracking this down and sharing it.
Dear Tyler Durden,
I enjoy reading your website and the comments section very much. Recently, I've been experiencing pages failing to load due to being stopped by non responsive website referances from within your pages to domains outside of zerohedge.com
I know these are you advertisers and whatnot, but ideally, a website should centralize as much content as possible upon it's own reliable servers.
I was not able to load and read quite a few pages on your website due to poorly maintained outside websites.
Very frustrating!
That aside, I thank you for a fine web experience.
ditto & a can of chips
Does this not beg the question of how much 'cash' is available in the money market funds?
As you all know the MMFs are used to underpin the commercial paper and other short term markets to a large extent.
The same crowding out you reference in the primary dealers, with a potential effect on equities, would also occur in any other market in which the Fed undertook draining operations in size.
Granted, there *might* be excess liquidity in the MMFs. Personally I think the Fed is responding to concerns from the banks who are already aggravated by the relative regulatory freedom which the MMF's enjoy, that they would have to take the brunt of the draining, with the MMFs getting a 'free ride' to pursue more lucrative arrangements and draw deposits from the banks.
Volcker also referenced the MMFs in his recent talk, and the need to bring them under the Fed umbrella.
So, we can speculate but it does seem that the motivations might not be obvious, or at least multifaceted.
Thanks, the Volcker comment on MMF's is relevant. He is not as much of an insider as Geithner or Summers, but the direction is clear: the Fed will be participating more in the money markets.
nice work...
This works until what?
Until the insiders can sell their stock and pay off their yachts, and then the market can safely be allowed to respond to gravity?
Obviously 990 Billion.
Congress hasn't authorized 990 Trillion yet. That comes next year.
This is insanity. Do you know how many Puts I have?! Fuck.
"The Fed purchases of MBS, Agency and Treasury securities netted $990 trillion since March 09."
Trillion or billion?
Thanks, should be "billion". Was looking too far ahead.
+1
Excellent post. Thank you.
"Fed officials think they could raise interest rates
even with this excess supply of reserves by offering to pay banks to deposit their surplus funds with it rather than lend them out."
The post admits no economic growth here, only zombie derivative banks facing Gresham's Law with $3.5 T in life saving MMFs that isn't going anywhere, certainly not into Bailouts, Binds, Equities or RE.
"Once over the October hump" may be quite an assumption.
Meanwhile, the world's largest hedge fund appears to
be counting on financial angels on the head of a pin.
Maybe the next ZH poll might be,
'How many think the Fed is going for broke?'
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