Open Market Operations
Much attention has fallen on the Fed's recent announcement that a new fixed-rate, full-allotment overnight reverse repo facility is in the works (so much so that both shadow banking experts Singh and Stella have opined on the issue). It appears that despite the Fed's "best efforts" at communication, not enough clarity has been shed on the topic. So here is Bill Dudley's explanation.
Current US Treasury issuance is relatively low due to sequestration and (at least temporarily) less US warmongering in the Middle East. That's about to change, of course, now that the US is getting ready to launch a Cruise missile attack on Syria (we’re already been arming and financing the opposition rebels, including groups directly linked to al-Qaeda for several years now). Bernanke and the Fed doves would like nothing better than another “controlled” war in the Mideast, because with war comes massive debt issuance, and with massive debt issuance comes the transmission mechanism (QE) for monetizing that debt and mainlining it onto the Wall Street banks' broken balance sheets. And yes, they’re still broken, and Ben is still bailing them out at the expense of the American middle class. Make no mistake, Jamie Dimon, Lloyd Blankfein, and every other complicit banker on the Street has no problem with this, or any other, war, regardless of whether such a conflict would destabilize the entire region and would almost assuredly pull Russia and China into the fray. The more the merrier, just keep letting that free QE monopoly money roll in from the 4X weekly Federal Reserve Permanent Open Market Operations (POMO’s). And with the significant financing needs for a large war effort in the Middle East, say good-bye to “Taper.”
This is our first out of four series where we look at all the various bail-out schemes concocted by Eurocrats.
Today we look at how the ECB has evolved since 2007. In the next three posts we will look at the Target2 system, various fiscal transfer mechanisms and last, but not least the emergence of a full banking union.
Much has been said about the recently announced (with the release of the Fed's July Minutes) proposal for a full-allotment overnight reverse repo facility, some of it confused, some of it desperate to read deeply into what the Fed is suggesting with this superficially tightening process, and most of it just plain wrong. What the Fed is simply trying to do with the O/N RRP, in a few words, is alleviate collateral pressures for "high-quality assets" - the same thing that the TBAC has been whining about for the past 2 quarters - by making available an elastic supply of risk-free assets to a fairly broad set of investors. As BofA adds, "The full-allotment feature would mean that eligible investors could effectively place as much cash as they wished at a fixed rate, which would be determined in advance by the Fed." In brief, a Fed O/N RRP facility would substantially reduce or even eliminate concerns about the lack of high quality liquid assets.
"What just occurred [in the mortgage-backed-securities (MBS) market] is indicative of just how important QE is," as government backed US mortgage bonds suffer their largest quarterly decline in almost two decades. As Bloomberg reports, the $5 trillion market lost 2% in Q2, the most since the 'bond market massacre' in 1994 (when the Fed unexpectedly raised rates) as wholesale mortgage rates spiked by the most on record in the last two months. The reason these bonds have been hardest hit - simple - fear that the Fed's buying program is moving closer to an end. "The Fed, at times during this period, was the only outlet in terms of demand for securities," explains one head-trader, as the Fed’s current buying provided demand as other investors retreated and has grown as a percentage of forward sales by originators tied to new issuance, which is set to fall as higher rates reduce refinancing. With Fed heads talking back what Bernanke hinted at, there was a modest recovery in the last 2 days in MBS but the potential vicious cycle remains a fear especially now that “what was once deemed QE Infinity is no longer viewed that way."
At the end of the day, Friedman jettisoned the gold standard for a remarkable statist reason. Just as Keynes had been, he was afflicted with the economist’s ambition to prescribe the route to higher national income and prosperity and the intervention tools and recipes that would deliver it. The only difference was that Keynes was originally and primarily a fiscalist, whereas Friedman had seized upon open market operations by the central bank as the route to optimum aggregate demand and national income. The greatest untoward consequence of the closet statism implicit in Friedman’s monetary theories, however, is that it put him squarely in opposition to the vision of the Fed’s founders. As has been seen, Carter Glass and Professor Willis assigned to the Federal Reserve System the humble mission of passively liquefying the good collateral of commercial banks when they presented it. Consequently, the difference between a “banker’s bank” running a discount window service and a central bank engaged in continuous open market operations was fundamental and monumental. In short, the committee of twelve wise men and women unshackled by Friedman’s plan for floating paper dollars would always find reasons to buy government debt, thereby laying the foundation for fiscal deficits without tears.
The People's Bank of China (PBOC) released an official statement addressing directly the latest liquidity conditions in the banking system and indicating that the central bank intends to maintain sufficient liquidity conditions in the interbank market. As Goldman notes, this clear communication of policy intentions is highly important to guide market expectations, avoid liquidity hoarding, and contain excessive volatility of market. While they hope this calms markets in coming days, Goldman notes that the interbank rates are likely to settle back to a level higher than before to rein in leverage growth. However, in a helpful prompt for more jawboning, the squid notes, continued communications on policy intentions and actions will be helpful to further ease market uncertainties, given the extreme volatility in recent weeks; though we note the tightening bias will remain as the new leadership appears to prefer to take their pain early (and blame previous parties) than wait.
Once again it is all about central banks, with early negative sentiment heading into Asian trading - following the disappointing announcement from the PBOC about "ample liquidity" leading to the 6th consecutive drop in the Shanghai Composite while the PenNikkeiStock index tumbled yet again - completely erased and flipped as Mario Draghi spoke, although not to explain his involvement with the latest European derivative window-dressing scandal, but to announce that he is, once again, "ready to act" (supposedly through the OMT, which despite the best hopes to the contrary, still DOES NOT OFFICIALLY EXIST) and that while it is up to government to raise growth potentials, growth would "partly come from accommodative policy." In other words, ignore all BIS warnings, for Europe's unaccountable Goldmanite overlord Mario Draghi continues to promise more morphined Koolaid (read record Goldman bonuses) to any banker that comes knocking.
Goldbugs the world over may not know it, but the one catalyst they are all waiting for, is for the PBOC to throw in the towel to Bernanke's and Kuroda's liquidity tsunami and join in the global reflation effort. Alas, those hoping the Chinese central bank would do just this on Friday were disappointed. Moments ago the 21st Century Business Herald, via MNI, reported that the People's Bank of China "decided to shelve plans to inject short-term liquidity into the market late Friday because of concerns it would be sending the wrong signal in light of the government's ongoing commitment to its "prudent" monetary policy stance. Rumors hit the market mid-afternoon about an injection in the region of CNY150 bln via the PBOC's rarely-used short-term liquidity operation (SLO) tool. But how much longer can it avoid the inevitable: what happens when overnight loan yields soar to 20% or 30% or more, and when the repo and SHIBOR markets lock up and no overnight unsecured wholesale funding is available? Because when China finally does join what is already an historic liquidity tsunami then deflation will be the last thing the world will have to worry about. In the meantime, we welcome every chance to dollar cost average lower on physical hard assets, the same hard assets that none other than 1 billion concerned Chinese will direct their attention to when inflation makes it long overdue comeback to the world's most populous country.
China continues to be stuck between an external hot money flows rock and a contracting economy and unstable banking sector hard place... Thanks to the G-0 central planners, the PBOC's hands are now tied: if it injects more hot money or lowers the interest rate the inflation on the margins, which it has so far been able to mask will spill over into the streets in a repeat of 2011, and force an even more epic scramble for inflation protection than the one seen two years ago, and which led to gold rising to just shy of $2000. Naturally, at a time when the central planners have gone all in on precipitating the Great Rotation out of bonds and into stocks at all costs, a re-exodus into gold might just end the Keynesian experiment. So the China central bank has that to contend with as well.Which means one thing: in reality Chinese credit and liquidity is in far worse shape than reported. And sure enough, over the past 24 hours we got news courtesy of Bloomberg that the "China Liquidity Squeeze Risks Companies’ Debt Rollover" leading to what may be the first harbinger of a Chinese bank failure which may subsequently lead to a whole lot of dominoes falling.
Despite the aura of control, Fed officials (and casual observers) may sense things spinning out of control. Of course, hyper-fragility is exactly the effect that all the Fed’s own actions would predictably lead to. When you divorce truth from reality, strange things are bound to happen. There is one thing that we know for sure in this strange period when bankers have tried to manage reality in the absence of truth: that advanced industrial-technological economies designed to run on $20-a-barrel oil can’t run on $100-a-barrel oil, and that is why the US economy was subject to financialization in the first place - to offset declining productive activity by an attempt to get something for nothing. The world is about to find out that you really can’t get something for nothing. It will be a harsh lesson.
This past week a near doubling of the amount to the ECB coincides with the Fed's non involvement with the direct bailout of European banks from $4,192 million to $8,343 million.
The net effect of QE4EVA is that on average, every business day in March will see the Fed effectively seed a new $4.25bn AUM investment firm whose sole goal is to buy, not sell, securities. Some of you have worked in asset management your entire careers. You know how hard it is raise assets. Out of thin air, a new $4.25bn competitor is starting up each and every business day in March, courtesy of the good folks in the Marriner-Eccles building in DC. It must be hard to sit by and watch while the Fed creates a new $4.25bn competitor every business day where the sole goal of that money is to buy simply because a Princeton academic thinks it should. The Princeton academic thinks stocks should be high, so they are. The Princeton academic thinks bond yields should be low, so they are. Period. Of course this makes a mockery of those of you who actually try to understand fundamental value, but hey, the Princeton academic gets what the Princeton academic wants. The devil take the hindmost. However, I do know that what the Fed is doing now is unsustainable and certainly unfair to those of us who actually work for a living. And what is unsustainable and unfair in the long-run does not last.
- 'London Whale' Sounded an Alarm on Risky Bets (WSJ)
- Deadly Blast Strikes U.S. Embassy in Turkey (WSJ)
- Abe Shortens List for BOJ Chief as Japan Faces Monetary Overhaul (BBG)
- Endowment Returns Fail to Keep Pace with College Spending (BBG) - More student loans
- Mexico rescue workers search for survivors after Pemex blast kills 25 (Reuters)
- Lingering Bad Debts Stifle Europe Recovery (WSJ)
- Peregrine Founder Hit With 50 Years (WSJ) - there is hope Corzine will get pardoned yet
- Deutsche Bank to Limit Immediate Bonuses to 300,000 Euros
- France's Hollande to visit Mali Saturday (Reuters)
- France, Africa face tough Sahara phase of Mali war (Reuters)
- Barclays CEO refuses bonus (Barclays)
- Edward Koch, Brash New York Mayor During 1980s Boom, Dies at 88 (BBG)
- Samsung Doubles Tablet PC Market Share Amid Apple’s Lead (BBG)
There have been very few times where in my 40+ years of capital markets participation that I’ve strongly believed that we have witnessed a significant, material, public but seemingly under-discussed, under appreciated watershed event that will over the next several years, impact capital markets in a profound manner. The recent announcement by the Fed that they were to pursue the future course of monetary policy with direct regard to a specific, numerical level of unemployment in my mind, represents exactly one of those rare events. While the optics of the recent decision to accept an active target of the unemployment rate might be well meant, socially responsible and politically correct, the dependency upon the single datum construct already of a highly controversial nature may well likely reduce further the credibility of the Federal Reserve’s monetary efforts, thereby leading to slower economic growth, hiring and economic well being as adverse unintended consequences. Indeed, another triumph of form over substance wherein appearances of a literally wondrous intent might soothe the fevered brows of the public but remain entirely within the manipulative province of the data managers.